This year has ushered in a new era of uncertainty as Republicans, led by newly elected president Donald Trump threatened to turn Washington on its head, leaving Democrats, pundits and investors everywhere baffled.
Markets continued their favorable reaction to the new regime with stocks rallying throughout February, surging ahead of where the economic data may point. The second reading of Q4 GDP showed the US economy muddling along at a 1.9% SAAR, certainly below what stocks are pricing in for US growth in the years ahead.
Nearly all of the growth witnessed in the 4th quarter of 2016 came from the US consumer, and with home prices surging, auto sales peaking, student loan debt soaring and short-term interest rates on the verge of rising, one wonders how long the consumer can carry the burden of growth. Certainly we’re not seeing a well-balanced US economy, and this is perhaps giving the Fed some pause as it pursues higher interest rates.
February’s nonfarm payroll report showed a gain of +227k jobs in January, surpassing estimates for a rise of +180k. The unemployment rate in the US came in at 4.8%, up slightly from the prior month’s 4.7% reading. Average Hourly Earnings were up a modest 0.1% for the month and are now up just 2.5% YoY. Certainly the Fed would like to see some traction in this reading before embarking too aggressively on a rate tightening agenda.
PMI’s remain elevated, pointing to an economy in expansion mode. The Markit US Manufacturing PMI for January came in at 55.0, meeting expectations, while February’s report came in at 54.3, slightly below expectations. Durable Goods for January grew at +1.8% MoM, versus expectations for +1.6% growth. Industrial Production declined slightly in January while Capacity Utilization registered 75.3%, just missing estimates.
The rebound in energy prices during 2016 should put some upward pressure on prices, however January saw CPI rise just +0.3% MoM (+2.5% YoY) while prices at the wholesale level surged +0.6% MoM but just +1.6% YoY. Asset inflation remains the bigger concern as continued low interest rates drive both home and equity values higher, further skewing the wealth divide that exists in the US.
Alternative investments were strong performers in February, with all major alternative sub components posting positive returns.
Real Estate, as measured by the FTSE NAREIR All REIT Index, was the top performer, up +4.0% on the month, likely benefitting from a pull back in Treasury yields.
Gold was the next best performer, up +3.1% during the period to close at $1,248/ounce. The metal has seen a bid so far in 2017, up nearly $100/ounce, or +8.3%.
Flows into Gold are likely being driven by the high level of complacency that is visible in the market and as a hedge to above average equity valuations.
Equity market volatility remains near historic lows, while most of the S&P 500’s gains in 2016 were again due to multiple expansion, as opposed to earnings growth.
The Dollar, as measured by the DXY Index, rose +1.6% on the month, recovering some of January’s -2.6% decline. The Dollar is below its year end 2016 level of 102.21, but is still up +3.33% since the November election.
Prospects for rising interest rates, which may come as early as the March 14-15 FOMC meeting, continue to give the Dollar a bid. Politics will likely continue to impact the Dollar in 2017, either from better economic conditions in the U.S. (hopefully!) or changes to tax policy (i.e. Border Adjustment Tax), which is hard to handicap at this juncture.
Despite the Dollar’s strength in February, broad commodities, as measured by the Bloomberg Commodities Index, rose +0.2%, bolstered by strength in West Texas Intermediate (WTI) crude oil, which rallied +2.3% on the month to close at $54/barrel on the NYMEX.
From a currency standpoint, the Euro was -1.9% weaker against the Dollar in February, closing at 1.06 USD/EUR, but virtually unchanged since three months ago.
Looking ahead, economic data and inflation in the Eurozone likely support a stronger Euro in “normal” times; however, political risks with upcoming French elections, and diverging monetary policies between the European Central Bank and the Federal Reserve are likely to keep the Euro depressed versus the Dollar in the short run. Additionally, the Yen was virtually unchanged versus the Dollar during the month, but +1.5% stronger against the Dollar over the past three months.