President Donald Trump’s first 100 days have thus far proven an adventure in politics, taking away much of the limelight from the somewhat maddeningly consistent economic data that we investors have by now come to expect.
From employment and housing to manufacturing and prices, the economic data picture is one of a strong labor market, rising home values, solid industrial numbers and low inflation. Goldilocks, indeed.
The steady recovery from the depths of the recession in 2008-09 have us once again exploring the NAIRU boundary (non-accelerating inflation rate of unemployment).
February’s unemployment rate edged lower by a tick from the prior month, coming in at 4.7%, with +235k new jobs added. Average Hourly Earnings grew by +0.2% on the month and are now up +2.8% YoY.
This is an increasingly important indicator to monitor as the Fed’s quest for evidence of inflation usually starts here. The labor market remains healthy with the JOLTS data (US Job Openings by Industry Total) continuing toset new highs, a bullish sign for employment and wages.
Having hit a record high in October of 2016, the S&P CoreLogic Case-Shiller U.S. National Home Price Index continued to make ground in January, rising +5.9% from the year ago period.
Though off it’s highs of 2013, the US Home Price Affordability Index has held steady around the 165 level, with low interestratesbuoying home buying. The Markit US Manufacturing PMI came in at 54.2 in February signifying continued expansion in the industrial sector.
The preliminary Durable Goods number for February rose +1.7% MoM while Industrial Production was unchanged. Capacity Utilization held steady around 75.4% while Retail Sales edged up +0.1% MoM.
As suggested above, inflation remains elusive. Despite one interest rate hike thus far in 2017 (and hints for two more floating about), the PCE Deflator remains a modest 1.9% while Core CPI registered a +2.2% change in February and Core PPI just a +1.5% gain.
Modest pressures on prices will surely give the Fed pause before acting too swiftly, likely prolonging this current benign economic state. Neither too hot nor too cold, the economic porridge appearsto be currently just right, andlikely to stay that way for some time.
Domestic Equity U.S. Equities finished the month relatively unchanged after a strong start to the first quarter. The benchmark S&P 500 Index rose a scant +0.12% on the month, but finished the quarter up +6.07% on a total return basis.
Mid- and Small-Caps, as measured by the S&P 400 Index and S&P 600 Index, finished March in the red, posting declines of -0.39% and -0.12%, respectively. Beneficiaries of the “Trump Trade,” SMID caps rose sharply postelection, but have cooled off so far in 2017.
For the quarter, Mid- and Small-Caps posted total returns of +3.94% and +1.05%, respectively, trailing their Large-Cap counterparts by a wide margin. With valuations stretched, earnings stagnant, and hopes for both individual and corporate tax reform waning after the healthcare bill debacle, it remains to be seen what the Commander in Chief has left up his sleeve for the remainder of 2017.
Should infrastructure policies materialize and tax reform take center stage, SMID caps could once again benefit; however, much remains to be seen. From a sector standpoint, only three of eleven S&P 500 sectors finished the month in positive territory.
Technology, Consumer Discretionary, and Materials posted positive returns of +2.55%, +2.05%, and +0.48%, respectively. Technologywas the majorstandoutin the first quarter, postingstrong gains of +12.57% thanks to a +24.57% gain for Apple.
Facebook, the third largest holding in the SPDR Technology Sector ETF (ticker: XLK) was up +23.47%. Amazon, the largest holding in the Consumer Discretionary sector gained +18.23% during the quarter, propelling the Consumer Discretionary sector +8.45% on the quarter. Financials were the month’s worst performers,losing -2.77% in March,after posting strong gains post-election and through the first two months of the year.
More specifically, Banks were the worst performing industry group, with money center banks down -3.25% in March, and regional banks down -6.22%.
For the quarter, Energy was the worst performing sector, down -6.88%, as West Texas Intermediate (WTI) crude oil prices dropped and crude oil inventories continued to pile up. Specifically, Exxon Mobil and Chevron, which account for nearly 40% of the S&P 500 Energy sector, were some of the biggest decliners, down -8.30% and -7.90%, respectively on the quarter.
International Equity Major International equity markets posted strong returns during March, with Eurozone equities, as measured by the MSCI EMUIndex, leading the charge up +5.46%.
Both Developed International equities, as measured by the MSCI EAFE Index, and Emerging Markets equities, as measured by the MSCI EM Index, posted strong gains, up +2.84% and +2.54%, respectively.
At the country level returns were less than stellar. Hong Kong equities, as measured by the Hang Seng Index, and British equities, as measured by the FTSE 100 Index, posted returns of +1.69% and +1.12%, respectively. Japanese and Chinese equities were worse off,with the Nikkei 225 Index and Shanghai Composite Index off -0.47%and-0.57%,respectively.
For the quarter, International equities handily outperformed Domestic equities, reversing a longstanding trend where U.S. equities have led the pack.
Developed International and Emerging Markets equities gained +7.39%and +11.45%for the quarter, compared to +6.07% for the S&P 500. Whileitremains to be seen whether or not this trend is here to stay, there are a plethora of reasons to favor International equities moving forward.
Expectations for global growth have stabilized, inflation trends have picked up, and manufacturing PMI readings continue to accelerate. These trends, along with rising confidence indicators, suggest that earnings estimates could pick up from here. Couple that with attractive relative valuations on a forward looking basis, and International equities may continue to perform well.
From a sector standpoint, Technology was the best performing sector outside of the U.S., gaining +4.58% on the month and +14.57% on the quarter. With little disparity amongst the majority of MSCI ACWI ex U.S. sectors, the only other standout performer was the Energy sector, which lost -0.80% during the quarter. Energy was also the worst performer in the S&P 500. Looking ahead, French elections still loom as a key political risk impacting the Eurozone, while further details on the ECB’s QE program are likely to come on April 27th , which could indicate the next move in the Euro. A hawkish stance from the ECB could cause a Euro rally, which could give investors more confidence investing overseas, and add a second element to total returns.
Fixed Income The Federal Reserve raised short-term interest rates by 25 basis points at its March meeting, a move which had been widely telegraphed and fully priced in to the bond market. Chair Yellen appeared in her post-meeting presser to be setting investors up for one to two more hikes in 2017, although she reiterated her desire to move at a measured pace.
Since the Fed meeting on March 15th , the yield on the 10 year Treasury has dropped by nearly 25 basis points as continued slow global growth emboldens fixed income investors. Most bond indices finished March slightly in the red (but up nicely for the quarter) as volatility in the bond markets continued to decline. The Merrill Lynch Option Volatility Estimate is approaching levels last seen in 2014. No one knows where, what or when the next shock to the bond market will occur, however, the Fed has been increasingly vocal on the topic of paring back it’s bloated $4.5 trillion balance sheet.
This will undoubtedly take time and care as not to upset the status quo; however any missteps will likely be pronounced as overall liquidity in the markets remains challenging. In Q1, risk once again dominated, with the ML USD Emerging Market Sovereign & Credit Index surging 4.18% while the ML US High Yield Master II Index gained 2.71% and the ML Municipal High Yield Index added 2.59%. US corporates gained 1.42% as spreads tightened throughout Q1, while US tax-free bonds gained 1.39%, with continued strong demand being witnessed, despite the talk of talk cuts on the horizon.
With Japanese and Eurozone yields still broadly negative out to 5 years, demand remains strong for US debt and will likely prevent a surge in US yields should inflation pick up unexpectedly. That said, TIPS appear reasonably attractive right now with break-even inflation rates at roughly 2.0% in the 10-year area and just 2.1% out 30 years. Although we don’t anticipate a near-term surge in prices, by our lights it doesn’t appear an unreasonable bet to think inflation will merely revert to the norm of the past 50 years or so. Should that occur, investors should be far better off with inflation-adjusted bonds versus standard issue Treasuries.
Alternative Investments Alternative investments were mostly negative performers in March. West Texas Intermediate (WTI) crude oil was the group’s worst performer, down -6.3% on the month as WTI fell more than $3/barrel to close at $50.60/barrel.
For the quarter, WTI lost -5.8% as crude stock piles rose and the Baker Hughes rig count continued to increase. Many operators are able to bring crude online much quicker, and much cheaper than years before, with overall break even prices continuing to fall. Absent a true drawdown in stockpiles, or further OPEC production cuts, WTI prices are likely to remain range bound for the foreseeable future.
The drop in crude prices dragged down the broad Bloomberg Commodities Index to the tune of -2.7%, even as the Dollar, as measured by the DXY Index lost -0.8% on the month. For the quarter, the Dollar gave back most of its post-election gains, falling -1.8% to close at 100.35. Additionally, Real Estate, as measured by the FTSE NAREIT All REIT Index, lost -2.1% in March, but managed to gain+1.9%on the quarter. Gold was the quarter’s top performer, up +8.4%, after tacking on a +0.1% gain in March.
The precious metal climbed nearly $100/oz during the quarter to close at $1,249/oz on the NYMEX. Gold has gained as volatility remains subdued (a natural tail hedge) and as real interest rates have declined (thanks to rising inflation). Looking ahead, a spike in market volatility or inflation, both of which are somewhat probable, may be boons for Gold. From a currency standpoint, the Yen continued to strengthen versus the Dollar, a key barometer for both risk aversion and safety.
The Yen gained more than +1% during the month and nearly +5% during the quarter as investors continue to monitor Japanese economic data and seek safe haven assets. The Yen closed at 111.39 JPY/USD at the end of March. Similarly, both the Pound and Euro strengthened on the month and quarter as better economic data was supportive of a stronger currency. The Pound closed the month at $1.26 USD/GBP, while the Euro climbed to $1.07USD/EUR.
Lastly, Hedge Funds continued to struggle, with mixed performance in March, and significant underperformance against the S&P 500 for the quarter. The top performing Hedge Fund strategy on the year is U.S. Equity Hedge, which is up +2.68%on the year, gaining lessthan half the returnof the benchmark S&P 500 Index.