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Trade optimism drives markets higher

FEB. 25, 2019
  • Equity markets maintained their momentum, with the S&P 500 Index higher in eight of the past nine weeks, and trading at the best level since November. The S&P 500 has now rallied 19% since Christmas Eve and is less than 5% below the all-time high. Momentum indicators suggests stocks are now very overbought, but historically that has not resulted in a sharp decline, rather a pause to consolidate the gains.
  • President Trump promised to delay the March 1 deadline in trade negotiations, citing “substantial progress” on structural issues, including intellectual property protection, agriculture, currency manipulation and others. Assuming the momentum continues, he will hold a summit with President Xi at Mar-a-Lago to formalize the agreement. While talks are clearly trending the right direction, there are reports that substantial disagreements remain, and it would be premature to celebrate too early.
  • Recent economic releases have missed expectations both domestically and abroad, leading to revised outlooks for the global economy. In the U.S., the shockingly poor reading on retail sales two weeks ago led to weak readings on existing home sales, Philly Fed, durable goods, manufacturing PMI and leading indicators last week. The release of fourth quarter GDP on Thursday will be closely watched, as estimates have plunged in recent weeks. The Atlanta Fed’s GDPNow model now sees 1.4% growth, down from 2.7% earlier this month. The consensus of economists remains roughly 2.5%.
  • Inflation: Fed officials made headlines last week, as the topic of the inflation target is increasingly in focus. There are preliminary talks to adjust their target framework that would be more flexible around the 2% target that was established in 2012. In each of the last several business cycles, core inflation has noticeably declined, averaging only 1.6% since the adoption of the 2% target. On potential outcome of the reassessment is to acknowledge that if inflation is below 2% for a period of time, the Fed may allow it to remain above 2% for a while to catch up.
  • Global Growth: While our Federal Reserve wrestles with their inflation target, foreign central banks are struggling with possible recessions. PMI data in Japan and Germany were below 50 last week, which is consistent with a contraction. The ECB has noted that they will be flexible on rates and other measures if the economy contracts, while the BoJ said that may ramp stimulus if the yen strengthens or inflation declines.
  • Brexit: Prime Minister May is weighing a two-month delay if she cannot secure a deal by March 12, as officials try to avoid a “no deal” Brexit. Betting markets still show a 20% chance of a “no deal” Brexit (down from 25% last week), with roughly a 50% chance of a delayed deal.
  • Details: Momentum in equity markets remain strong, with investors adopting a “risk on” approach. The breadth of the market is encouraging, with the equal-weighted S&P 500 consistently outperforming the market-cap weighted index, and small caps outperforming large by 6% this year. To date, growth has modestly outperformed value, with industrials, energy and technology the leading sectors. Volatility has moderated, with the VIX below 15 for the first time since October.
  • International stocks outperformed domestic, with developed and emerging indexes up more than 1% despite weak economic data. Commodity prices surged, with oil prices up nearly 20% this year. Interest rates declined, as investors continue to allocate to bond funds despite the rebound in the market. Credit spreads continued to narrow, with high yield spreads tighter by nearly 25% this year.

What to Watch

  • Geopolitics will drive news this week, including trade talks with China, nuclear talks between the U.S. and North Korea and a Brexit vote. Fed Chair Powell spends two days testifying before Congress and Trade Representative Lighthizer testifies on Wednesday. Economic data includes housing starts, consumer confidence and sentiment, durable goods, revised fourth quarter GDP, ISM manufacturing, personal income and spending, and PCE deflator.

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