Economic data continues to suggest a solid expansionary backdrop. The final revision of fourth quarter gross domestic product (GDP) was revised up from 1.9% to 2.1% on stronger spending on foreign travel and recreation services, along with spending on gasoline and other energy goods. This follows third-quarter GDP growth that checked in at 3.5%, the fastest growth in two years. Meanwhile, fourth quarter corporate profits increased 0.5% from last quarter and 9.3% compared to the fourth quarter of 2015. The almost 10% increase in year-over-year corporate profits marks the largest percentage increase since 2012. Most economists are projecting a respectable 2.0%-2.5% GDP growth for the second quarter.
Consumer trends are strong and improving with March consumer confidence hitting its highest level since December of 2000. Home prices remain firm, despite increasing mortgage rates, with February prices coming in slightly higher than expected. The unemployment rate is low and stable at 4.7% and weekly unemployment claims are strikingly low, coming in at 258,000 and just off early-March lows not witnessed in 44 years. By most accounts, the labor market now appears to be reaching levels that most economists would consider to represent “full-employment”. Positively, manufacturing and industrial activity are starting to contribute meaningfully to growth prospects, in what appears to be a lifting of the malaise that has plagued such businesses for most of the recovery. The Institute for Supply Management’s manufacturing survey came in at a robust 57.7 (anything above 50 indicates an expansion) in February, approaching the highest levels of the recovery. Moreover, chief executives of the largest U.S. companies say they are more optimistic now than at any point in the past seven years, according to a Business roundtable survey.
Oil prices appear to have somewhat stabilized after investors witnessed a 45% increase throughout 2016. Nevertheless, volatility remains evident. Oil prices fell significantly in the first few weeks of March, on a surge in global crude stockpiles, before rallying back in the waning days of the month due to strong demand for crude products and renewed commitments by major oil producers to rein in production.
Investors appear to continue to hold a general belief that the Trump presidency will improve business conditions, recent political setbacks notwithstanding. Going forward, the Trump administration is likely to change its focus to tax reform and infrastructure stimulus in the wake of the apparent standstill in reforming the Obama administration’s Affordable Care Act. International economic activity also appears to be firming. German business sentiment hit its highest level in nearly six years in March while Chinese industrial profits rose at their fastest pace in six years. Disrupting nascent signs of European growth could be the upcoming French election that could prove to be the most consequential contest yet between the world’s ideological divide between nationalism and globalism.
Yields on shorter-term government bonds increased during the quarter while yields on longer-term government bonds held generally steady. The 10-year Treasury bond finished the quarter yielding about 2.39%, up significantly from pre-election yields, but approximating the level at which it started the year. On the other hand, shorter-term rates were influenced by the Federal Reserve’s March rate hike. The 3-month Treasury bill finished March yielding 0.75%, up from 0.50% to start the year. This flattening of the yield curve resulted in longer-term bonds outperforming their shorter-term counterparts.
Corporate bond spreads ground lower throughout much of the quarter resulting in corporate bonds generally besting their government counterparts, especially in the high-yield segment. However, credit spreads did widen slightly in March from over-bought levels as the post-election rally faded.
The Federal Funds Target Rate now stands at a range of 0.75%-1.00% after the Federal Open Market Committee voted to increase the rate at its March meeting. This move was the Fed’s first hike for calendar year 2017, and its third hike since moving to virtually 0% rates in 2009. Federal Reserve policy signals suggest that rate hikes will continue, albeit at a measured pace. Fed Vice Chair Fisher was recently quoted as saying two more rate increases seem justified given current economic readings.
Inflation and inflation expectations are increasing but remain well contained. Low unemployment and recent multi-faceted economic strength have many pondering if a return to the higher price levels experienced in the 1970s and 1980s is inevitable.
Treasury yields of selected maturities for recent time periods are displayed below.
|Treasury Bill||Treasury Notes & Bonds|
|3 mo.||2 yr.||5 yr.||10 yr.||30 yr.|
The total return numbers for various fixed income indices over the last twelve months are displayed below (data from Bloomberg).
|12 Month Returns (as of 03/31/17)|
|Barclays Capital US Aggregate||0.44%||Merrill Lunch US High-Yield||16.88%|
|Barclays Intermediate Government||-0.63%||Merrill Lynch US Municipal Index||0.19%|
|Dow Jones Corporate||-1.35%||JP Morgan EMBI Global||8.82%|
The stock market rally generally continued through most of the first quarter of 2017. The technology-heavy NASDAQ Composite Index lead the way, posting an impressive return of 10.13% as the market decidedly favored “growth” over “value” in the first three months of the year. This marks a reversal from 2016 where value stocks significantly outperformed their growth counterparts. Although not as robust as the NASDAQ, both the Dow Jones Industrial Average and the S&P 500 Index also had a strong quarter with returns of 5.19% and 6.07%, respectively, indicative of a market rally that extended across both the defensive and cyclical sectors of the economy. First-quarter returns for small-capitalization stocks, depicted by the Russell 2000 Index, trailed large-caps by a wide margin that was intensified late in the quarter on speculation that executive-branch policy action may not be as beneficial to smaller companies as previously thought.
Despite the positive quarter, the post-election rally ran into resistance in early March with the Dow topping out near the 21,000 level, before falling to 20,663 at quarter end. U.S. equities experienced their largest weekly decline since just before the election in the penultimate week of March. Most market watchers attributed the selloff to dampened policy optimism in Washington following the failure of the Congress to repeal and replace the Affordable Care Act. Also, weighing on equity returns were talks of a watered-down package of tax cuts coming out of the Trump administration as political wrangling over the proposed boarder adjustment tax intensified.
Although some domestic equity valuations appear stretched, economic and business fundamentals are still very favorable and on the rise with many of the monthly and quarterly economic statistics showing improvement. The consumer indicators which have led the economy from recovery to expansion are now being joined by the industrial and capital spending sectors, contributing to more balance in overall economic growth.
Internationally, both developed and emerging markets reported strong first-quarter performance which generally exceeded returns from U.S. markets. Although several foreign economies are still stuck in a low-growth environment and are grappling with political uncertainty of their own, recent economic data suggests that the worst of their global-growth concerns may be abating. Of particular note, European stocks appear attractive from a valuation standpoint relative to their U.S. counterparts and firming economic conditions in the Eurozone could potentially warrant a market revaluation.
Below is a table which displays various equity index returns for the past quarter.
|Equity Indices||1st Quarter 2017|
|Dow Jones Industrial||5.19%|
|S&P 500 Growth||8.53%|
|S&P 500 Value||3.29%|
|Russell 2000 (small-cap)||2.46%|
|MSCI/EAFE (developed international)||7.39%|
|MSCI/EM (emerging markets)||11.45%|
Overall, healthy first-quarter returns were buoyed by broad-based sector support. Contributing the most were strong returns from the technology, consumer discretionary and health care sectors. Certain technology and consumer discretionary shares benefitted from a market reversal that favored growth and momentum stocks. Health care sector returns were strengthened from the late-March surge in hospital operators in response to fading prospects for the repeal of Obamacare. Conversely, the energy sector fared the worst as oil prices dropped on early-March supply concerns and profit-taking from a strong 2016.
The following table details S&P 500 sector returns for the quarter (price only).
|Return by Stock Sector||1st Quarter 2017|
|2. Consumer Discretionary||8.45%|
|3. Health Care||8.37%|
|5. Consumer Staples||6.36%|
|8. Real Estate||3.54%|