(Monday Market Open) The somewhat disappointing Q1 is officially over, and today marks the start of Q2 trading. Both the S&P 500 (SPX) and Dow Jones Industrial Average ($DJI) lost ground in Q1 for the first time since mid-2015 amid tariff fears and concerns about info tech, but Friday delivered a positive coda with solid gains across most sectors.
The new quarter begins with stocks in the red, with all of the major indices softer in pre-market trading on an announcement from China that it's slapping about $3 billion worth of tariffs on U.S. products including steel pipes, meat, nuts and wine. This is in response to the recent move from the White House two weeks ago to levy tariffs on aluminum and steel. Markets dislike uncertainty, and the potential for an all-out trade war certainly qualifies as uncertainty.
Thus begins Q2 2018. With the full quarter stretching ahead and offering a fresh slate, long-term investors might want to monitor some of the following trends:
- Sector rotation. The tech sector fell apart in March, dropping 4% for the month as concerns snowballed about privacy issues, product demand, taxes, and other issues. It was the worst month for tech since 2012, though it’s worth noting that tech is still up more than 3% year-to-date. The long market rally since early 2016 was a tech-led rally. If tech doesn’t recover quickly, it’s going to be interesting to see if any other sector jumps in to take its place. Financials would be a good place to look, because strong financials often lead to a strong overall market. However, financials have also struggled lately. The best-performing sector over the last month is utilities, traditionally a “countercyclical” one that tends to do better during hard times.
- Earnings ahead. Q1 earnings loom after a very strong Q4 earnings season. Many analysts expect another double-digit earnings growth performance from S&P 500 companies in Q1, but as baseball great Yogi Berra said, “It ain’t over till it’s over.” Keep an eye on sectors to see if any start to get weighed down. Also remember to watch revenue, which is often where the rubber really meets the road. Companies can use financial creativity to put a ribbon around earnings per share, but there’s no hiding weak revenue.
- Following yields. U.S. Treasury bond yields fell into a narrow range between 2.8% and 2.9% for the benchmark 10-year yield through most of March, but finished the month around 2.75%. The question is which way they might go in Q2. A lot could depend on data, including this Friday’s jobs report. If yields start creeping up above 2.9% again, it could renew the inflation worries that helped trip up the market back in early February. On the other hand, a significant drop below 2.8% might signal worrisome economic developments.
- Flattening yield curve. Speaking of yields, watch the yield curve, which is at its lowest level since 2007 with just a 48 basis point gap between 2-year and 10-year Treasury note yields. This may sound arcane, but even long-term investors should pay heed, because a falling yield curve has sometimes signaled investor pessimism in the past.
- Crude and consumer spending. The price of crude oil stayed mostly between $60 and $65 a barrel during Q1, arguably a sweet spot that allowed U.S. producers to make money, but not high enough to put too big a dent in consumers’ wallets (see chart below). The quarter ended with hints that OPEC might keep production down throughout 2018. One concern is that with spring and summer “driving season” ahead, a rise in crude prices could put gas prices on an upward spiral, potentially cutting into consumer spending on other products.
- Rate hikes. The Fed just raised rates for the first of what’s projected to be three times this year. Keep an eye on Fed funds futures to see if probabilities start creeping up for a possible fourth hike, and also listen to what Fed speakers have to say about the economy. This holds true for any quarter, by the way.
- Across the Atlantic. The European Central Bank (ECB) meets later this month and holds a press conference to give its take on economic performance and the possible direction of rates. Although many analysts expect Europe to put the brakes on its stimulus as the year advances, recent economic data haven’t been too reassuring. If the ECB hints at maintaining its stimulus, look out for a possible bullish impact on the U.S. interest rate complex, with a potential for lower yields.
- Volatility. Volatility remains elevated, and some indicators point to more choppiness in the weeks ahead. The VIX fell to 15 in mid-March, but quickly jumped to near 20 by month’s end. The narrative seems to be that after a historically mild 2017, volatility is officially back to more historical levels. If that’s the case, the quarter ahead could bring more ups and downs, just like Q1, meaning turbulent days like the ones we got used to seeing in February and March. Tighten your seat belt.
Putting aside the long-term view and looking at the week ahead, data are front and center with earnings season still a couple weeks away. Friday’s March jobs report, and to a lesser extent today's construction spending and tomorrow's auto and truck sales and numbers, could give investors a better sense of the economic landscape.
If you think back a few weeks, the February jobs report could hardly have been scripted any better. The U.S. economy added 313,000 jobs and wages climbed just 2.6% year over year. The mystery remains how wages can climb so slowly when employment keeps gaining at this frenetic pace. Though the mystery remains unsolved for now, the fact is jobs growth has been sparking over the last few months and that tends to put a positive spin on the outlook.
One thing to consider, however, is that with unemployment near 20-year lows, the monthly job numbers may not be able to keep up the 242,000-a-month average they’ve posted between December and February. Don’t be surprised if there’s a pullback in the headline number, but also keep in mind that any figure above around 100,000 is probably enough to keep up with population growth.
The wage growth number also comes under a microscope. The February pullback to 2.6% from January’s 2.9% came as a relief to those worried about possible inflation, but one month isn’t a trend. If the number starts ticking up again, inflation fears might resurface. Later this week, we’ll look at Wall Street’s estimates.
Blurring the Lines? In a year that’s already seen Amazon (AMZN) team up with JP Morgan (JPM) and Berkshire Hathaway (BRK.A) on plans to help reduce health costs, Wal-Mart (WMT) also seems ready to enter the medical fray. The Wall Street Journal reported that WMT is in preliminary discussions to buy health insurer Humana (HUM). While there’s no guarantee they’ll agree on a merger or pursue some other partnership, the reported discussions, if confirmed, hint at a blurring of lines in which major companies like WMT feel the need to move out of their core competencies.
This has been especially prevalent in retail, where the entire industry is under pressure to boost profits amid competition from AMZN and other online retailers. As the WSJ reported, WMT’s revenue eclipsed $500 billion in its latest fiscal year—more than Apple (AAPL) and Exxon Mobil (XOM) combined. But WMT’s profits have declined 30% over three years to $10.5 billion, squeezed by competition and e-commerce investments to fend off AMZN. It’s way too early to predict where this might go, but it’s a retail trend worth monitoring.
Millennials Not Saving: Here’s an alarming fact to start the quarter: The National Institute on Retirement Security reports that 66% of people between ages 21 and 32 have nothing saved for retirement. The report also found that even though two-thirds of Millennials work for an employer that offers a retirement plan, only slightly more than one-third (34.3%) of Millennials participate in their employer’s plan. That’s a little troubling. It’s never too soon to start saving for retirement, and if your employer offers you a plan, it’s folly not to participate. Even putting a little aside now can mean a lot later when you think about the power of compounding. When you’re 25, being 50 is outside of most people’s thought process, but one of the greatest investments you can make for yourself is to start putting money away at that age. It should be an investment in the future of you.
Unsmoothed. Most economic indicators released by the government are in some way smoothed—to remove potentially volatile elements that might give a false reading. Employment figures are seasonally adjusted. Inflation numbers are sometimes reported minus food and energy—two historically volatile segments, and so forth. By contrast, the Federal Reserve Bank of Atlanta has begun publishing a running estimate of real gross domestic product (GDP) based on the most recent data, often within hours of the release of a data point in which it tracks. This GDPNow forecasting model is based solely on the math, with no smoothing or other subjective adjustments.
GDPNow was quite volatile in Q1. In early February, the metric registered a 5.4% annualized GDP growth for 2018. Since then, muted readings on inflation, retail sales and home sales, GDPNow fell to 1.8%. But after last week's data points were added in, it's up to 2.4% — still below 2017's 2.9% growth, but more in line with growth over the last few years.
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