Two thousand nineteen isn’t even a third over and it’s already shaping up as a great year for the financial markets. The S&P 500 index and the Nasdaq Composite both ended the week at record highs, a big reason that global equity markets have gained $10 trillion in value since the turn of the year, with global credit markets kicking in another $2 trillion to investors’ wealth, by the reckoning of Torsten Slok, chief economist at Deutsche Bank Securities. (The Dow Jones Industrial Average is close to a new record high, too).
At the risk of propounding American exceptionalism, U.S. markets have handily outdistanced the rest of the world. Using exchange-traded funds to illustrate, the SPDR S&P 500 ETF (ticker: SPY) posted a total return (including dividends) of 16.73% for the year through Thursday, according to fund tracker Morningstar’s data. The Invesco QQQ Trust (QQQ), which tracks the biggest stocks in the tech-heavy Nasdaq, returned 23.7%. Venturing abroad paid less well. The iShares MSCI EAFE ETF (EFA), which tracks the major non-U.S. developed markets, returned 12.59%, while the iShares MSCI Emerging Markets ETF (EEM) returned 11.9%.
The robust recoveries from the fourth quarter’s slide came after the Federal Reserve said it would be patient in raising interest rates, a declaration that would place a blanket of calm over equity, bond, and currency markets. Dampened volatility has worked to lower the cost of insuring high-yield corporate credits against defaults, points out Peter Cecchini, Cantor Fitzgerald’s global chief market strategist. And those more salubrious corporate conditions, in turn, have worked to the benefit of the equity market.
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Take Netflix (NFLX) as a prominent example. The video streamer sold $2.2 billion of its junk-rated debt (Ba3 by Moody’s Investors Service; BB-minus by S&P) this past week at yields of 5.375% for U.S.-dollar-denominated debt and 3.875% for euro-denominated debt, in what one pro described as a yield-starved market. Those billions went to finance the streaming service’s ambitious production plans, as Barron’sAlexandra Scaggs wrote. Even Saturday Night Live made fun of all the money that Netflix is throwing at dubious projects. No matter: The stock is up 40% year to date, since Netflix’s subscriber rolls are growing fast enough to convince bulls that the costs are worth it.
Conspicuous among the averages not setting records was the Dow Jones Industrial Average, which actually slipped 0.06% in the week. Credit, or more properly blame, goes to a few of its 30 component stocks, such as Intel (INTC), which plunged 9% on Friday on disappointing guidance. An earnings miss sent 3M (MMM) down 13% on Thursday, its biggest loss since its 26% Black Monday plunge on Oct. 19, 1987.
Louise Yamada, the doyenne of technical market analysis, who heads an advisory service bearing her name, admits that this year’s rally has yet to trigger her monthly momentum indicators. That leaves her at something of a crossroads. Other technical indicators, such as the preponderance of advancing stocks over decliners and the roster of names making new highs, also are unconvincing at this point. The major averages such as the S&P 500 and the Nasdaq are making new highs, but other erstwhile FAANG leaders such as Amazon.com (AMZN) and Facebook (FB) are still shy of their old peaks.
Yamada instead points to leadership from tech stars of the past boom, such as Microsoft (MSFT), which touched $1 trillion in market value this past week, and Cisco Systems (CSCO). Industrial names, including Expeditors International of Washington (EXPD), Paccar (PCAR), Illinois Tool Works (ITW), Ingersoll-Rand (IR), and Ametek (AME), are also among other leaders that don’t get mentioned much.
Yet within the averages, there are wide dispersions. Howard Silverblatt of S&P relates that, since the previous peak in the S&P 500 last September (during which the market is little changed, after the fourth-quarter swoon and the 2019 recovery), half of the component stocks are up and half are down. That makes it a stockpicker’s market, he says. Indexers aver that that’s fine, if you omnisciently pick the winners and avoid the losers.
The calendar offers less guidance, as well, since the hoary “sell in May and go away” rule has lost its reliability. Our colleagues at Dow Jones Market Data find that the Dow rose an average of 7.55% in the Nov. 1 to April 30 span over the past 50 years, while it was up just 0.31% in the May 1 to Oct. 31 period. But more recently, the disparity has narrowed markedly. The May 1 to Oct. 31 Dow gain averaged 4.31% in the past five years, trailing the 5.48% average gain for the Nov. 1 to April 30 period, but rather less convincingly. Past performance rarely has been less assuring of future returns.
Lies, damned lies, and GDP statistics. That pretty much describes the first-quarter report card that showed the U.S. economy growing at a much-faster-than-predicted 3.2% annual rate after inflation.
But even a look beneath the gross domestic product headline number showed far less robust growth. Still, predictions of the economy sliding into a recession proved, like reports of Mark Twain’s demise, premature.
And despite the data showing inflation running well below the Fed’s 2% target, 3% real growth and a stock market setting records this past week make interest-rate cuts by the central bank seem unlikely.
The top-line GDP first-quarter number represented a marked acceleration from the 2.2% pace in the fourth quarter of 2018 and, as they say in earnings reports, a beat relative to the 2.3% consensus forecast. But after stripping away transitory factors, the economy actually slowed markedly in the first three months of the year.
Net exports added a full percentage point to the first-quarter growth rate, writes Paul Ashworth, chief U.S. economist at Capital Economics, in a research note. Exports expanded at a 3.7% annual rate while imports contracted, also at a 3.7% pace, both pluses for the GDP number. Typically, exports and imports move in the same direction, along with the overall economy. In any case, this improvement in trade “won’t continue against a backdrop of very weak global trade,” he adds.
The GDP also was flattered by a sharp jump in inventories, which added 0.7 percentage point to the 3.2% figure. Government spending also surged at a 2.4% annual rate, reflecting a jump in highway and road spending, reversing a 0.4% contraction in the fourth quarter.
Stripping out the government, trade, and inventory swings, real private domestic final sales—the core of the economy—grew at only a 1.3% annual rate, half the pace of the fourth quarter. That was the weakest rate since the second quarter of 2013, Morgan Stanley economists write in a research note.
The boost from inventories in the March quarter points to downside risks for the current quarter, the bank’s economists further point out. Indeed, this was the third consecutive quarter in which stock building boosted GDP. Now comes payback time. Morgan Stanley is looking for a large GDP reversal in the second quarter, with its economists forecasting a downshift to just a 1.1% pace.
Personal-consumption expenditures—which account for more than two-thirds of the U.S. economy—slowed sharply in the first quarter, to a mere 1.2% annual rate from 2.5% in the fourth quarter of 2018 and 3.5% in the third quarter. “Consumption was likely held back in the first quarter by a number of headwinds including the government shutdown, poor weather, and market volatility at the very end of last year, and so we would expect a healthier pace of spending next quarter,” the bank’s economists write.
Residential investment continued to contract at a 2.8% annual rate in the first quarter, which was less severe than the fourth quarter’s 4.7% annualized drop. (Although you wouldn’t know it from the 24% year-to-date surge in the iShares U.S. Home Construction ETF [ITB].)
Business investment, meanwhile, grew at a 2.7% rate in the latest quarter, mainly on the strength of an 8.6% surge in intellectual property, according to an RDQ Economics client note. How this number is calculated is something of a mystery, writes David Rosenberg, chief economist and strategist at Gluskin Sheff, although strength in software was apparent in Microsoft’s blockbuster results.
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The GDP report presents a dilemma for the Fed, however. The core personal-consumption expenditures deflator (which excludes food and energy prices and is the central bank’s favorite inflation gauge) rose at just a 1.27% rate in the first quarter and 1.68% year over year, Morgan Stanley calculates. Some economists contend that below-target inflation requires an interest-rate reduction to keep real rates from rising.
But, after a good headline GDP number, what if the unemployment rate were to fall further, to 3.6% in the April report due out next Friday, from 3.8% in March, wonders Greg Valliere, chief U.S. strategist at AGF Investments. “A rate cut obviously is now totally out of the question, despite demands from President Trump and his economic adviser, Larry Kudlow,” he writes in a client note. Indeed, rate hikes could be back on the table if inflation rises.
Despite the headline economic numbers, the federal-funds futures market was still betting on a cut of a quarter-point or more in the Fed’s 2.25%-2.5% target range. According to the CME FedWatch site, futures traders had a 63.8% chance of a reduction priced in for the December policy meeting and a 68.6% probability at the January 2020 meeting. Even though there was a lot less than met the eye in the GDP headline number, it’s hard to see the Fed lowering rates without signs of a more severe deterioration.
Write to Randall W. Forsyth at randall.forsyth@barrons.com
https://www.barrons.com/articles/intel-and-3m-are-among-the-losers-in-this-record-setting-market-51556325767
2019-04-27 20:48:00Z
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