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Strategic Insights

Volume 7, Edition 19 | May 29 - June 1, 2018

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Banging the Steel Drum

Doug_Walters Doug Walters | Articles

Read Time: 4:30 min

060118_Main

Steel tariffs and trade war concerns were front and center again this week, but the steady beat of job growth calmed frayed nerves…

Market Review

Contributed by Doug Walters

The S&P 500 rallied off Tuesday’s weakness, ending a holiday-shortened week on a positive note thanks in part to a solid jobs report. The market took a break on Monday for Memorial Day, while my kids and I paid tribute to our veterans in the local school marching band.

CLINTON, NY MARCHING BAND – May 28, 2018

The Memorial Day parade in Clinton took place this morning. Here’s the Clinton Marching Band and Clinton Fire Department. Photos from the event will be in this week’s edition of The Waterville Times.

Posted by Zach Lewis – The Waterville Times on Monday, May 28, 2018

 

Restoring the Rhythm

We managed not to talk about Washington and geopolitics last week, but it would be negligent to ignore them this week as it drove much of the volatility we saw in both debt and equity markets. It started on Monday in Europe as fears were raised that Italy would put in a place a government (and specifically a finance minister) interested in exiting the Euro. While the eventual result was still a cabinet with Euro-skeptic tendencies, the removal of the controversial finance figure calmed market nerves.

Closer to home, the Trump administration was banging the drum on trade again. On May 31st, the exemption deadline passed on steel tariffs for our local trade partners Mexico and Canada as well as the European Union. The result is a 25% tariff on steel for some of our closest global allies. All countries involved are discussing counter-measures raising the specter of a protracted trade war. The President’s National Economic Council director Larry Kudlow said, “It’s not a trade war, it’s a trade discussion,” but capital markets were clearly on edge.

The jobs report on Friday helped calm some of those nerves and restore rhythm to the market. 223K jobs were created in May, which is very close to the average of the past eight years, so a continuation of the post-recession trend. Unemployment moved lower to 3.8%. Despite the tight employment market, wage growth remains stubborn. More on this in our Spotlight section.

2.7%

Wage growth has yet to break out

Positive commentary surrounding the jobs report buoyed equity markets on Friday. However, there was little mention of wage growth which, at 2.7%, appears unable to break free from the average of the past 30 months of about 2.6%. Job growth is welcome, but it is wage growth that is needed for the recovery from the great recession to be felt more broadly beyond those of us lucky enough to own stocks. We keep hearing companies say they are applying part of their tax savings to raise wages, but we have yet to see it meaningfully in the data.

Strategy Update

Contributed by Max Berkovich , Aleksey Marchenko

Strategic Asset Allocation

Playing with Dragon Fire

Bonds enjoyed slight gains as worries over government stability in Italy and Spain created a bid for safety assets (i.e. Bonds).  U.S. equities advanced higher this week, as did India. India’s stocks have lagged Emerging Market peers like Brazil, Russia, and China this year as higher oil prices and U.S. dollar strength weighs on India’s GDP growth. Speaking of Emerging Markets…

  • China’s largest companies will join MSCI’s Emerging Market indices. Around 230 company A-shares (shares listed on the Shanghai and Shenzhen Exchanges) will eventually gain 16% allocation in the index and will increase China’s total allocation to around 42% of the MSCI Emerging Market Index. Previously only Hong Kong-listed shares qualified for inclusion in indices.
  • Of course, it will take time for the index to implement this change. Trade limits and stock supply may hinder passive investments to fully implement new allocation to Chinese stocks by year’s end.
  • This will allow for global investors to gain more exposure to mainland China which was not easily available prior to this move.
  • The MSCI move comes at a time when International Monetary Fund (IMF) predicts China’s GDP growth rate to decline from 6.8% at year-end 2017 to 6.4% in 2019.
  • In our managed portfolios we have overweighted our exposure to India as the IMF expects GDP growth rate to go from 6.7% at previous year-end to 7.8% in 2019.

STRATEGIC GROWTH

Toppling a Tree

The Energy and Materials sectors bounced back from last week to finish as top sectors for the short week, while the Consumer Discretionary sector was the laggard thanks to an earnings report from…

  • Dollar Tree, Inc. (DLTR) reported a quarter that missed both earnings and sales expectations. While the company reported positive same-store sales results overall, it was a negative number from the Family Dollar unit that toppled the tree. The Dollar Tree legacy business did produce a 4% increase in same-store sales. The retailer blamed rising costs on the earnings miss. On the positive side, the company did site accelerating sales in the early weeks of its second quarter.

STRATEGIC EQUITY INCOME

Barn Burner

The Consumer Discretionary sector edged out Energy for the lead. Financials, on the other hand, were a laggard thanks to retrenching interest rates and political instability in Europe. In other news…

  • Over a week ago, retailers William-Sonoma, Inc. (WSM) and The TJX Companies, Inc. (TJX) both reported strong earnings results. TJX reported 12% sales growth year-over-year and increased its guidance for the full year. The company also increased its dividend by 25%. William-Sonoma reported revenue growth of 5.5% for first quarter, with positive revenue growth in all segments. Pottery Barn and Pottery Barn Kids & Teens had positive revenue growth. Both had revenue declines in the first quarter of 2017. The company grew e-commerce by double-digits, and online sales now account for 53.7% of company’s revenue.
Indices & Price ReturnsWeek (%)Year (%)
S&P 500 0.52.3
S&P 400 (Mid Cap)0.63.0
Russell 2000 (Small Cap)1.37.3
MSCI EAFE (Developed International)-1.4-3.2
MSCI Emerging Markets-1.4-3.3
S&P GSCI (Commodities)-0.18.8
Gold-0.6-0.9
MSCI U.S. REIT Index2.0-4.2
Barclays Int Govt Credit0.0-2
Barclays US TIPS0.0-1.8

The Week Ahead

Contributed by Aleksey Marchenko

The Market Will Take Its CUE from Global Economics

Chinese economic data on inflation, imports, and exports will be released on Friday.

  • China’s inflation has been in decline since March, with annual inflation now below 2%.
  • Given ongoing trade talks, China’s exports and imports have received extra scrutiny. The export growth has been on the decline (on average) while imports have been outpacing exports since 2017.

U.S. economic data such us the Purchasing Managers Index (PMI), Job Openings and Labor Turnover Survey (JOLTS), and non-manufacturing ISM will give some clues about the progress of our economy.

  • Indexes that measure the health of the services sector from (PMI) and non-manufacturing (ISM) reports are estimated to remain at healthy levels indicating continued expansion.
  • The (JOLTS) job openings report should serve as an indicator for how much further unemployment may fall, especially after a strong job creation print for May.

European Union’s economic releases include inflation, Purchasing Managers Index (PMI), Gross Domestic Product (GDP), and retail sales and should consume headlines next week.

  • We think the markets will welcome economics, good or bad over recent political headlines from across the Pond.

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