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Strategic Insights

Volume 7, Edition 10 | March 5 - March 9, 2018

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Steel-ing the Show

Doug_Walters Doug Walters | Articles

Read Time: 5:00 min

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U.S. equities celebrated this week as the President walked back on some of his tough talk on tariffs, while job growth outpaced expectations.

Market Review

Contributed by Doug Walters

Last week’s U.S. stock declines were reversed this week as President Trump softened his stance on trade tariffs and the threat of a nuclear conflict with North Korea appears to be off the table for a few months. The positive news week got an exclamation point with the first 300K+ gain in payrolls since 2016.

A Softening Stance

Last week’s trade war concerns abated as the President significantly softened his hardline stance on tariffs. Investors feared that the broad-based steel and aluminum tariffs proposed by Trump would kick off a global trade war. For an administration hell-bent on cutting taxes, a trade war has the potential to tax companies and consumers, in the form of higher input costs and higher prices respectively.

Under pressure from Republicans, the President has softened his stance by excluding Canada and Mexico from the tariffs and indicating that others might ultimately be exempt as well (at his discretion). The sharp rebuttal from Congress was encouraging for investors who are eager to avoid escalating trade disputes.

The S&P 500 ended the week up over 3%. Adding to the improving trade sentiment was a thawing in the North Korea standoff and a surprisingly large gain in new U.S. jobs. We provide some insight on the latter in our Spotlight.

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Spotlight: Pulling Apart Payrolls

U.S. equity markets reacted positively to this month’s Non-Farm Payrolls report, which showed 313,000 jobs added in February. It is fun (at least for us economic nerds) to create contests amongst colleagues to predict this monthly number. Its attraction for contestants is that it is highly volatile and unpredictable. For these same reasons, we should not read too much into just one good monthly number. We dig deep into this and other economic data in search of meaningful trends that will drive future market moves. Despite the big February number, job creation over the past 12 months is actually down (both compared to last month and last year).

Our Take: It is too soon to determine if this is just a rebound from the dreadful hurricane-impacted numbers last fall, or a sustainable bounce. Given the volatility of this number, we would not be surprised to see a less inspiring figure in March, particularly given the series of storms battering the East Coast.

Strategy Update

Contributed by Max Berkovich , Aleksey Marchenko

STRATEGIC ASSET ALLOCATION

Three is a Magic Number

After February’s roller coaster of a month, U.S. equities regained their footing. Small capitalization stocks led the pack this week but have more work to do to catch up to large capitalization stocks for the year.  Bond yields are regaining their upward bias, but are still below the February 21st peak for 2018. Speaking of bond yields…

  • In January, the legendary bond king Bill Gross predicted the U.S. 10-year Treasury hitting 3% percent.
  • While 3% might not seem a whole lot (or all that magical), it is a lot higher than Germany’s 10-year Bund yields 0.64% or Switzerland’s 10-year yields of 0.05%. Both nations enjoy the same credit rating as the United States.
  • Italy’s credit rating is seven notches lower than U.S.’s credit rating, but its 10-year sovereign bond is trading at 2% yield! By comparison, 3% would be a magical number.
  • See Schoolhouse Rock for other reasons why three is a magic number.

STRATEGIC GROWTH

Shaking the Tree

The Industrials sector outran another cyclical sector, Materials, for top spot this week. On the other hand, the Consumer Discretionary sector received unwelcome winds that pushed it down to the bottom thanks to…

  • Dollar Tree, Inc. (DLTR) reported 4th quarter results that missed numbers slightly, but guidance was received by investors like an unwanted nor’easter storm. The discount retailer reported 2.4% same-store sales growth, including a 3.8% increase in Dollar Tree stores. The company improved margins and cut expenses as well. In the past year, the company increased its store count by 501 locations bringing the total to 14,835. Investors responded to the company’s use of its tax benefit to increase wages and employee benefits unfavorably. Several Wall Street analysts dismissed the below-consensus guidance as conservative.

STRATEGIC EQUITY INCOME

The Bank Teller

The Consumer Discretionary sector was the laggard on the week, while the Industrials sector was the leader. In other strategy news…

  • Bank of New York Mellon Corp. (BK) held its annual investor day this week. CEO Charles Scharf (took over in July) outlined his plan to grow the company. The plan includes consolidating several parts of its asset management business (6th largest globally) and investing $300 Million in technology initiatives including artificial intelligence and blockchain. The transaction processor will continue to focus on expense cuts, including cutting the number faxes it still receives down from 22,000 per day and reducing its headcount from 20,000 in operations (total employees number 53,000). Finally, the company expects revenue growth of 12-14% and intends to pay 100% of its earnings out to investors, 80% as stock buybacks.
Indices & Price ReturnsWeek (%)Year (%)
S&P 500 3.54.2
S&P 400 (Mid Cap)3.82.6
Russell 2000 (Small Cap)4.24.0
MSCI EAFE (Developed International)1.8-0.5
MSCI Emerging Markets2.14.2
S&P GSCI (Commodities)0.60.4
Gold0.11.5
MSCI U.S. REIT Index2.8-9.3
Barclays Int Govt Credit-0.1-1.7
Barclays US TIPS-0.1-1.8

The Week Ahead

Contributed by Aleksey Marchenko

A RICH Week of Market Moving Events

Retailers Ulta (ULTA) and William-Sonoma (WSM) are scheduled to report their earnings next week.

  • Investors will be looking for any signs of weakness from Ulta’s previously strong growth trends. The specialty retailer is mired in controversy over its return and resale policies which weighed the stock down recently.

Inflation reports Consumer Price Index (CPI) and Producer Price Index (PPI) are expected to remain unchanged.

  • Inflation has again taken center stage as the vital needle mover for the Federal Reserve’s rate decision. Mild results may allow for a more dovish rate environment to remain a bit longer.

Consumer sentiment index from the University of Michigan is expected to remain near 17-year highs, while retail sales are expected to improve in February after a slight decline in January.

Housing starts and building permits are expected to be flat in February and remain just below the 30-year median level.

  • According to the Home Depot, 66% of the U.S. housing stock is older than 30 years.

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