Last week stocks suffered their worst loss in two years
A retest of the early February low was to be expected, and on Friday the S&P 500 close of 2588 came within a shade of the February 8 2581 close, but did hold just above the 200-day moving average of 2585. But the February decline was related more to fears of rising interest rates in the face of economic strength and incipient inflationary pressure. This time, it was the imposition of tariffs and a possible trade war resulting in an economic slowdown that sent investors to the sidelines. These same concerns were manifested in wider credit spreads and a surging VIX volatility index, which rose from 15.8 to 24.9 on the week. The dollar also
resumed its decline after several weeks of stability.
Investors Respond to the Fed
The Federal Reserve raised the overnight rate another quarter point as expected. It was the first Federal Open Market Committee (FOMC) meeting presided over by Jerome Powell, and included updates to the Fed’s projections of economic conditions and expected rate policy. As intimated in the Chair’s recent congressional testimony, the Fed raised its estimate of 2018 GDP growth to 2.7 percent from 2.5, while simultaneously acknowledging that first quarter growth had moderated, and raised the 2019 estimate to 2.4 from 2.1 percent. It also left in place its projection of a total of three rate hikes this year, but the dispersion of individual member estimates edged higher, suggesting that subsequent evidence of firming growth could easily push the 2018 projection to four rate hikes.
The Fed also raised its 2019 estimate from two rate hikes to three, and raised its anticipated terminal rate as well. Importantly, however, although it lowered its forecast of the rate of unemployment, it simultaneously left unchanged at 1.9 percent its 2018 outlook of both headline and core Personal Consumption Expenditures (PCE). The net result was a pullback in bond yields. The ten-year note ended the week at 2.81 percent, down from 2.90 percent before the Fed decision. The two-year fell eight basis points following the Fed’s announcement, ending the week at 2.26 percent.
Trade Concerns are Real, but Fundamentals Remain Solid
The first quarter ends this week and sentiment is in a far different place from where it began. Euphoria over tax reform has been replaced by worry over trade. What had been a 7.5 percent year-to-date gain in the S&P 500 on January 26 is now a 3.2 percent loss at the end of last week. But while worries over the direction of trade policy are real, the underlying fundamentals of the economy and the outlook for corporate earnings remain sound. First quarter GDP growth estimates have been lowered, but that has become a common occurrence in this recovery. Yet full year forecasts have remained intact. According to Factset, first quarter earnings are expected to rise 17.2 percent, up from 11.3 percent at the start of the quarter, in sharp contrast to the normal historical pattern of falling estimates throughout the quarter. Revenue estimates have risen as well. For all of 2018 earnings are now forecast to grow by a robust 18.4 percent, up from 11.9 percent at the start of the year, and well in excess of the 11 percent 2017 pace.
Trade policy will remain in focus as investors watch to see if tensions escalate, with negative implications for the broader global economy, or whether tensions ease as counter parties maintain a constructive dialogue. In the meantime, this week’s economic calendar is headlined by the February PCE report. The price component is expected to show a 0.2 percent monthly increase at both the headline and core level, resulting in an unchanged 1.7 percent year-over-year reading for the former, and a modest increase in the core to 1.6 from 1.5 percent. It is next month when things will get interesting, however, as the monthly change last March was negative at both the headline and core level. Both consumer confidence and sentiment reports are also scheduled and will be watched for any signs of deterioration.