Weekly Nolte Notes
A quick scan of the internet for “Irish quotes” and “interest rates” yielded nothing of the pithy quotes that can be found under a variety of other topics. However, one quote that may be employed quite often this week, leading up to St. Patrick’s Day as well as the Fed meeting mid-week, is “where the tongue slips, it speaks the truth.” After the press conference following the Fed’s decision, investors will be listening closely to Chair Yellen’s discussion of the economy and expectations for even more rate increases than the promised three. The markets have moved rapidly from maybe three increases (and the first at mid-year) to definitely three and now maybe four. What has changed other than the White House occupant? The economic data has been persistently better than expectations, including the job data released last Friday. There has been a nagging question though with the positive data. If things are so good, why are commodity prices falling again and wages struggling to get above 2% annual growth? As has been the case for much of the past eight years of this recovery, things are not always what they seem to be, especially in a low rate environment. Maybe a pint during the press conference will make everything better!
For the first time since the opening weeks of the year, the markets took a breather. While the “headline” averages showed modest declines, there has been a bit more erosion beneath the surface that has been absent since the election. Save for the two-month period leading up to the election, the net number of rising to falling stocks has been in a solid uptrend since the market bottom early in 2016. This week marked the second time. Whether this marks the beginning of a 5% correction like last October/November remains to be seen, but a more forceful Fed could spell trouble for stocks. The markets have had a rough time holding gains made during the early hours of trading, a departure from the past year, when stocks usually rallied into the close. The sharp rally from the election is destined to end at some point, if only to take a rest. If this is the beginning of such a rest, we could see stocks trade in a rather jagged pattern for the next month or two. However, the past declines have tended to be swift and sharp, bottoming quickly and resuming the rally just as swiftly. The euphoria around the potential for stronger economic figures and earnings could be dealt a blow if legislation gets bogged down in Washington and those benefits get pushed out even further than most currently expect.
Short-term rates have priced in a rate increase this week and are now at their highest levels since late 2008. Bonds maturing beyond 10 years also saw yields rise (and bond prices drop), but not to the extent of the adjustment in short bonds. This “flattening” of the yield curve is at the lowest levels since the election as inflation expectations pushed long bond yields higher. Commodity prices are back to levels last seen nine months ago. As noted above, wage growth remains rather subdued. Without significant wage growth, it will be hard to sustain higher spending, which can fuel further economic growth. Yes, rates will go up this week. However, we’ll be listening closely to the press conference as well for clues about further gains.
For the first time all year, only four of the seven major asset classes we track are trading above their long-term average price. Emerging markets were hit the hardest last week as energy prices fell, even though the dollar dropped slightly. Small cap stocks, as measured by the Russell 2000, have struggled to keep up with the SP500. Their relative performance has declined significantly, erasing most of their post-election gains. Commodity prices, as outlined above, are also declining again. Investors continue to flock to the largest US stocks as the top 100 by size are doing better than the SP500. Within the SP500, the “Trump Trade” stocks, like energy, materials and industrial stocks, are all trading below their post election bump. Financials have been holding up, but their gains have only matched the market since early December. Healthcare and Technology has taken the performance mantle and by virtue of their size, has masked the erosion below the “averages.” We’ll be watching these two groups for any weakness in the coming weeks.
International holdings got hit hard this week as energy prices declined. The market internals have weakened and we could be looking at the first 3-5% correction since the weeks leading to the election. Bond prices are declining. Any available cash dedicated to bonds will be used to buy short-term bonds as we anticipate further rate increases throughout the year.
The opinions expressed in the Investment Newsletter are those of the author and is based upon information that is believed to be accurate and reliable, but are opinions and do not constitute a guarantee of present or future financial market conditions.