February 5, 2018

Data Source: Bloomberg


  • Despite a volatile end to the month, global equities surged in January led by Emerging Markets and the U.S. 
  • Market pricing remains euphoric following the passage of Republican tax legislation that lowered corporate taxes to be more competitive with the rest of the world. Capital expenditure surveys tracked by the Philadelphia and Richmond Federal Reserve offices reveal cycle-high intentions to increase capital spending by U.S. companies. 
  • ‘Momentum’ style of investing led all other factors but sectors/asset classes that are sensitive to interest rate changes experienced losses in January. Investors expressed a clear preference for U.S. large cap growth as both small cap and value lagged this month. 
  • Consumer discretionary, technology, and health care led broad market sectors while interest rate sensitive sectors such as real estate and utilities were down in January. 
  • U.S. fixed income suffered as the 10-Year Treasury rose to 2.7% from 2.4% at the beginning of the year. Inflation fears continue to creep into fixed income pricing as investors are now pricing in 2.2% long-term inflation (up from 2% at the end of 2017) based on the difference between U.S. Treasury Inflation-Protected Securities (TIPs) vs nominal Treasuries. 
  • The trade-weighted U.S. dollar spot index (DXY) gave up 3.2% for the month and is down 12.8% from the end of 2016, when strong dollar sentiment reached a high following the November 2016 election. Investors continue to shift their asset allocation oversees with higher growth expectations for foreign markets. 
  • Commodities also saw gains in January with 1-month spot market oil prices reaching $64.73/barrel up from $60/barrel at the beginning of the year. The negative gap between global supply and demand continues to widen as investors do not expect an immediate supply response to the more robust pricing environment for oil. 
  • Strong equity and commodity performance has also supported risky fixed income credit despite the rise in interest rates. Investment grade and high yield spreads narrowed in January suggesting that fixed income investors feel more comfortable taking on credit risk despite tighter financial conditions implied by rising rates. 
  • Indeed, despite rising interest and hawkish comments from the Federal Reserve, the Bloomberg’s Financial Conditions Index for the U.S. has exceeded the easy conditions of late 2007 and mid-2014 (prior to the subsequent sell-off in oil prices). Credit remains widely available. 
  • In our year-end market commentary, we expressed a cautiously bullish outlook for risky assets but also highlighted some short- and longer-term risks surrounding the Federal Reserve and China. We wrote that narrow risk premiums have resulted in a tightly-coiled market “susceptible to any hint of trouble…” 
  • With cycle-high valuations in equities and cycle-low credit spreads in fixed income, investors can expect to ‘clip’ their coupon as long as cyclical reflation provides a supportive macro backdrop for corporate earnings and cash flow to grow. 
  • According to Factset Earnings Insight (based on reported earnings through 2/2/2018), analysts are projecting earnings growth of 16.8% and revenue growth of 6.4% for all of 2018. Some of this is tax-driven and some on expectations of an infrastructure spending initiative expected to be pushed by the Trump administration. 
  • So, assuming sustainable U.S. earnings growth in the area of 10-12%, one can argue that the strong surge in global market performance this month effectively front-loaded much of the stock market gains expected this year. Essentially, investors have already clipped half their coupon, if there is no change in S&P equity market valuations (already steep at 20x forward earnings).

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