Capital Markets Observations:
After recovering much of the recent drawdown, risk assets declined last week. Two obvious catalysts were (1) Fed Chair Powell’s testimony before Congress suggesting a stronger US economy might lead to a quicker pace of rate hikes and (2) Trump’s announced tariffs on certain metals imports. The former is a byproduct of stronger growth; gradually rising rates should not disrupt fundamental growth, especially with taxes and regulatory cost burdens lower. The latter, in our view, is quintessential Trump: Announce severe policy changes for effect – to influence the next round of trade negotiations.
Thirdly, and more notably, a smattering of economic indicators show signs of peaking, especially in non-US markets. For example, the IHS Markit Eurozone Composite dipped to a four-month low of 57.1 in February after a 12-year high of 58.8 in January. However, readings above 50 signal expansion and the EZ metric is above the its average of 53.0. In general, growth metrics like this remain on solid footing, but markets thrive on momentum, so investors are on alert for any trend shifts. For now, we see this as part of the normal ebb and flow of data – keeping in mind that macro data dominates during the earnings off-season and company-specific catalysts do not ramp up again until mid-April.
Finally, seasonal trends in the US have shown weaker growth in Q1 in recent years. For whatever reason – perhaps weather-related or due to the post-holiday period – this is a pattern we have come to expect. Over the last 10 years, US GDP has averaged 0.2% in Q1. Excluding the recession years of 2008-09, Q1 GDP has averaged 1.2% over the last eight years. By comparison, economic growth over the last 10 years has averaged 2.4%, 1.9%, and 1.4% for Q2, Q3, and Q4, respectively.
Stepping back to reassess fundamental growth trends. The Atlanta Fed is estimating US GDP growth for Q1 of 3.5% and for the full year, most economists we track expect GDP above 3%. According to IBES, S&P 500 earnings are expected to rise by 19% for 2018 and Emerging Markets' profits by 14% - both well above average. Lastly, the S&P 500 just posted EPS growth of ~15% for the Q4 earnings season, but the S&P 500 Index was up just 1% through last Friday. Thus, valuations are now cheaper.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.