For the week ending May 3
In any market cycle (or popular race of thoroughbreds), it is wise to expect and prepare for the unexpected.
To prove the point, on Sunday, President Trump threatened increasing tariffs on Chinese imports, a sign that negotiations between the U.S. and China may have run into some obstacles.
The next marker on this issue comes up on Wednesday (May 8), as a large Chinese delegation is scheduled to visit Washington to continue trade talks. Yesterday’s Presidential Tweet may be a negotiating tactic on the way to some eventual resolution or could reveal more substantive disagreement, despite upbeat comments from administration officials over the last several weeks.
These headlines served to disrupt the rally in global equities. International equity markets declined sharply in early Monday trading. U.S. equity markets and oil futures also plunged, as U.S. Treasuries caught a safe haven bid.
Strong Jobs Report but Below Forecast Wage Gains
Beyond the trade war rhetoric, April employment provided upbeat headline news, as new jobs rose by a strong +263,000 and the unemployment rate dropped to 3.6% in Friday’s release. This is the lowest unemployment rate recorded in nearly 50 years.
The graph below highlights the history of the Civilian Unemployment Rate over the last 50 years. The drop in the rate is viscerally dramatic coming out of the Great Recession of 2008-09.
USA Civilian Unemployment Rate
(April 1969 – April 2019)
Sources: U.S. Bureau of Labor Statistics; Federal Reserve Bank of St. Louis
However, in April 2019, average hourly earnings rose a sluggish +0.2% on a month-over-month basis and +3.2% on a year-over-year basis – both below forecast. In addition to torpid wage growth, the Labor Force Participation Rate fell -0.2% to 62.8%, which was a disappointing aspect of the release.
Equity markets reacted positively to the release on Friday, helping the broad bellwether S&P 500 to end essentially where they started the week (+0.14%). Bond yields declined, reflecting tepid wage inflation and slowing manufacturing data both domestically and internationally. The 10-year U.S. Treasury bond ended the week to yield 2.52%.
We also note that Fed funds futures currently indicate at least a 50% probability of a rate cut at this year’s December FOMC meeting.
First quarter 2019 earnings reporting season has made its final turn toward the finish line. With over 77% of S&P 500 companies having reported, the blended year-over-year earnings growth rate is -0.84% on revenue growth of slightly over +5%.
According to data compiled by FactSet, Inc., 76% of reporting companies beat consensus forecasts in the quarter, which is better than the five-year average of 72%. Considering the dour outlook coming in to earnings reporting seasons, expectations were generally exceeded.
The graph below depicts the price of oil on the spot (cash) market on a year-to-date basis as measured by WTI (West Texas Intermediate) on a per barrel basis. WTI peaked at $66.24 on April 23, 2019 and has dropped almost 6.5% to $61.99 per barrel on Friday’s cash close.
WTI Crude Oil Spot Price ($/barrel)
Source: FactSet, Inc.
The decline in oil prices is being driven by a surge in U.S. production, despite OPEC’s self-imposed production constraints. We acknowledge that U.S. waivers on Iran oil sanctions expire this week, which could put a floor under pricing. However, domestic oil production may continue to offset international supply variables.
What Does All of this Mean?
The current U.S. economic expansion is closing in on the longest in history. The longest expansion on record lasted 10 years (March 1991 – March 2001). The current economic expansion will celebrate its tenth birthday in June.
We ascribe to the view that the central bank will keep short term interest rates unchanged in 2019, barring any unforeseen events. The low and somewhat predictable level of liquidity costs and the better than expected news on the corporate earnings front, provide a fundamental underpinning for financial assets.
Equally, it is important to be mindful that certain issues, such as the accumulation of public and private debt and extending for return at the consumer and corporate levels, can lead to unintended consequences and possible credit distortions. In this environment, forecasting becomes more difficult, thus exacerbating volatility.
We have stated previously that a positive resolution to the trade talks was largely priced into the markets. We reiterate our call to remain vigilant as to investment objectives and asset allocation in balancing risk/volatility and potential return in portfolios.