Stocks Fall As February Economic Data Has Been Weak
Stocks Fall Sharply On Monday
There was a steep decline on Monday, which pushed the S&P 500 towards the lower end of the range it has been in for the past few weeks. The S&P 500 was down 1.42% and the Nasdaq was down 1.84% because Facebook’s 6.8% decline dragged it down. Even though the market doesn’t appear to react to most economic reports immediately, I still think part of the stagnation in stocks is because February was a weak month. March will include, what looks like, 4 winter storms for the northeast which lessens its importance.
Labor Market Not At Full Employment
The economy is creating excess jobs compared to the population growth, so the labor market is strong. The 13-month average jobs growth is 191,000. To keep up with population growth, the economy needs to create 80,000-100,000 jobs. That average job growth would signal the labor market is at full employment. The stagnant wage growth, high job growth, and increased labor participation rate all signal the economy isn’t at full employment. Even with this job growth, the retail sales results were weak. The industrial economy is strong, but it’s too small of a part of the economy to keep the economy running at its potential growth rate.
Other Markets Were Placid
The 10-year bond yield was up 1 basis point to 2.85%. The 10 year minus 2-year bond is still at 55 basis points. In the past few weeks, we’ve seen the yield curve steepen when stocks sold off, but today there wasn’t much movement in bonds. The chart below shows the 90-day correlation between equity and bond prices. The latest relationship is positive, but it’s too volatile to expect that relationship to remain consistent. The dollar index was also flat and WTI oil fell 28 cents, furthering the point that it was equity-focused volatility on Monday.
GOP Looks Towards Phase 2 Of Tax Reform
Don’t get preoccupied by Trump’s tweets. The media acts like every tweet moves the markets just because a couple important ones were sent in regards to the tariffs. Politically, they may be important, but they don’t affect stocks. It will cost you money if you focus on politics while you are trading and investing. According to the Investor’s Almanac, the best political situation is a Republican Congress and a Democratic President, but that hasn’t played out in the past year as both the President and Congress are Republicans and stocks have rallied. There is only a small group of new events in politics which effect stocks. They are the following: the tariffs, the trade agreements, any debt ceiling or budget issues, the Dodd-Frank repeal bill (and other regulatory cuts), and the potential tax reform legislation.
As you can see, tax legislation is on the list. It’s pertinent to the current market even though the tax bill passed last year. On April 15th the GOP is planning to unveil the second phase of tax reform. This could excite stocks and give them renewed momentum. The plan includes making the individual tax cut permanent and indexing capital gains to inflation. Larry Kudlow, who is now President Trump’s chief economic advisor, wrote an article on CNBC last year supporting indexing capital gains to inflation, so that will likely be something the GOP aims to get approved in legislation.
Manufacturing Strength
As I mentioned, the manufacturing economy is strong. The chart below shows the reports from the ISM and the regional Fed. The latest data point from the regional Fed includes 2 of 5 reports. As you can see, this is the highest reading since at least 2011. Even though the latest readings from the Philly Fed and NY Fed show optimism about the next 6 months, I don’t think this level of growth is sustainable. Even if Trump’s tariffs help some areas of manufacturing, the industry is extremely cyclical, so I doubt the strength will last for the rest of the year. If the service sector improves later this year, it will be a great tradeoff for the economy since the service sector is larger. If both are weak, it means GDP growth will be below 2%.
Fed Meeting On Wednesday
I think the most important event of the week is the Fed meeting on Wednesday. The chart below shows the Fed funds futures compared to the dot plot. The Fed fund futures are slightly more hawkish than the dot plot this year, but next year, the dot plot implies rates will be 14 basis points higher than what the market expects. In 2020, the Fed is forecasting about 2 more hikes than the market expects. In 2018 the decision is between 2, 3, or 4 hikes and next year the decision is between 1 or 2 hikes. I don’t think the Fed will be hiking in 2020 as a recession will be closing in. The futures market for the meeting on Wednesday show a 91.6% chance of a hike. The guidance will move the Fed fund futures market. In the past few days, the market has come to expect more hikes as the chance of 4 or more hikes in 2018 is at 34.9%.
The chart below shows the difference in the various dot plot forecasts from each FOMC member. Because the estimate has a large range, the number of rate hikes is uncertain. 6 FOMC members are below the median and only 4 members are above it. I think Powell will have an important role in guiding policy this year as he tries to get enough votes to reach his desired outcome. I’m not sure which way he leans, but the market thinks he is a hawk. Many unanswered questions should be answered in his first meeting as chair on Wednesday. I’m expecting a hike and a dovish statement because of the disappointing retail sales and diminished inflation. We don’t know for sure what the Q1 GDP report be, but I think it will be below expectations. The Fed may decide to ignore the weak data from February and use hawkish language anyway.
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