MARKET PERSPECTIVES - Citizens Business Bank · 2019-01-08 · MARKET PERSPECTIVES. 2018. First...
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CitizensTrust A Division of Citizens Business Bank cbbank.com/investing Donald Evenson Senior Vice President Chief Investment Officer R. Daniel Banis Executive Vice President Head of CitizensTrust MARKET PERSPECTIVES 2018 First Quarter Equity Markets After a record nine “up” quarters in a row, U.S. equity markets were down in the first quarter of 2018. While the -0.76% decline was rather mild, the volatility with which it was delivered was a break from the recent low volatility trend that has been in place since early 2016. After a strong January return, the markets began to sell off in February with some extreme intraday declines, then bounced, and sold off again in late March. After no up or down daily moves of two percent or more in 2017, there have been seven already this year. While daily market moves can be attributed to a variety of factors, the prevailing issue in the first quarter was uncertainty around new trade tariffs that could escalate into trade wars with other countries. Thus far, the market has pulled back roughly 10% from its highs ending a unique and prolonged period of relative calm. Small-cap stocks were down slightly, as well, during the quarter as were International Developed markets as measured by the EFA ETF which fell 0.9%. Emerging markets, measured by the EEM ETF bucked the trend and gained 2.5% during the quarter; a reminder as to why we like diversified portfolios. Corporations continue to deliver strong revenue and earnings results, and got a further boost from the passage of the Tax Cut and Jobs Act in late December. Earnings have been revised upward for the first quarter and the year at the fastest pace since FactSet began tracking the data. This is a significant development as the economy moves through this period of very positive fiscal policies (tax cuts and budget agreement) offsetting tighter monetary policy (higher rates). This is driven by lower corporate tax rates that became effective this year. The combination of falling equity prices and increasing earnings estimates has had a meaningful impact on the price to earnings multiple of the market. The forward twelve month P/E ratio of the S&P 500 began the year at 18.4 and has fallen to 16.3 over the quarter, which is a significant decline in valuation. It is also greater, on a percentage basis, than the 10% price decline from the January highs in the S&P 500. The annual bottoms-up earnings growth rate for this year is now expected to be roughly 19%, significantly higher than the 11.8% expected just three months ago. 2017 will be remembered for its low volatility. Large moves in the indices on both an absolute and a percentage basis were largely absent during year. Interest Rates U.S. Treasury ten year bond yields rallied to a new recent high after the passage of the Tax Cuts and Jobs Act in December. The Fed raised their target Fed Funds rate in March for the sixth time since this slow and steady rate hike cycle began in December of 2015. The Fed continues to believe under its new chairman, Jerome Powell, that it will hike three times
Transcript of MARKET PERSPECTIVES - Citizens Business Bank · 2019-01-08 · MARKET PERSPECTIVES. 2018. First...
CitizensTrustA Division of Citizens Business Bankcbbank.com/investing
Donald EvensonSenior Vice President Chief Investment Officer
R. Daniel BanisExecutive Vice PresidentHead of CitizensTrust
MARKETPERSPECTIVES
2018First Quarter
Equity Markets
After a record nine “up” quarters in a row, U.S. equity markets were down in the first quarter of 2018. While the -0.76% decline was rather mild, the volatility with which it was delivered was a break from the recent low volatility trend that has been in place since early 2016. After a strong January return, the markets began to sell off in February with some extreme intraday declines, then bounced, and sold off again in late March. After no up or down daily moves of two percent or more in 2017, there have been seven already this year. While daily market moves can be attributed to a variety of factors, the prevailing issue in the first quarter was uncertainty around new trade tariffs that could escalate into trade wars with other countries. Thus far, the market has pulled back roughly 10% from its highs ending a unique and prolonged period of relative calm.
Small-cap stocks were down slightly, as well, during the quarter as were International Developed markets as measured by the EFA ETF which fell 0.9%. Emerging markets, measured by the EEM ETF bucked the trend and gained 2.5% during the quarter; a reminder as to why we like diversified portfolios.
Corporations continue to deliver strong revenue and earnings results, and got a further boost from the passage of the Tax Cut and Jobs Act in late December. Earnings have been
revised upward for the first quarter and the year at the fastest pace since FactSet began tracking the data. This is a significant development as the economy moves through this period of very positive fiscal policies (tax cuts and budget agreement) offsetting tighter monetary policy (higher rates). This is driven by lower corporate tax rates that became effective this year.
The combination of falling equity prices and increasing earnings estimates has had a meaningful impact on the price to earnings multiple of the market. The forward twelve month P/E ratio of the S&P 500 began the year at 18.4 and has fallen to 16.3 over the quarter, which is a significant decline in valuation. It is also greater, on a percentage basis, than the 10% price decline from the January highs in the S&P 500. The annual bottoms-up earnings growth rate for this year is now expected to be roughly 19%, significantly higher than the 11.8% expected just three months ago. 2017 will be remembered for its low volatility. Large moves in the indices on both an absolute and a percentage basis were largely absent during year.
Interest Rates
U.S. Treasury ten year bond yields rallied to a new recent high after the passage of the Tax Cuts and Jobs Act in December. The Fed raised their target Fed Funds rate in March for the sixth time since this slow and steady rate hike cycle began in December of 2015. The Fed continues to believe under its new chairman, Jerome Powell, that it will hike three times
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in 2018 (2 more) and the next hike is expected at their June 13th meeting. The Fed also raised its GDP growth estimate for the year to 2.7%. Short – term rates have responded as well. The two year treasury yield rose from 1.9% to 2.3% during the first quarter. This step up in rates put pressure on bond prices. The Barclays AGG fell 1.5% as bond prices declined. Municipal bonds also had a tough start to the year, generally falling roughly one percent.
Long term interest rates appeared to react to the passage of the tax reform bill and some upward inflationary pressures early in the quarter. Upward rate pressure initially steepened the yield curve, however, the continuous rise at the shorter end of the curve ultimately led to flattest levels of this economic expansion.
The Economy
Economic measures continue to point to a solid economic environment. Business and consumer confidence surveys remain in solid, if not record territory. Manufacturing expansion indices are at elevated levels. The labor market exhibited strength with record low unemployment claims and an unemployment rate of 4.1%. Fourth quarter GDP was revised upward to 2.9% last month. Most high frequency economic indicators suggest a solid footing for the economy.
One area of concern during the quarter has been recent housing indicators. Home sales on a year over year basis have been down for the last few months and, although this is not uncommon throughout an expansion, the housing sector is an important component of the economy. Low inventory levels, high prices, and higher interest rates are all headwinds for housing activity and their impact bears watching.
During the quarter, Congress passed a $1.3 trillion budget bill which funds federal spending through fiscal 2018. The bill adds further fiscal stimulus to the economy since it was a significant increase from prior budgets. Both military and domestic spending programs are expected to increase by over $100 billion over the next two years.
The Quarter Ahead
Equity market volatility will likely continue as the market evaluates the economic effects of late cycle fiscal stimulus and a conflicting Fed that is eager to increase rates to a neutral level. This year is a mid-term election year, adding another element of uncertainty to markets. The average drawdown in the S&P 500 during mid-term election years is 18%. However, the primary supporting pillars of the stock market have improved; earnings are strong, unemployment is low, inflation remains below targeted levels, and economic growth is “solid” in the words of the Fed.
The first quarter typically experiences a sequentially slower growth rate due to a number of seasonal factors. This has been rather pronounced over the past few years with the economy producing its weakest growth in the first quarter of the past 3 years. The prospects look better for this year but the trend is likely still intact with consensus estimates for Q1 growth in the 1.75 to 2.25% range. We expect economic growth to pick up in Q2 and Q3, primarily due to the effects of tax reform and increased spending filtering through the economy.
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