For a PDF version of the below commentary please click here Weekly Letter 2-20-2018

Commentary quick take:

 

  • Major developments:
    • US markets rebounded
    • VIX remains elevated
    • Global markets took the lead from the US
    • On the verge of a trade war

 

  • US:
    • Markets moved higher
    • Inflation fears remain
    • Trade war possible
    • 4th Quarter Earnings Season
      • 80 percent complete
      • 75 percent of companies beating revenue estimates
      • Blended earnings growth stands at 15.2 percent

 

  • Global:
    • Global markets followed the US lead higher
    • Asian Lunar New Year holiday
    • Italian election in focus

 

  • Hybrid investments strategy update:
    • Several changes to the hybrid models
    • Opportunistic purchases

 

  • This week for the markets:
    • Shortened trading week
    • Earnings
    • Fed officials in focus

 

  • Interesting Fact: Since they blew up the bolivar!

 

Major theme of the markets last week: Rebound!

After having the US markets plummet into official correction levels two weeks ago, it was time for a rebound last week and the markets did not disappoint. They moved higher every trading day last week for the S&P 500 and the Dow and all but one trading day for the NASDAQ. However, the increases continue to come with a healthy dose of skepticism as the indexes have only made back about half of what they declined since the end of January and the VIX remains more than 75 percent higher than it was on January 26th. As the markets move forward over the next few weeks, we will likely see continued bouncing around on the indexes as investors weigh the prospects of higher interest rates against the potential positive impact of the tax law changes enacted late last year, but starting to be realized now. Globally, all eyes remain on the US markets and their potential impacts around the world as increasing rates in the US is historically bad for other areas of the world that rely on higher rates than the US to fund their businesses and economies.

 


US news impacting the financial markets:

The financial news here in the US that impacted markets last week was primarily related to inflation and politics. You may remember that inflation fears initially drove the markets lower at the end of January; the fear is if inflation increases too quickly, it will force the Fed to raise rates four times during 2018. Inflation is difficult to measure and it is even more difficult to interpret what impact it will have on the economy. The chart to the right from Econoday shows the Consumer Price Index (CPI), both overall and core. When looking for signals about possible inflation, most economists (Fed officials included) use the core readings as they remove the very volatile food and energy components of the indexes. As you can see looking at the core CPI bars to the right, there is a clear upward trend that has been in place since approximately March of 2017. The latest reading of 0.35 percent (far right) is the highest reading that we have seen on the core CPI in more than 12 years. The overall CPI reading of 0.54 percent is the highest that we have seen in almost 5 years. It, too, is posting gains that are starting to look significant. These numbers are monthly numbers, however, and the data series can be very volatile. Looking at the annualized data, the CPI becomes steadier and has recently been running at a rate of 2.1 percent. However, the annualized core CPI rate has been stuck at 1.8 percent for the past 12 months. Fed officials weigh the PCE (personal consumption expenditure) index more heavily, which is currently running at 1.5 percent annualized and has not been above the 2 percent inflation target since briefly rising above it back in 2012. In total, while it looks like inflation may be starting to pick up, according to some of the indexes that track inflation, it does not look like inflation is at any risk of running away to the upside. Although, a change in the nearly flat readings observed for more than a year to slightly rising sure feels like inflation is coming back with a vengeance. In addition to the inflation debate last week in the financial media, the focus was on US trade policies.

 

On Friday last week, the US Commerce Department caught many by surprise as it recommended high tariffs on US imports of steel and aluminum. The department outlines what it says are necessary measures to stop foreign countries from undercutting US production of both aluminum and steel here in the US. The department recommended a 24 percent tariff on steel imports globally or a 53 percent tariff on steels imported from 12 specific countries. For aluminum, the tariff figure globally is 7.7 percent or 23.5 percent on a select list of five countries, including China, Hong Kong, Russia, Venezuela and Vietnam. The World Trade Organization immediately released a note that there are no winners in a global trade war. It was interesting that the Commerce Department decided to release its recommendations while China (the hardest hit country by the recommendations) was closed for several days as it celebrates its Lunar New Year. With China being closed through Wednesday of this week, we will not receive an official response from China until Thursday morning. The response will not likely be taken lightly by the global markets. One action that China could take is to follow through on its threat to stop buying US government issued debts, which would present an interesting conundrum for US officials who for years have relied on China’s insatiable appetite for US debt. One other note about this situation is that these are only the Commerce Department’s recommendations. President Trump has until April 11th for steel and April 19th for aluminum to sign off on the recommendations. China’s actions or threats will likely play a significant role in the President’s thinking between now and then. While the markets were rebounding and countries were worried about a potential trade war last week, earnings here in the US and around the world for the fourth quarter of 2017 continued to move forward.

 

Last week was the sixth week of the fourth quarter 2017 earnings season and we continued to see mixed results from many industry leaders. Below is a table of the well-known companies that released earnings last week with earnings that missed expectations highlighted in red, while earnings that beat expectations by more than 10 percent are highlighted in green:

 

Agilent 14% Groupon -22% JM Smucker 16%
Barrick Gold 10% Hyatt Hotels 21% Molson Coors 11%
Applied Materials 9% Hilton Worldwide 23% Treehouse Foods 10%
Baidu 12% Kraft Heinz -6% Toyota Motor pushed
Brookdale Senior pushed Coca-Cola 3% TrueCar 400%
CBS 1% Marriott 12% HOSTESS BRANDS pushed
Campbell Soup 23% Met Life 1% Under Armour -100%
Cisco Systems 7% Overstock pushed V F -1%
CenturyLink -18% Occidental Petroleum 3% Waste Connections 6%
Deere & Company 13% PepsiCo 1% Waste Management 2%
Dr Pepper Snapple 0% Pilgrim’s Pride 9% Western Union -7%
First Data 0% Shake Shack 100% Wyndham Worldwide 10%

 

Companies that sell consumer focused products, such as beverage makers, were one of the focal points of the earnings releases last week, with the big three – Coca-Cola, Pepsi and Dr. Pepper Snapple – all coming in very close to market expectations, both in terms of sales and earnings per share. Under Armor has been under pressure for the past several quarters as the company has faced stiff competition from other brands in the athleisure market segment and in the area of endorsement deals. The 100 percent miss in earnings in the above table is a little misleading as the company only missed expectations by one penny. However, Under Armor was only expected to post a one cent profit for the quarter, thus a 100 percent miss on expectations. There are several companies above this week that are noted as “pushed;” this is because the tables are created every week based on the historical times that companies have previously released their earnings as well as the pre-announced earnings release dates. Companies may release their earnings after these expected dates.

 

According to Factset, we have seen 402 (80 percent) of the S&P 500 companies release results for the fourth quarter of 2017. Of the 402 companies that have released earnings, 75 percent have beaten earnings estimates, while 9 percent have met expectations and 17 percent have fallen short of expectations. When looking at revenue, of the companies that have reported, 78 percent of the companies have beaten estimates, while 22 percent have fallen short. The overall blended earnings growth rate for the S&P 500 now stands at 15.2 percent. The materials sector has been the largest contributor to the earnings growth rate, while the telecom services sector took over from materials last week as the largest drag on earnings. Of the 79 companies that have issued forward looking guidance at the same time they released their latest earnings figures, 40 have revised future earnings lower for the future and 39 companies have revised earnings higher.

 

The table is significantly smaller this week than it was last week, and it will continue to shrink as we draw nearer to the close to the fourth quarter reporting season. This week we have about 50 of the remaining 100 component companies in the S&P 500 that will report earnings. The table below shows the companies that will be releasing their earnings this week with those that have the greatest potential to move the markets highlighted in green:

 

Brookdale Senior Living Home Depot Public Storage
Berkshire Hathaway Hewlett Packard Enterprise Transocean
British American Tobacco Intuit Roku
Cheesecake Factory Jack In The Box Sanderson Farms
Avis Budget Group KAR Auction Services Sprouts Farmers Market
Dillard’s Medtronic Six Flags Entertainment
DISH Network Newmont Mining Toyota Motor
Dominos Pizza Nintendo Wendy’s Arby’s Group
Genuine Parts Pandora Media Wal-Mart Stores

 

At the start of the trading week this week all eyes will be on Walmart as it is the world’s largest private employer and one of the largest retail companies in the world. Of interest will be the company’s online sales results as well as the in-stores sales change. Home Depot will also report earnings this week and should provide a good gauge about how Americans feel about their homes in the current real estate market as home owners will typically put money into home renovations and repairs more readily during an increasing housing market than a decreasing one. At the end of the week this week, Warren Buffet’s Berkshire Hathaway will report its latest earnings ahead of the annual shareholders meeting in Omaha. The company’s holdings in Wells Fargo will be of most interest to shareholders as Warren Buffet prides himself on investing in honest companies, something that Wells Fargo has very recently proven itself not to be.

 

Global news impacting the markets:

 

There was very little of substance in the global financial media last week with much of the world watching and trading off the movements seen in the US markets and with the Asian markets closed at the end of the week last week through part of this week for the Lunar New Year. The global financial media could become very interesting over the next few weeks as the Brexit negotiations move forward with uncertainty and Italy once again will likely start to make headlines. On March 4th, there is a general election being held in Italy. According to the latest polls, it is a true toss up over who will come out on top within the elected government. If some of the more extreme political parties win big in the election, we could be looking at a Brexit taking place in Italy. Quitaly is currently in the lead for what a process of Italy leaving the EU should be called, with Italgone coming in a close second.

 

Hybrid model performance and update

For the trading week ending on 2/16/2018, returns in the hybrid and quant hypothetical models* (net of a 1% annual management fee) were as follows:

 

  Last Week 2018 YTD Since 6/30/2015

(Annualized)

Aggressive Model 2.89% 0.87% 6.95%
Aggressive Benchmark 3.89% 1.71% 7.56%
Growth Model 2.14% 0.58% 5.89%
Growth Benchmark 3.03% 1.38% 6.05%
Moderate Model 1.43% 0.29% 4.57%
Moderate Benchmark 2.16% 1.04% 4.50%
Income Model 1.08% -0.14% 3.92%
Income Benchmark 1.09% 0.60% 2.52%
Quant Model 2.39% -3.70%
S&P 500 4.30% 2.19% 11.25%

*Model performance does not represent any specific account performance but rather a model of holdings based on risk levels that are like my actual holdings, the hypothetical models are rebalanced daily to model targets.

 

There were several changes to the hybrid models last week as they stepped back into some higher risk areas of the markets. The first change was to add a position in small caps using the IndexIQ Chaikin US Small Cap ETF (CSML). This position was purchased to take advantage of what could be out performance of the small cap companies that had underperformed during the upside of the past several months, but performed much better than expected during the recent downturn. The ETF utilizes the Chaikin power gauge rating system to evaluate stocks and invests in the stocks that have the highest potential for return based on their system. The second change last week was to buy an initial position into the Rydex equal weighted technology fund (RYT) as this fund represents a wide range of companies that are generally underweighted in the individual equity positions of the hybrid models. The fund focuses solely on technology companies and historically performs very well in a rising market environment. Both positions that were purchased last week were partial positions with the thought being that the positions will be filled out in the coming weeks if the volatility in the markets continues. In general, the hybrid models are still overweight cash currently and will be actively moved toward a more fully invested position should the rebound we saw last week continue.

 

Market Statistics:

 

Index Change Volume
NASDAQ 5.31% Above Average
S&P 500 4.30% Above Average
Dow 4.25% Above Average

 

The US financial markets went back into rally mode last week, posting gains of more than four percent across the board. The technology heavy NASDAQ led the way higher as investors picked up shares of previously high flying large technology companies on the hopes that they will resume their upward movements like before the market stumble. As mentioned above, with the gains seen last week, both the NASDAQ and the S&P 500 have now recovered a little more than half of what was lost in the latest market correction, while the Dow has yet to do so. It is still too early to say that the correction that started at the end of January is over, as technically we would need to see the major indexes retake their previous high levels. In the meantime, we are in a sort of market limbo.

 

The following were the top 5 and bottom 5 performing sectors over the course of the previous week:

 

Top 5 Sectors Change   Bottom 5 Sectors Change
Software 6.46%   Utilities 2.92%
Technology 6.12%   Healthcare Providers 2.69%
Aerospace & Defense 6.05%   Energy 2.45%
Semiconductors 6.00%   Telecommunications 2.12%
Pharmaceuticals 5.77%   Real Estate 1.36%

 

With the performance of the major indexes in mind, it is not surprising to see the sectors that made both the top and bottom performing sectors last week. High flying technology focused sectors including Software, Technology in general, Aerospace and Defense, Semiconductors and Pharmaceuticals are the highest risk and highest reward sectors of the markets and made up all of the top five sectors last week. Investors seemed to be investing with a “buy the dip” mentality and are now hoping for the markets to continue to recover. On the flip side last week, four of the five sectors that saw the lowest performance (there were no negative performing sectors last week) are defensive in nature and include Real Estate, Telecommunications, Healthcare Providers and Utilities. Only Energy made the list and is not considered a defensive sector of the markets as this sector is known for wild market movements based on the volatile price of oil.

 

The fixed income markets in the US continue to try to adjust to the thought that inflation may actually come in higher than anticipated in the US during 2018. Combine these uncertainties and the fact that there is new leadership at the Federal Reserve and it is easy to see why there is so much uncertainty about bonds in the US. For the week last week, the long end of the curve increased in value, pushing yields slightly lower while the middle of the yield curve declined and the short end held up well. TIPS, which are inflation protected bonds, increased by more than a quarter of a percent and have been on an upward trajectory since the higher than expected CPI print two weeks ago that pointed toward a potentially more inflationary environment.

 

Fixed Income Change
Long (20+ years) 0.65%
Middle (7-10 years) -0.21%
Short (less than 1 year) 0.02%
TIPS 0.27%

 

Best and Worst Currencies Change
US Dollar -1.40%
Russia ruble 3.50%
Philippines peso -1.55%

 

 

After gaining about 1.5 percent two weeks ago, the US dollar proceeded to give back 1.4 percent last week against a basket of international currencies, ending the winning streak for the US dollar at two weeks. The best performing currency last week was found in Russia and was the Ruble, which gained 3.5 percent against the value of the US dollar. The worst performing currency last week globally was the Philippines Peso as it declined by 1.55 percent as President Duterte continues his brutal war on drugs that has overshadowed almost everything else going on in the country.

 

Commodities were all positive over the course of the previous week as oil and metals led the way higher:

Metals Change   Commodity Change
Gold 2.56%   GS Commodity Index 3.23%
Silver 2.21%   Oil 4.38%
Copper 6.81%   Livestock 2.21%
      Grains 2.71%
      Agriculture 0.80%

 

The GS Commodity index increased 3.23 percent last week, approximately half of what it declined two weeks ago. Oil advanced by 4.38 percent for the week last week as a “rebalance” in global oil looks to be under way as the markets adapt to the reality that US shale production will become a significant part of the global oil balance. Gold, Silver and Copper all posted solid gains last week, more than making up the declines seen two weeks ago, increasing by 2.56, 2.21 and 6.81 percent, respectively. Soft commodities were also positive last week as Livestock increased 2.21 percent, while Agriculture overall increased by 0.80 percent and Grains posted a gain of 2.71 percent.

 

Top 2 Indexes Country Change   Bottom 2 Indexes Country Change
Merval Argentina 8.41%   S & P BSE Sensex India 0.01%
RTS Index Russia 6.53%   Colombo Stock Exchange Sri Lanka -0.13%

Last week saw global indexes essentially flipped from what we saw two weeks ago, with all but one of the indexes advancing for the week. Argentina posted the largest gain last week of any of the global indexes, advancing 8.4 percent, thanks in large part to the increases seen in the metal prices around the world helping to boost the miners in the country that make up a significant part of the index. Sri Lanka’s Colombo Stock Exchange had the dishonor last week of being the only index to post a loss, giving up 0.13 percent. This decline in the Colombo exchange goes to show just how uncorrelated the index really is with the rest of the world as you may remember that two weeks ago this same index was the only index to post a gain globally.

After two weeks of outsized gains from the VIX, last week we saw a decline of more than 33 percent on the fear gauge as investors seem to be trying to look past short-term volatility and focus on what they hope will be a continuation of the bull market with the low volatility they have become accustomed to. Despite the decline of 33 percent last week, the VIX remains more than 75 percent above the closing level of January 26th as fear remains in the financial markets. As mentioned previously, we are likely to see the VIX move around wildly over the next few weeks as there tends to be a clustering of volatility when the market experiences large movements, either up or down. With the current VIX reading of 19.46, it implies that a move of 5.62 percent is likely to occur over the next 30 days. As always, the direction of the move is unknown.

Economic Release Calendar:

 

Last week was a busy week for economic news releases, as the US markets got ready for a shortened week to follow. Releases that significantly beat market expectations are highlighted in green below while releases that significantly missed market expectations are highlighted in red:

 

Economic Impact Date Economic News Release Date Range Actual Expectation
Slightly Negative 2/14/2018 CPI January 2018 0.50% 0.40%
Slightly Negative 2/14/2018 Core CPI January 2018 0.30% 0.20%
Negative 2/14/2018 Retail Sales January 2018 -0.30% 0.20%
Negative 2/14/2018 Retail Sales ex-auto January 2018 0.00% 0.40%
Neutral 2/15/2018 PPI January 2018 0.40% 0.40%
Slightly Negative 2/15/2018 Core PPI January 2018 0.40% 0.20%
Slightly Negative 2/15/2018 Empire Manufacturing February 2018 13.1 18.0
Slightly Positive 2/15/2018 Philadelphia Fed February 2018 25.8 22.0
Neutral 2/16/2018 Housing Starts January 2018 1.33M 1.23M
Neutral 2/16/2018 Building Permits January 2018 1.4M 1.3M
Positive 2/16/2018 University of Michigan Consumer Sentiment Index February 2018 99.9 95.5

Data for table from Econoday.com, Bloomberg and Yahoo Finance

 

Last week, the economic news releases kicked off on Wednesday with the release of the Consumer Price Index (CPI), both overall and just looking at core items. Both the overall and core CPI figures came in one tenth of a percent higher than was expected, but the financial markets did not move into an inflationary panic like they did two weeks ago. Retail sales, also released on Wednesday, could have been the offsetting factor on inflation as they were shown to have decreased overall during January and remained flat when looking at retail sales excluding auto sales. Both declines were negative in terms of potential impact on the overall US economy as consumer spending remains the workhorse of the US economy. On Thursday, the Producer Price Index (PPI), was released and came in at or slightly above market expectations, adding a little more data to the case for inflation potentially running hotter than expected in 2018. Later during the day on Thursday, both the Empire Manufacturing index and the Philly Fed index were released with the two releases having offsetting impacts on the markets as the Empire index missed expectations, while the Philly index beat market expectations. On Friday, building permits and housing starts for the month of February were released with both coming in close to, but a little higher than, what was anticipated by the markets, a signal that the US housing market remains strong. Wrapping up the week last week was the release of the University of Michigan Consumer Sentiment Index for the month of February (first estimate), which posted a higher than expected increase with a reading that was just shy of 100 as consumers remain very confident according to this index. The results, however, are somewhat at odds with what was seen in retail spending and in other US consumer indexes.

 

This week is another very slow week for economic news releases with only a single release on the calendar during the shortened trading week. It should not have a material impact on the overall markets:

 

Date Release Release Range Market Expectation
2/21/2018 Existing Home Sales January 2017 5.62M

Data for table from Econoday.com, Bloomberg and Yahoo Finance

 

The release this week is on Wednesday and is the existing home sales figure for the month of January, which like the housing starts and building permits reports from last week is expected to show modest improvements over the December levels. While this week is a slow week for economic news releases, it is a very busy week for Fed officials as there are nine scheduled speeches being given by officials, in addition to the minutes from the latest meeting being released. The markets will be listening to the speeches to see if there is any change in tone or language toward the future of interest rates in the US.

 

Interesting FactSince they blew up the bolivar!

 

Last week it was reported that Venezuela had officially blown up its only currency with a devaluation of more than 99 percent. This week, Venezuela is back in the financial media as the country is planning and pre-selling a new crypto currency that it will try to manage. The currency is called Petro and each Petro will supposedly be backed by one barrel of oil reserves in Venezuela.

 

This will be an interesting financial experiment to watch as almost everything the Maduro government has tried in the past has failed.

 

Source: theverge.com

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For a PDF version of the below commentary please click here Weekly Letter 2-12-2018

Commentary quick take:

 

  • Major developments:
    • US market plunged into official correction territory
    • Market confidence shattered
    • Global markets took the lead from the US
    • Tactical asset management worked well
    • VIX spiked at a historic rate

 

  • US:
    • Wild market trading
    • Shortest government shut down ever
    • New Federal Reserve Chairman
    • 4th Quarter Earnings Season
      • 68 percent complete
      • 74 percent of companies beating revenue estimates
      • Blended earnings growth stands at 14 percent

 

  • Global:
    • US instability felt around the world
    • Brexit deal may not happen in time
    • China housing market in jeopardy
    • Venezuelan Bolivar drops 99.6 percent

 

  • Hybrid investments strategy update:
    • Several more changes to the hybrid models
    • Hedging positions have been added
    • Church & Dwight performance

 

  • This week for the markets:
    • Wild trading potentially
    • Earnings

 

  • Interesting Fact: Bolivar still overvalued?

 

Major theme of the markets last week: Wild trading week in US financial markets last week

After seeing the markets decline on Friday the 2nd, many investors had been expecting to see a bounce back in the major indexes to start the week last week. Over the past few years, after every decline the markets had come roaring back and in many cases made new highs. However, investors who jumped back into the markets on Monday morning received a bit of a surprise when the Dow fell off a cliff late in the trading day, in what some are calling a flash crash. In total on Monday, the Dow traded in a 1,596.55 point trading range, which is the widest point trading range ever on a single day for the Dow. After seeing the markets stage a comeback on Tuesday (with another 1,000 plus point trading range on the Dow), many investors felt the decline seen on Friday and Monday were just small corrections that were healthy. However, volatility remained very elevated. On Thursday, the US markets resumed their decline once more with the Dow seeing another 1,000 plus point trading range. Never for the Dow has there been four 1,000 plus point trading ranges in such a brief period. In fact, there have only ever been seven 1,000 point trading ranges ever for the Dow, including this week’s four days. Looking at straight points declines is somewhat unfair, however, as the Dow has only recently climbed above the 20,000 level where a 1,000 point move would correlate to a 5 percent move. When looking at trading ranges as a percentage of the index, this week’s 1597.55 point decline was only a 6.3 percent wide trading range. This percentage range is not large on a historical basis as it ranks 25th on the historical list going back to 2000. For comparison, in October and November of 2008, the Dow traded with a daily percentage trading range of more than 10 percent for four days. So, while this latest bout of volatility in the Dow may feel large, it is not even close to the volatility we saw in the markets back in late 2008. As mentioned last week, there tends to be a clustering of volatility once a spike occurs, which can look a lot like aftershocks. The markets are currently in the throes of such aftershocks and are likely to continue for the near term, as investors look toward reasons for the declines. Being a tactical investment manager made it possible to sidestep some of the declines seen in the markets over the past week, which should continue if the markets continue their current trajectory.

 


US news impacting the financial markets:

 

Financial media last week focused on the wild market movements in the US, but there were several other story lines that would have otherwise made large headlines. The US government shutdown on Thursday at midnight after Senator Rand Paul held up a vote on a budget deal that would have kept the government open. However, shortly after midnight Senator Paul lost his ability to continue to holdup the vote and the budget bill passed the Senate, then the House and then was signed by President Trump in rapid fashion, making the shutdown the shortest in US history. The budget deal raises some very interesting questions, however, for what will happen going forward with the US financial markets and the US economy. The bill raises the budget caps by $300 billion over the next two years with $165 billion going to the military (total spending in 2018 up to $700 billion) and about $135 billion going to non-defense programs (total spending in 2018 up to $591 billion). The debt ceiling is essentially removed until March of 2019, allowing the government to borrow as much as it would like between now and then. According to the Congressional Budget Office (CBO), the 10-year cost of the budget bill is about $2.1 trillion after considering extensions of existing programs and the interest expense of all the increases in spending. Democrats and many economists warned that increasing spending by $2 trillion over 10 years in a non-war time is risky for the US economy. The financial markets seemed concerned that such an increase in spending could have negative impacts on the US economy going forward. On Friday, after the budget deal had been passed, Moody’s rating agency said it had the US credit rating under review for a potential downgrade, with the large projected increase in the deficit being the primary reason for the review. A change in budgetary spending was not the only change seen last week in Washington DC as new Fed Chair Jerome Powell had his first official business day on the job on Monday.

 

Month Current Chance of Rate Increase Chance of Rate Increase Previous Week
March 2018 66% 76%
May 2018 69% 78%
June 2018 87% 94%

Perhaps it was just a coincidence that the markets’ decline on Monday happened to be Chair Powell’s first business day on the job. Whatever the reason, Fed Chair Powell stepped into his new position at a time when the financial markets seem to have done an abrupt turn in terms of going from calm and tranquil to uncertain and volatile. With the movement seen over the past week in the financial markets, the odds of future rate hikes by the Fed have come down. The table to the right shows the next three FOMC meetings and the likelihood of a rate hike. This time last week, the odds of a rate hike at Powell’s first meeting was 76 percent. Given the market movements of the past week, the odds of a rate hike have declined to only 66 percent. Overall, the number of expected rate hikes this year by the Fed has also changed, going from 3 rate hikes in 2018, anticipated at the start of last week, to only 2 rate hikes in 2018. There is concern that the financial market movements are having too much of an impact on Fed policy as the Fed is not supposed to take any of its cues from the financial markets and should rather focus on price stability and full employment in the US. In addition to the market movement, budget deal and new Fed chair, earnings season continued to move ahead last week as we have now crossed over the 65 percent mark of companies having reported their results.

 

Last week was the fifth week of the fourth quarter 2017 earnings season and we saw the results of many industry leaders. Below is a table of the well-known companies that released earnings last week with earnings that missed expectations highlighted in red, while earnings that beat expectations by more than 10 percent are highlighted in green:

 

Arrow Electronics 9% Goodyear Tire & Rubber 30% Rayonier 122%
Bristol-Myers Squibb 1% Hain Celestial Group -2% Sally Beauty 2%
BP -3% Hanesbrands -2% SNAP INC 13%
Buffalo Wild Wings N/A Humana 3% Sanofi-Aventis -10%
Church & Dwight 4% Intercontinental Exchange 1% Statoil 15%
Chipotle Mexican Grill 2% Jack Henry & Associates 0% Sysco 2%
Walt Disney 17% Kellogg 0% Toyota Motor pushed
Callaway Golf 12% Nvidia 48% Tesla Motors 5%
Edgewell Personal Care -65% O’Reilly Automotive 4% Tyson Foods 20%
Twenty-First Century Fox 17% Philip Morris International -4% Twitter 36%
Gilead Sciences 5% Prudential Financial 3% Xcel Energy -2%
General Motors 23% Republic Services 7% Yum Brands 20%
Glaxo SmithKline 4% Ryanair 4% Zillow Group 0%

 

The biggest news from the companies that reported earnings last week came from Nvidia as the company posted record sales and earnings thanks to the high demand for some of its chipsets in the mining of cryptocurrencies and blockchain technology. Twitter also made positive headlines last week as the number of active users and revenues from ad sales both increased during the fourth quarter, helping the company top expectations by 36 percent. Large drug manufacturers were a focus of the earnings releases last week and their results were mixed, but one common thread in the analyst calls was concerns about the US government potential clamping down on drug prices. Tesla Motors made some headlines, as it typically does when it announces its latest results. The company posted a much better than expected cash burn rate during the fourth quarter, as customers continued to put down deposits on Model 3 and semi-truck future orders.

 

According to Factset, we have seen 341 (68 percent) of the S&P 500 companies release results for the fourth quarter of 2017. Of the 341 companies that have released earnings, 74 percent have beaten earnings estimates, while 9 percent have met expectations and 17 percent have fallen short of expectations. When looking at revenue, of the companies that have reported, 79 percent of the companies have beaten estimates, while 21 percent have fallen short. The overall blended earnings growth rate for the S&P 500 now stands at 14.0 percent. The materials sector has been the largest contributor to the 14 percent earnings surprise figure, while the energy sector has been the largest drag on the earnings figure. Of the 65 companies that have issued forward looking guidance at the same time they released their latest earnings figures, 33 have revised future earnings lower for the future and 32 companies have revised earnings higher. The big wild card that remains for many of the sectors of the markets is future government spending, as this can have a meaningful impact on almost any sector of the markets.

 

This week we start to see the decline in the number and significance of earnings releases in the US for the fourth quarter of 2017. The table below shows the companies that will be releasing their earnings this week with those that have the greatest potential to move the markets highlighted in green:

 

Agilent Technologies Groupon JM Smucker
Barrick Gold Hyatt Hotels Molson Coors Brewing
Applied Materials Hilton Worldwide Treehouse Foods
Baidu Kraft Heinz Toyota Motor
Brookdale Senior Living Coca-Cola TrueCar
CBS Marriott International HOSTESS BRANDS
Campbell Soup Met Life Insurance Under Armour
Cisco Systems Overstock V F
CenturyLink Occidental Petroleum Waste Connections
Deere & Company PepsiCo Waste Management
Dr Pepper Snapple Pilgrim’s Pride Western Union
First Data Shake Shack Wyndham Worldwide

 

Soft drink manufactures will be in the spotlight this week for earnings releases as Dr. Pepper Snapple, Coca-Cola and Pepsi all report their earnings for the fourth quarter of 2017. Expectations for the group going into reporting is that their sugar based business lines contracted, while their sport drink and natural drink lines likely increased. Hotel operators will also be a focal point for earnings this week as many of the large nationwide and worldwide brands report their results.

 

Global news impacting the markets:

Aside from the massive amount of market volatility seen around the world last week, there were a few headlines the markets took notice of as well. Brexit made headlines late in the week as the EU chief negotiator Michel Barnier threw into question the thought that the UK would be given a transition period after the formal Brexit date. The main sticking points that came to light after last week’s round of negotiations had to do with EU nationals living in the UK as well as rules and laws needed to transition after the Brexit date. Barnier said the United Kingdom needs to “accept the ineluctable consequences of its decision to leave the EU, to leave its institutions and its policies.” While the language of Mr. Barnier’s statement seemed more aggressive than previous statements, it could just be a negotiating tactic to get further concessions from the UK at the negotiating table. Whatever the reason for the language change, the UK markets took note and moved down on the announcement.

Last week, China saw some of the worst stock market performance globally as investors pulled risk out of their investments, seeing China as one of the riskier investments in their portfolio. There could be a bigger market moving event starting to unfold in China as its real estate market looks like it could be starting to roll over. The chart below from Bloomberg shows the Chinese A share investment index in cyan and the real estate index for China in dark blue:

As you can see in the above chart, the dark blue line (real estate index) is moving down significantly faster than the overall index, and the decline has been accelerating. The Chinese real estate market has been a source of great wealth for many people in China, but is also likely a bubble as it has increased in value far too quickly on the back of speculative investing and shady lending practices that are widely utilized in the country. The housing market is also a market that the government in China has very little control over and it could be very difficult for the government to employ any meaningful controls to stop a significant decline. This could be the start of a major event for China that negatively impacts its already slow growth (relative to the previous decade) expected during 2018. If the real estate market in China comes apart, the negative reverberations will be felt across the global financial markets.

 

Hybrid model performance and update

For the trading week ending on 2/9/2018, returns in the hybrid and quant hypothetical models* (net of a 1% annual management fee) were as follows:

 

  Last Week 2018 YTD Since 6/30/2015

(Annualized)

Aggressive Model -2.86% -1.98% 5.83%
Aggressive Benchmark -5.18% -2.10% 6.06%
Growth Model -2.55% -1.54% 5.08%
Growth Benchmark -4.04% -1.60% 4.89%
Moderate Model -2.27% -1.14% 4.04%
Moderate Benchmark -2.88% -1.09% 3.68%
Income Model -2.28% -1.22% 3.52%
Income Benchmark -1.44% -0.48% 2.11%
Quant Model -5.93% -5.96%
S&P 500 -5.16% -2.02% 9.56%

*Model performance does not represent any specific account performance but rather a model of holdings based on risk levels that are like my actual holdings, the hypothetical models are rebalanced daily to model targets.

 

There were a few changes to the hybrid models over the course of the previous week as a few more trailing stops triggered selling and a few purchases were made. On Monday last week, the hybrid model sold positions in high yield bonds (RYHGX), the final pieces of emerging markets (SFENX, DXELX), the International Low Volatility ETF (IDLV), the Wisdom Tree International Dividend Fund (DGRW) and the Dorsey Wright Momentum ETF (PIZ). The ETFs were sold as the triggers hit and were sold by mid-day—before the waterfall decline occurred. There was also one purchase made on Monday and that was a partial hedging position in DXSSX, which is an inverse S&P 500 fund that is designed to increase in value as the S&P 500 moves down. This position was purchased to help offset some of the potential future downward movements of the individual stock holdings in the models. On Tuesday, with the market bouncing higher, a further step in the hedging position of DXSSX was purchased. Also on Tuesday, a floating rate ETF (FLRN) was purchased as this fund, being short term in nature and having floating rate bonds as the underlying holdings, should take advantage of a rising rate environment, which we saw occurring during most of the week last week. On Wednesday, the position in the Financials funds (BKPIX and RYKIX, depending on which hybrid risk model is being looked at) was increased as the sector had come down significantly and looks to be one of the winners from a rising rate environment in the longer term. The position was purchased with a trailing stop in mind. Should the sector continue to slide, it will be sold, but after the decline of the previous few days it was worth moving into the position. On Thursday early in trading, both the Defensive equity ETF (DEF) and the JP Morgan Diversified Global ETF (JPGE) both hit their trail stop trigger points and were sold. In total for the week, cash increased and a hedging position was initiated, while overall risk in the models was greatly lowered. One stock spotlight from last week was Church & Dwight (CHD), which saw some very strong relative performance. During the two largest declines, on Monday and Thursday, CHD posted gains (2.35 and 0.02 percent respectively) and was the only stock in the S&P 500 to post gains on both days.

 

Market Statistics:

 

Index Change Volume
Dow -5.03% Above Average
NASDAQ -5.06% Above Average
S&P 500 -5.16% Above Average

 

As mentioned above, the market movements last week were very unusual with wide swings intraday on all three of the major US indexes. A prime example of how wild the trading has been can be found if you look at the Dow going into the close on Friday. At 1:30 pm EST, the Dow was at 23,374 and it closed the day at 24,200 less than three hours later. That is an 825-plus point swing that represented about three and a half percentage points and there was no material news released anywhere. This type of chaotic trading looks like it will remain present for a while longer as investors adjust to what may be a “new normal” in market volatility after being lulled into thinking that market volatility was gone for good. The declines seen last week, while large, were not the largest weekly declines that we have seen in the past three years as the Dow saw a larger weekly decline in early January 2016, while the S&P saw larger declines both in early January of 2016 and mid-August of 2015. These were the same two weeks the NASDAQ saw larger declines than those experienced last week.

 

The following were the top 5 and bottom 5 performing sectors over the course of the previous week:

 

Top 5 Sectors Change   Bottom 5 Sectors Change
Global Real Estate -1.76%   Telecommunications -6.34%
Utilities -2.44%   Medical Devices -6.75%
Multimedia Networking -2.98%   Natural Resources -7.49%
Healthcare Providers -3.30%   Energy -8.04%
Basic Materials -3.37%   Oil & Gas Exploration -8.39%

 

There were no equity sectors of the markets to post gains last week. The best performing sectors of the markets last week were an interesting group as Global Real Estate performed the best, declining only 1.76 percent. Utilities, one of the historically most defensive equity sectors of the markets, came in second with a decline of 2.44 percent. Multimedia Networking got a bump from a few solid earnings reports that kept the small sector more afloat than it otherwise would have been. Healthcare Providers and Basic Materials rounded out the list as these two sectors did not have the outsized gains from the past 14 months that many investors wanted to sell and lock in. Oil was the primary driver of three of the bottom five performing sectors last week as the black gold took down the Oil & Gas Exploration, Energy and Natural Resources sectors. Medical Devices took a hit as the sector had been one of the top performing sectors over the past 14 months, but also one of the most volatile, leading investors to jump out now that overall volatility is going up and being magnified by the sector. Telecommunications rounded out the bottom five performing sectors last week as all of the major cell phone carriers had a difficult week, declining by more than 5 percent across the board.

 

Fixed income saw some very interesting movements last week as the long end of the curve declined, pushing yields higher. However, the middle and shorter end of the curve held their own for the week. After gaining a significant amount on Monday when the equity markets crashed, they faded right back to where they started the week by the close on Friday.

 

Fixed Income Change
Long (20+ years) -1.37%
Middle (7-10 years) 0.00%
Short (less than 1 year) 0.00%
TIPS -0.77%

 

Best and Worst Currencies Change
US Dollar 1.50%
Ukraine hryvnia 2.78%
Venezuela bolivar -99.96%

 

 

Overall, the US dollar had a momentous week as the safe haven aspect of the currency was very apparent; it gained 1.50 percent last week against the value of a basket of foreign currencies. The gain last week makes it two weeks in a row of gains for the dollar, which may have turned the corner on its slide against many of the other global currencies. The best performing currency last week was found in Ukraine and was the Hryvnia, which gained 2.78 percent against the value of the US dollar. The Venezuelan Bolivar finally broke last week with the government in Venezuela giving up on its official peg of 10 bolivar to one US dollar. In doing so, it revalued the bolivar down to 25,000 to one US dollar. Officially, it was a decline of 99.6 percent. However, the market pushed the value of the currency lower, which is why the table above shows a loss of 99.96 percent, not 99.6 percent. We will have to wait and see what President Maduro’s next move is given how close the Presidential elections are in the country he is slowly losing control of.

 

Commodities were mixed over the course of the previous week as Grains managed to post a small gain:

Metals Change   Commodity Change
Gold -1.28%   GS Commodity Index -6.34%
Silver -1.72%   Oil -9.05%
Copper -4.69%   Livestock -3.31%
      Grains 0.55%
      Agriculture -0.79%

 

The GS Commodity index decreased 6.34 percent last week as oil sunk the index. Oil declined by 9.05 percent for the week last week as many factors came into play. US oil production increasing, according to and IEA report, was one of the driving factors, as was the Baker Hughes rig count for the US, which showed the highest number of rigs operating in the US since April of 2015. The higher risk nature of the oil stocks also came into play as investors were selling risky assets. At the close of the week last week, West Texas Intermediary (WTI) closed below $60 per barrel. Gold, Silver and Copper all posted declines last week, decreasing by 1.28, 1.72 and 4.69 percent, respectively. Soft commodities were mixed last week as Livestock decreased 3.31 percent, while Agriculture overall decreased by 0.79 percent and Grains posted the lone gain of the week in all commodities with a gain of 0.76 percent.

 

Top 2 Indexes Country Change   Bottom 2 Indexes Country Change
Colombo Stock Exchange Sri Lanka 0.79%   Hang Seng Hong Kong -9.49%
OMX Copenhagen Denmark -1.02%   Shanghai Composite China -9.60%

Last week was a very rare week as there was only a single major stock exchange globally to post a gain. Sri Lanka’s Colombo Stock Exchange had that honor last week as the index advanced by 0.79 percent. Sri Lanka happens to be one of the least correlated stock exchanges in the world when compared to all the other major indexes, which might explain some of the divergence in performance.  On the negative side, China’s Shanghai Composite index posted the largest decline globally last week as it declined by 9.6 percent. The prospects of increasing rates in the US and the strengthening of the US dollar caused a double hit to the Chinese stock market. Combine these two factors with a visible selloff in real estate stocks last week in a country that has a real estate bubble and you can see why the index performed so poorly.

Two weeks ago, the VIX ended the week with a spike higher that seemed to catch everyone off guard. While surprising, the movement seen on February 2nd in the VIX was just a precursor of what was to come for the VIX last week.  For the week, the VIX gained 64.93 percent, making it two weeks in a row of gains greater than 50 percent for the index. However, the final closing number does not tell the whole story of what happened with the VIX last week, which at one point was showing a gain of more than 125 percent. One Monday alone, the VIX jumped by 100 percent (hit a value of 49), causing several inverse VIX ETFs to blow up after losing 100 percent of investors’ money. This is the same index that, not too many weeks ago, was having a tough time staying above 10. Later during the week, after the VIX had settled back down a little, we saw a second spike over 40, which caused more panic in investors. As mentioned last week, once there is a spike in the VIX there tends to be a cluster of extreme movements, both up and down, as computers and investors alike try to readjust their thinking and parameters for risk measurements of the markets. With the current VIX reading of 28.55, it implies that a move of 8.24 percent is likely to occur over the next 30 days. As always, the direction of the move is unknown.

Economic Release Calendar:

 

Last week was a very slow week for economic news releases, which was a good thing since everyone’s attention was squarely focused on the movements of the global financial markets:

 

Economic Impact Date Economic News Release Date Range Actual Expectation
Slightly Positive 2/5/2018 ISM Services January 2018 59.9 56.7

Data for table from Econoday.com, Bloomberg and Yahoo Finance

 

On Monday last week, the only meaningful economic news release of the week was released, that being the services side of the ISM index. Expectations had been for a slight acceleration in the growth of the services sector during the month of January. The actual reading came in slightly better than anticipated at 59.9. This increase is in line with the overall ISM index released two weeks ago and had no impact on the US financial markets that were incurring the largest single point moving day for the Dow ever.

 

This week, the economic news releases could have a significant impact on the US equity markets as we receive several pieces of data that could impact the thinking of the Federal Reserve, which is under new leadership. The releases that could have greatest impact on the overall markets are highlighted below in green:

 

Date Release Release Range Market Expectation
2/14/2018 CPI January 2018 0.40%
2/14/2018 Core CPI January 2018 0.20%
2/14/2018 Retail Sales January 2018 0.20%
2/14/2018 Retail Sales ex-auto January 2018 0.40%
2/15/2018 PPI January 2018 0.40%
2/15/2018 Core PPI January 2018 0.20%
2/15/2018 Empire Manufacturing February 2018 18.0
2/15/2018 Philadelphia Fed February 2018 22.0
2/16/2018 Housing Starts January 2018 1.23M
2/16/2018 Building Permits January 2018 1.3M
2/16/2018 University of Michigan Consumer Sentiment Index February 2018 95.5

Data for table from Econoday.com, Bloomberg and Yahoo Finance

 

This week, the economic news releases kick off on Wednesday with the release of the Consumer Price Index (CPI), both overall and just looking at core items. Expectations are for 0.4 percent overall and 0.2 percent when looking at core. If both figures come in at or below these estimates, the markets will likely breathe a sigh of relief. If, however, either number comes in above, we could see another inflation panic. Retail sales, also released on Wednesday, should post small gains, but could impact the markets either positively or negatively if they come in meaningfully different than expectations. On Thursday, another inflation indicator, the Producer Price Index (PPI), will be released and expectations are for the exact same readings as the CPI earlier during the week. Much like the CPI, if either of these PPI figures comes in above expectations the markets could panic about inflation in the US economy at the producer level. One aspect of this release that could come into play is the decline we have seen in the price of oil as it relates to producer prices. If the PPI number comes in above expectations, the pundits will likely say it is only temporary as the decline in the price of oil will be seen in February’s figures. While this could be true, the markets will likely have already reacted to the announcement. Later during the day on Thursday, both the Empire Manufacturing index and the Philly Fed index are released with expectations of slight changes over the January levels on both indexes. On Friday, the building permits and housing starts figures for the month of February are set to be released with both expected to post more than a million units during the month. This would signal a steady US housing market. Wrapping up the week this week is the release of the University of Michigan Consumer Sentiment Index for the month of February (first estimate), which is expected to show no change in consumer sentiment over the end of January reading that was released just two weeks ago. In addition to the above mentioned economic news releases, there is a single Fed official giving a speech on Tuesday that the markets will listen closely to for any signs of changes under Jerome Powell as the new Fed Chair.

 

Interesting Fact — The Venezuelan bolivar could still be overvalued

 

Despite the Government in Venezuela officially moving the pegged exchange rate from 10 bolivar per US dollar to 25,000 bolivar per US dollar, the currency may still be overvalued. The new rate is still dwarfed by the black market rate for greenbacks, currently at 228,000 bolivars per dollar, according to website DolarToday.

 

It’s unclear why the government did not change the exchange rate to something in that range because there is very little difference between a currency falling 99.96 and 99.99999 percent.

 

Source: http://www.voanews.com

For a PDF version of the below commentary please click here Weekly Letter 2-5-2018

Commentary quick take:

 

  • Major developments:
    • Amazing how fast the markets can turn
    • Volatility came back with a vengeance
    • Dow declined 666 points on Friday
    • 10-year government bond marched toward 3 percent

 

  • US:
    • January FOMC meeting—no change in rates
    • New Federal Reserve Chairman
    • State of the Union address 2018
    • 4th Quarter Earnings Season
      • 50 percent complete
      • 75 percent of companies beating revenue estimates
      • Blended earnings growth stands at 13.4 percent
    • Bond yield continued higher, bond prices declined

 

  • Global:
    • All eyes on the US financial markets
    • Bond yields rose, putting downward pressure on prices

 

  • Hybrid investments strategy update:
    • Six positions tripped stops
    • Cash holding increased meaningfully

 

  • This week for the markets:
    • Is the bull market going to breakdown further?
    • Earnings
    • Bond yield rising
    • Potential government shutdown

 

  • Interesting Fact: Super Bowl 52

 

Major theme of the markets last week: Bull market had a difficult week last week

The cartoon this week shows something other than happy bulls dancing around sad bears, as has often been shown for the past several months. Risk and volatility made a comeback last week as fears about rising interest rates seemed to hit both fixed income and stock markets abnormally hard. Yields on US government bonds had been steadily rising since the start of 2018, but last week things seemed to come to a head as rates on the 10-year US government bond pushed up above 2.75 percent on their way up toward 3 percent to start this week. 30-year government bonds also pushed higher and traded above 3 percent. Analysts and economists have long warned that there is some level for interest rates at which investors that had been stuck in the equity market would flip back over to fixed income investments to pick up a reasonable yield and collect a historically safer income stream. Economists and investors alike seemed split on the inflection point, with some saying the number is 3 percent and others thinking it is closer to 3.5 percent. Thus far, 3 percent seems like a big tipping point when looking at the markets’ reaction last week, but we have yet to see 3.5 percent, so we don’t know for sure where the tipping point may lie. Fixed income investment correlated very highly last week to equity markets as almost everything moved lower. At the time of this writing, we still had not officially made it to a 5 percent correction on the three major indexes, but if the trend continues it looks likely to happen in the next few trading days. If we see a 5 percent correction, it will be the first such correction in many months and could signal the start of the end of the bull market that the markets have enjoyed for the past several years. Adding to the uncertainty of the financial markets last week was the fact that the VIX increased by more than 50 percent for the week, only the ninth time it has done so going all the way back to 2002. The thought of a market that only goes one direction has been shattered; now we will have to wait and see what investors do about the resurgence of volatility in the markets.

 

US news impacting the financial markets:

 

Earnings were not the focal point of the financial markets last week. Market movements combined with risk and volatility took the top spot in terms of attention, while the State of the Union and the January FOMC meeting also managed to make a few headlines. As mentioned above, risk returned with a vengeance last week as several things happened at once, causing the markets to decline. Early during the week last week there was a lot of talk about how the Fed may end up increasing rates four times during 2018, rather than the previously anticipated three hikes. Four rate hikes would likely increase borrowing costs by one full percent and push yields on government bonds to attractive levels for some investors seeking a safe steady stream of income. With little change in the language of the FOMC statement and Jerome Powell being seated as the new Fed chair, the markets were on edge about what may occur at the Fed. Jerome Powell, as you may remember, was President Trump’s pick to replace Chair Yellen as the head of the Fed following Chair Yellen’s term expiring. While Powell is expected to be a steady hand at the helm of the Fed, he is also not an economist. Powell is a lawyer with no training in economics other than the basic courses in college; he came from the private equity Carlyle Group and has a net worth of more than $100 million according to 2017 investment filings. Unlike the past few Fed Chairmen, Powell may lean more heavily on the Fed’s staff economists to come up with policy ideas rather than come up with them from his own knowledge base. This brings the chance for policies to be made much differently than with the past several FOMC voting members. To his credit, Chair Powell has said he would like to be even more transparent in disclosing to the public the thinking inside the Fed and what they are planning on doing.

 

Aside from the new Fed chairman coming in at the end of the week, the first State of the Union address by President Trump was given last week and, for the most part, went as planned. As is always the case, there were a lot of ideas floated during the speech, with no mention of how to fund any of them, and a lot of stories spotlighting individuals in the audience. Pharmaceuticals, Healthcare and Biotechnology bore the brunt of the President’s remarks following the State of the Union as he specifically said his administration was going to act against the ever-increasing healthcare costs, including drug costs. Infrastructure was another topic that made a few headlines from the State of the Union. However, there was a muted market response as the sector had already increased in value after it became known that this would be a focal point of the administration’s agenda for 2018 late in 2017. Up next for Washington DC, however, will be yet another budget fight that could entail the government being shut down for the second time in as many weeks as the resolution agreed to two weeks ago to reopen the government only funded it through February 8th. The markets seem to be growing more and more immune to government shutdowns, however and should not react much at all if the government shuts down again on February 8th.

 

Last week was the fourth week of the fourth quarter 2017 earnings season and we saw the results of many industry leaders. Below is a table of the well-known companies that released earnings last week with earnings that missed expectations highlighted in red, while earnings that beat expectations by more than 10 percent are highlighted in green:

 

Apple 2% Alphabet -4% Nintendo 173%
AFLAC 3% Honda Motor 42% Nucor 18%
Amgen -5% Harley-Davidson 17% Pfizer 11%
Amazon 17% Hershey -3% Phillips 66 24%
Anthem 3% Ingersoll-Rand 0% PayPal 6%
Astrazeneca 189% Johnson Controls 6% Ferrari -3%
Boeing 65% J&J Snack Foods 0% Polo Ralph Lauren 9%
Alibaba Group -1% Eli Lilly & Company 6% Sprint 50%
Clorox 1% Lockheed Martin 6% Stryker 1%
ConocoPhillips 0% Mastercard 2% AT&T 20%
Chevron -43% McDonald’s 8% Time Warner 11%
DR Horton 20% McKesson 17% UPS 1%
DowDuPont 24% Mondelez 2% Visa 10%
Electronic Arts 2% Meredith 25% Valero Energy 9%
eBay 0% Metropolitan Life pushed Weyerhaeuser -11%
Estee Lauder 6% Altria Group 14% US Steel 12%
Equity Residential -58% Merck & Company 4% Exxon Mobil -17%
FaceBook 12% Microsoft 12% Xerox 11%

 

Last week, the primary focus of earnings reports was large technology. Amazon turned in the best performance, beating estimates by 17 percent as online sales skyrocketed around the holiday shopping season. Facebook tied for second, besting expectations by 12 percent as ad revenue picked up, despite a downward trend in usage. Microsoft was the other part of the tie for second as the company beat expectations by 12 percent, thanks to a strong boost from its web services group. Apple posted good gains, beating expectations by 2 percent. However, it sold 3 million fewer iPhone during the quarter than was expected, causing the stock to decline following the announcement. Google (Alphabet—its official name in the above table) missed expectations last week by about 4 percent, having a snow ball effect on the technology sector on Friday as the stock was down nearly 5 percent. Visa and Mastercard both reported figures that indicated that the US consumer is becoming more confident, somewhat validating the other consumer sentiment figures that have been coming out over the past few weeks. Nintendo had a standout quarter for the fourth quarter of 2017 as its new Switch gaming system was one of the hottest trending Christmas gifts of the year. Big oil last week posted very mixed results with Exxon and Chevron both missing expectations by double digits, while Phillips 66 beat expectations by 24 percent. Equity Residential (the largest apartment operator in the US) badly missed earnings expectations by 58 percent last week as changes in the corporate tax code required the company to take a large one time hit.

 

According to Factset, we have seen 253 (50 percent) of the S&P 500 companies release results for the fourth quarter of 2017. Of the 253 companies that have released earnings, 75 percent have beaten earnings estimates, while 9 percent have met expectations and 16 percent have fallen short of expectations. When looking at revenue, of the companies that have reported, 80 percent of the companies have beaten estimates, while 20 percent have fallen short. The 80 percent of companies beating revenue expectations represents the highest percentage of companies beating revenues estimates since Factset started calculating the figure back in the third quarter of 2008. The overall blended earnings growth rate for the S&P 500 strongly rebounded last week and now stands at 13.4 percent. Of the 50 companies that have issued forward looking guidance at the same time they released their latest earnings figures, half have revised earnings higher for the future and half have revised earnings lower.

 

This week is the peak week for the fourth quarter 2017 earnings season as we see the maximum number of companies reporting their earnings this week at 550 companies. After this week, we will see the slowdown in the number of companies reporting and the significance of the earnings being reported as we begin to draw the reporting season to a close. The table below shows the companies that will be releasing their earnings this week with those that have the greatest potential to move the markets highlighted in green:

 

Arrow Electronics Goodyear Tire & Rubber Rayonier
Bristol-Myers Squibb Hain Celestial Group Sally Beauty
BP Hanesbrands SNAP INC
Buffalo Wild Wings Humana Sanofi-Aventis
Church & Dwight Intercontinental Exchange Statoil
Chipotle Mexican Grill Jack Henry & Associates Sysco
Walt Disney Kellogg Toyota Motor
Callaway Golf Nvidia Tesla Motors
Edgewell Personal Care O’Reilly Automotive Tyson Foods
Twenty-First Century Fox Philip Morris International Twitter
Gilead Sciences Prudential Financial Xcel Energy
General Motors Republic Services Yum Brands
Glaxo SmithKline Ryanair Zillow Group

 

This week, the focus of earnings will be on large pharmaceutical companies as there are many of the large international players within the sector reporting their earnings. One area that will surely be a hot topic on the earnings calls for these companies will be the current US administration’s threat to lower drug prices and the actions the companies are taking to counter this action. Auto manufactures Tesla and General Motors will draw the spotlight this week as investors eagerly await the production figures from both companies. Tesla looks to be at risk of missing its production and delivery estimates this quarter as rumors flew during the quarter about production issues at its facilities as well as a general shortage of batteries. Walt Disney is always a good proxy for how confident US consumers are as the company has very wide-ranging business operations. ESPN is one spot analysts always monitor closely in earnings results for the company as it has been a drag on Disney since it was acquired.

 

Global news impacting the markets:

 

There was little of substance in the global financial media last week as traders and investors around the world were watching the US financial markets throughout the week and taking cues from their movements. Overall, the economic data that came out in the Eurozone and Japan signaled slow and continued growth. A little manufacturing data came out of China late in the week last week that signaled that manufacturing activity was starting to slow down a little, but not by a significant amount. The rise in bond yields as bond prices declined was seen around the world last week as investors seemed to become more aware of what it may mean for the US to speed up its rate hikes in 2018 while much of the rest of the world is still in full monetary easing policy mode.

 

Hybrid model performance and update

For the trading week ending on 2/2/2018, returns in the hybrid and quant hypothetical models* (net of a 1% annual management fee) were as follows:

 

  Last Week 2018 YTD Since 6/30/2015

(Annualized)

Aggressive Model -3.24% 0.91% 7.08%
Aggressive Benchmark -3.08% 3.25% 8.31%
Growth Model -2.84% 1.04% 6.18%
Growth Benchmark -2.39% 2.54% 6.61%
Moderate Model -2.39% 1.16% 5.00%
Moderate Benchmark -1.71% 1.84% 4.89%
Income Model -2.34% 1.09% 4.48%
Income Benchmark -0.84% 0.98% 2.70%
Quant Model -3.47% -0.02%
S&P 500 -3.85% 3.31% 11.90%

*Model performance does not represent any specific account performance but rather a model of holdings based on risk levels that are like my actual holdings, the hypothetical models are rebalanced daily to model targets.

 

Last week there was a significant amount of change in the hybrid models as several of the holdings’ trailing stop triggers hit during the week. The first change last week was a trailing stop trigger that hit on the Guggenheim Mid Cap Pure Value ETF (RFV), which was tripped on Tuesday. The proceeds from the sale were put into cash. On Friday, triggers were hit on multiple holdings through the day and sold very close to when triggers were hit, saving some further downside movement on each of the holdings that occurred on Friday. The funds that were sold included Guggenheim S&P 500 Pure Value (RPV), Schwab Large Cap growth (SCHG), Guggenheim Materials (RTM), SPDR Barclays Convertibles (CWB), Powershares DWA Momentum fund (PDP) and half of the positions in emerging markets through either DXELX or SFENX, depending on model. All the proceeds from the sales were moved to cash. In aggregate, all the hybrid models went from fully invested to start the week to between 18 and 25 percent cash at the end of the week. We are also very close on several other trailing stops on a few of the remaining positions within the models. At the current time, with the markets’ confidence likely to be tested over the coming several weeks, it looks most pertinent to maintain an elevated cash position to fund further purchases should the market bottom out and start back upward. Even with the declines last week, all of the investments on my watch list for potential investment are still significantly over valued.

 

Considering the outsized market movements of today (Monday, 2/5/18), I just wanted to add that a few more positions did hit their trail stops and were sold throughout the day, prior to the water fall decline seen toward the close. The signals were also received, and acted on intraday, that it was time to apply a small partial hedging position to offset some of the potential downside that the individual stocks hold. Overall, while the hybrid models did decline today, they did so significantly less than the overall markets. Closing out the day, cash positions had been increased to between 26 and 36 percent. More on what looks to be turning out to be an interesting week for the markets in next week’s commentary.

 

Market Statistics:

 

Index Change Volume
Dow -2.85% Above Average
NASDAQ -3.53% Average
S&P 500 -3.85% Average

 

What a difference one week can make. Last week this section of the commentary was about the bull market extending its run even further on higher than expected volume. This week, volume came back to about average and the equity markets fell significantly, leading some to question if we have seen the start of the end of the bull markets. Overall, the three major US indexes gave back about half of what they had made so far during 2018 last week and volatility in the equity markets returned.

 

The following were the top 5 and bottom 5 performing sectors over the course of the previous week:

 

Top 5 Sectors Change   Bottom 5 Sectors Change
Multimedia Networking 0.70%   Pharmaceuticals -6.28%
Regional Banks -1.04%   Natural Resources -6.42%
Gold -1.31%   Energy -6.65%
Broker Dealers -1.48%   Oil & Gas Exploration -7.18%
Aerospace & Defense -1.85%   Home Construction -7.58%

 

Multimedia Networking was the only equity sector of the markets to post a gain last week as the sector was on the positive side of news out of Washington DC. Interest in building and securing a 5G network nationally has now come up several times in Washington DC and each time it does the networking stocks jump higher as the expansion will cost billions of dollars and lead to higher profits for those companies involved. Regional Banks and financial Broker Dealers both made the top performing list as they lost less than other sectors due to the increasing odds of four rate hikes during 2018 and the slight increase in inflation seen last week. The safe haven investment sector of Gold made the top performing sectors last week as investors moved into the precious metal as a form of safety. Aerospace and Defense rounded out the top performing sectors last week as the sector is largely funded by governments around the world and most of the time is seen as not highly correlated to short term downward movements of the financial markets. On the negative side of performance last week, the worst performance was found in Home Builders as the sector declined by more than 7.5 percent on the idea that raising rates at the Fed could price some would-be buyers out of the home purchasing market. The next three in the bottom performing sectors were natural resource/energy related as global demand for oil came in lower than anticipated last week with downward pressure further compounded by investors pulling profits out of sectors that had been performing well in the recent past. Pharmaceuticals made the negative list last week after President Trump specifically hit out at the industry’s pricing practices in his State of the Union address last week.

 

Fixed income was no hiding spot last week as the equity markets declined. The long end of the fixed income markets (30 years+) declined by more than 3 percent as the bonds turned out to be highly correlated to equity markets. The middle of the yield curve also took a hit, falling by more than 1.3 percent while the short end of the curve held relatively steady, gaining 0.02 percent for the week. This strong correlation between stock movements and bond movements is troubling as it indicates that if the market were to fall meaningfully because of rising interest rates on bonds, they will not be a safe asset to invest in to protect on the downside, as classical modern portfolio theory (MPT) would suggest and as many retirees are counting on with their retirement accounts.

 

Fixed Income Change
Long (20+ years) -3.04%
Middle (7-10 years) -1.33%
Short (less than 1 year) 0.02%
TIPS -0.86%

 

Best and Worst Currencies Change
US Dollar 0.04%
Venezuela bolivar 4.86%
South Korea won -2.36%

 

 

Overall, the US dollar had an uneventful week, increasing by 0.04 percent last week against the value of a basket of foreign currencies. Despite the small gain last week in the dollar, it was still a gain and the first such weekly move that we have seen in 2018. The best performing currency last week was found in Venezuela and was the Bolivar, which gained 4.86 percent; the gain is almost exactly the amount that the Bolivar was down two weeks ago. The South Korea won was the worst performing currency globally, last week falling by 2.36 percent, as the country tries to combat the rise of cryptocurrencies and the ever present unknown situation going on with its northern neighbor.

 

Commodities were mixed over the course of the previous week as oil declined and soft commodities increased:

Metals Change   Commodity Change
Gold -1.31%   GS Commodity Index -1.69%
Silver -4.57%   Oil -1.51%
Copper -0.69%   Livestock 0.55%
      Grains 0.76%
      Agriculture 0.42%

 

The GS Commodity index decreased 1.69 percent last week in movements that looked tame when compared to the overall US equity markets, which is a rare phenomenon. Oil declined by 1.51 percent for the week last week as global demand subsided slightly and as news emerged that US oil production could be the highest of any country globally during 2018. Gold, Silver and Copper all posted declines last week, decreasing by 1.31, 4.57 and 0.69 percent, respectively. Soft commodities were positive last week as Livestock increased 0.55 percent, while Agriculture overall increased by 0.42 percent and Grains posted a gain of 0.76 percent.

 

Top 2 Indexes Country Change   Bottom 2 Indexes Country Change
S & P/NZX 50 New Zealand 1.25%   OMX Copenhagen Denmark -6.35%
S & P/ASX 200 Australia 1.18%   Merval Argentina -7.15%

Last week was a difficult week for the global stock indexes, with only 11 percent of the global markets posting gains (that is six indexes in total representing five countries). New Zealand saw the largest gains last week as the main NZX 50 index posted a gain of 1.23 percent for the week. The difference between New Zealand and Australia’s performance and the US last week was Friday’s market movement in the US. With New Zealand and Australia having some of the first indexes to close on any trading day, the indexes were already fully closed before the US markets fell on Friday. On the negative side, Argentina’s Merval index posted the largest decline globally last week as it declined by 7.15 percent. The decline in the Merval was seen because of a surprise cut of 0.75 percent by the central bank of Argentina. This cut in rates comes at a time when inflation is already running higher than economists in the country would like to see, putting the central bank policy at odds with the overall movement of the economy.

After such a boring week two weeks ago when the VIX moved less than two percent, last week was the opposite with the VIX spiking higher. For the week, the VIX gained 56.23 percent, a somewhat rare move of gaining more than 50 percent for a single week. The last time we saw an increase greater than the jump last week was the week of December 11th, 2015, a week that the VIX gained 65 percent. Looking all the way back to 2002 there have only been nine occurrences of the VIX gaining more than 50 percent, including last week. What happens historically after such a significant increase in the VIX? Typically, the VIX falls back a little in the immediate aftermath of the increase as it overshoots to the upside. However, the VIX tends to cluster, meaning that once there is one large spike, there are typically several additional large movements in the following months as volatility remains top of mind for many investors. The current reading of 17.31 implies that a move of 5 percent is likely to occur over the next 30 days. As always, the direction of the move over the next 30 days is unknown.

Economic Release Calendar:

 

Last week, the economic news releases focused on employment and inflation in the US, with only a single release coming in significantly above or below market expectations:

 

Economic Impact Date Economic News Release Date Range Actual Expectation
Neutral 1/29/2018 Personal Income December 2017 0.40% 0.40%
Slightly Negative 1/29/2018 Personal Spending December 2017 0.40% 0.50%
Neutral 1/29/2018 PCE Prices December 2017 0.10% 0.20%
Neutral 1/29/2018 PCE Prices – Core December 2017 0.20% 0.20%
Slightly Positive 1/30/2018 Consumer Confidence January 2018 125.4 124
Positive 1/31/2018 Chicago PMI January 2018 65.7 61
Neutral 1/31/2018 FOMC Rate Decision January 2018 1.375% 1.375%
Neutral 2/1/2018 ISM Index January 2018 59.1 58.5
Neutral 2/2/2018 Nonfarm Payrolls January 2018 200K 180K
Neutral 2/2/2018 Nonfarm Private Payrolls January 2018 196K 175K
Neutral 2/2/2018 Unemployment Rate January 2018 4.10% 4.10%
Neutral 2/2/2018 Avg. Hourly Earnings January 2018 0.30% 0.30%
Neutral 2/2/2018 University of Michigan Consumer Sentiment Index January 2018 95.7 95

Data for table from Econoday.com, Bloomberg and Yahoo Finance

 

Last week, the economic news releases started on Monday with the release of personal income and spending for the month of December. Both income and spending posted gains of 0.4 percent last week in a small sign that inflation may be on the horizon, a little faster than some economists had been expecting. Also released on Monday was the latest reading on PCE prices, both overall and core, which posted small but positive gains in prices during the month of December. On Tuesday, consumer confidence as measured by the US government was released and indicated a slight uptick in confidence during January, a trend that looks to be continuing from the end of 2017. On Wednesday, the final FOMC meeting being chaired by Janet Yellen took place and ended with no rate hike. This lack of movement on the Fed funds rate was fully anticipated by the markets, and there were very few changes to the Fed statement, so this did not rattle the markets ahead of the handover of Chairmanship at the Fed. Largely being overshadowed on Wednesday was the latest release of the Chicago area PMI, which handedly beat market expectations as manufacturing activity picked up faster than expected. On Thursday, the overall ISM index for the month of January was released and posted a slight increase from the December levels, but not a large enough increase for the market to react. Friday was a busy day for economic news releases as all the standard employment related data for the month of January was released by the government. Both payroll figures came in better than anticipated, but not in a large way. Overall, the unemployment rate in the US remained at 4.1 percent. Average hourly earnings and the overall wage growth seen in the report was the real story as average hourly wages increase by 0.3 percent. This may not seem like much of an increase, but the overall dollar wage in the US hit a multiyear high with the small gain. This caused a lot of concern in the financial markets as wage growth directly impacts inflation and, in most cases, pushes prices higher. Last week wrapped up on Friday with the release of the University of Michigan’s Consumer Sentiment Index for the month of January (final estimate), which came in very close to market expectations and was ignored as the financial media focused in on the declines taking place on the market throughout the day.

 

After such a busy week last week on the economic front, this week there is only a single release and it is highly unlikely that it will have any impact on the overall markets when it is released:

 

Date Release Release Range Market Expectation
2/5/2018 ISM Services January 2018 56.7

Data for table from Econoday.com, Bloomberg and Yahoo Finance

 

The only economic news release this week is released on Monday and is the services side of the ISM index, which is expected to post a slight increase in non-manufacturing activity during the month of January.  With the hand-off at the Federal Reserve having been completed, the markets, lacking economic news releases, will likely focus on the seven speeches being given by Fed officials this week. Any speeches or comments given by new Fed Chairman Jerome Powell will surely garner the full attention of the financial markets and, in particular, the bond market this week.

 

Interesting FactSuper Bowl 52

 

Super Bowl 52 was a very exciting game between the Philadelphia Eagles and the New England Patriots, with many records falling throughout the night. In total, there were 52 records that were either tied or broken surrounding the game. Some of the most notable were:

  • 1,151 total yards of offense between the two teams; the highest of any game
  • Nick Foles became the first quarterback to catch a touchdown pass in the Super Bowl
  • Tom Brady threw for 505 yards; the most in a postseason game ever
  • New England did not punt once
  • The average gain for a passing play during the game was 8.5 yards
  • The average gain on running plays for the game was 5 yards
  • Lastly, Philadelphia finally won a Super Bowl and moved off the list of now 12 teams that have never won a Super Bowl

 

Source: sbnation.com

For a PDF version of the below commentary please click here Weekly Letter 1-29-2018

Commentary quick take:

 

  • Major developments:
    • Bull market continues to pick up steam
    • US government is open again, temporarily
    • Interestingly no change in volatility last week
    • NASDAQ 10,000?

 

  • US:
    • The US government is reopened—for now
    • 4th Quarter Earnings Season
      • 24 percent complete
      • 81 percent of companies beating revenue estimates
      • Blended earnings recovered—with an accounting change

 

  • Global:
    • World Economic Forum in Davos, Switzerland
    • IMF upgraded global growth for 2018 and 2019
    • Central banks delayed actions
    • Can China’s economic number be believed?

 

  • Hybrid investments strategy update:
    • No changes last week
    • Models remain fully invested

 

  • This week for the markets:
    • Earnings season rolls onward
    • Fed Chair Yellen’s last FOMC meeting

 

  • Interesting Fact: IKEA’s Ingvar Kamprad

Major theme of the markets last week: Earnings helped to continue the markets’ bull run!

This section of the weekly market commentary is starting to sound like a broken record as almost every week for the past two months the cartoon of the week has related to the extraordinary run of the bull markets. While the bull run that we have seen has been fun, it may behoove everyone to take a step back and think about just how fast the markets have been running recently. There have been 18 trading days so far in 2018 with only five days of negative performance on both the Dow and the NASDAQ, while the S&P 500 has seen only four days of negative performance. The returns so far in 2018 have been the strongest start to a year that we have seen in a very long time on the major US indexes. The S&P 500 is the laggard of the three main indexes with a gain of only 7.45 percent so far, this year. If this rate of return is extrapolated out through the end of 2018 it would see the S&P 500 gaining 173 percent and taking it to a level around 4,640 by year end. The Dow is the middle performer so far in 2018, gaining 7.68 percent. If this return is run through the end of 2018, it would see the Dow increase by some 182 percent, taking it all the way up to almost 45,000 by year end. The NASDAQ, as in normally the case in a bull market, is running the hottest, gaining 8.73 percent so far this year. If this rate of return is extrapolated out through the end of 2018 it would see the NASDAQ gaining 223 percent, taking it to a level around 15,366 by year end. I imagine that the day the NASDAQ crosses over 10,000 will be a very celebratory day down on Wall Street! While the run so far this year has been fun, it certainly will not continue at this pace. The US economy is simply not growing fast enough, if it ever has grown fast enough, to justify such lofty movement in a single year. Accounting changes and the hopes of corporate America wisely using their tax law change windfalls along with sheer investor hope and optimism is all that is driving these markets. If, for a second, we think about what triple digit gains on the main indexes would mean to the US economy, we would likely see double digit inflation very quickly, the Fed way behind the curve on rates and forced into some significant rate hikes and Donald Trump taking the credit for the whole thing. This cannot last and we do appear to be in a “too good to be true” scenario with the current market movements—but cheer for NASDAQ 10,000!

 

US news impacting the financial markets:

Last week, the US financial markets opened on Monday, while the US government remained closed. It became very quickly apparent that a deal would be made on Monday to reopen the US government. The Senate managed to pass a bill that funded the government through February 8th, which was voted on and passed by the House of Representatives and then signed by President Trump on Monday night. This bill is known as a short term stop gap measure in that it is only good for three weeks and allows the government to continue paying its bills and workers during that time. However, a longer lasting continuing resolution or maybe even an actual budget for fiscal year 2018 remained elusive in the negotiations. The financial markets here in the US and around the world paid almost no attention at all to the government shutdown this time around and will be unlikely to pay any attention to future shutdowns as desensitization seems to have occurred on this subject. However, the government shutting down will likely play a role in the upcoming midterm election held later this year as Democrats attempt to make it look like it was the fault of the Republicans and Republicans try to make it look like it was the fault of the Democrats. The elections later this year could have a material impact on the markets if it looks like the Democrats will pick up a significant number of seats, thus breaking the one party in control of Washington DC power play that the Republicans currently enjoy. Meanwhile, the markets really liked the corporate earnings released for the fourth quarter of 2018.

 

Last week was the third week of the fourth quarter 2017 earnings season and we got to see the results from a much broader range of sectors and industries than we saw in the first two weeks of reporting. Below is a table of the well-known companies that released earnings last week with earnings that missed expectations highlighted in red, while earnings that beat expectations by more than 10 percent are highlighted in green:

 

American Airlines 3% Halliburton 15% Progressive 3%
Abbott Laboratories 1% Honeywell 1% Royal Caribbean 12%
Arthur J Gallagher 9% Intel 26% Raytheon 1%
Baker Hughes 7% J&J Snack Foods pushed Starbucks 14%
Biogen Idec -3% Johnson & Johnson 1% Sherwin-Williams -7%
Caterpillar 22% Kimberly-Clark 2% Stanley Black & Decker 2%
Celgene 3% Southwest Airlines 1% Texas Instruments 0%
Colgate-Palmolive 0% Las Vegas Sands 14% Union Pacific -1%
Comcast 4% McCormick 1% United Rentals 0%
Canadian National Railway -4% 3M Company 3% United Technologies 3%
Capital One Financial -10% Netflix 0% Verizon -2%
Ford Motor -7% Northrop Grumman 3% Western Digital 4%
General Dynamics 5% Norfolk Southern 8% Whirlpool 2%
General Electric -4% Procter & Gamble 3% Wynn Resorts 3%

 

Many of the stocks listed in the above table moved higher last week regardless of what they reported on earnings as the bull market that has gripped the US markets continued to run higher last week. Intel saw the highest surprise last week in the above table as the fourth quarter of 2017 was a strong quarter for sales and the latest mobile devices helped propel sales higher. Starbucks also had a big quarter during the fourth quarter as sales helped boost its bottom line, especially of gift cards for the holidays.. Transportation as a sector did not have a good week last week as United announced that it thinks there will likely be an airfare war in 2018 and the rail lines reported a difficult fourth quarter, as is seen above with Union Pacific and Canadian National Railway. Most of the consumer product-based companies above, including Johnson & Johnson, Kimberly-Clark and Colgate-Palmolive; all posted modest beats on earnings, thanks to increased sales during the fourth quarter. Netflix, the first of the mega technology companies to report their fourth quarter figures, came in almost exactly in line with markets expectations. However, their subscriber growth rates for the quarter jumped off the chart and the stock pushed higher by more than 10 percent on the day after earnings were reported.

 

According to Factset, we have seen 121 (24 percent) of the S&P 500 companies release results for the fourth quarter of 2017. Of the 121 companies that have released earnings, 76 percent have beaten earnings estimates, while 8 percent have met expectations and 16 percent have fallen short of expectations. When looking at revenue, of the companies that have reported, 81 percent of the companies have beaten estimates, while 19 percent have fallen short. The overall blended earnings growth rate for the S&P 500 strongly rebounded last week and now stands at 12 percent. However, much of this increase was due to an accounting change by Factset in how it is accounting for the one-time tax hits that many American companies are taking during the fourth quarter of 2017. Factset decided to essentially ignore the tax hit all together and calculate the earnings growth rates on a forward basis. I’m not certain this is the best way that it should have been done, but it was done the same way at all the other major financial reporting companies such as Zach’s, S&P and Moody’s.

 

The number of companies reporting earnings continues to pick up this week with more than 450 companies reporting results. The table below shows the companies that will be releasing their earnings this week with those that have the greatest potential to move the markets highlighted in green:

 

Apple Alphabet Nintendo
AFLAC Honda Motor Nucor
Amgen Harley-Davidson Pfizer
Amazon Hershey Phillips 66
Anthem Ingersoll-Rand PayPal
Astrazeneca Johnson Controls Ferrari
Boeing J&J Snack Foods Polo Ralph Lauren
Alibaba Group Eli Lilly & Company Sprint
Clorox Lockheed Martin Stryker
ConocoPhillips Mastercard AT&T
Chevron McDonald’s Time Warner
DR Horton McKesson UPS
DowDuPont Mondelez Visa
Electronic Arts Meredith Valero Energy
eBay Metropolitan Life Weyerhaeuser
Estee Lauder Altria Group US Steel
Equity Residential Merck & Company Exxon Mobil
FaceBook Microsoft Xerox

 

This week is all about big technology as Alphabet (Google to most people), Apple, Microsoft, Facebook, Amazon and Alibaba all report their fourth quarter results. With the strong preliminary figures surrounding Black Friday and Cyber Monday, it seems possible that Amazon posts a blow out quarter. For Alibaba, the fourth quarter of 2017 held its very important singles day, which smashed all kinds of online sales records and could propel a strong quarter for the company as well. Apple was a little slow on its new phone adoptions during the quarter from preliminary numbers, but the company seems to always find a way to make their estimates. Visa and Mastercard will be closely watched by Wall Street for signs of the strength of the US consumer as the two companies’ credit card operations cover almost anyone in the US who uses a credit card. McDonald’s has a large task ahead of it to beat analyst’s expectations this time around as the company has been undergoing some meaningful changes that could show a little bit of a lag in adoption by consumers during the fourth quarter of 2017. Finally, this week Wall Street will be closely watching the performance of US Steel as steel trade has become a hot button issue around the world as the US has looked at adding massive tariffs to foreign steel that is being imported into the US; “trades wars” seemed to be one of the most popular phrases out of the World Economic Forum in Davos, Switzerland last week.

 

Global news impacting the markets:

 

Last week was the annual World Economic Forum (WEF) in Davos, Switzerland, a gathering that brings together numerous heads of corporations from around the world as well as global and academic thought leaders to discuss a wide range of economic related topics over four days. At the meeting, the IMF always releases its updated guidance for global growth as well as any key changes to individual country growth projections that may have occurred since the previous update in October. During this update, the IMF increased its outlooks for the US and China for 2018 and 2019. In total, the IMF now expects the global economy to grow at a rate of 3.9 percent up 0.2 percent from their previous estimates. The IMF said the US increase was “due to sweeping tax cuts,” but warned that US growth from the tax cuts would likely fade in 2022 as the tax cuts to individuals expire. One of the other main topics of the WEF this year was global trade, as leaders from all over the world tried to show a unified face against protectionist trade policies around the world. This was done likely because President Trump attended part of the Davos meetings and gave the closing address. The speech, titled “America First Does Not Mean America Alone,” had some attendees nervous about what President Trump may say, and the US financial markets were watching closely with import and export companies seeing the most movement before the speech. President Trump emphasized the idea that the US supports free trade, but that it must also be fair trade. There were a few barbs thrown in at countries such as Iran, but overall, most people who watched or read the President’s speech got the feeling that President Trump truly does want the US to strengthen and he is willing to do so with the help of other countries.

 

While the WEF was taking place, there were also other economic focused meetings happening around the world with the two most pertinent being an ECB meeting and a rate setting meeting at the Bank of Japan (BoJ). Both meetings, as expected, resulted in no changes to interest rates. In his press conference following the BoJ meeting, Governor Kuroda called out growth in corporate earnings as well as household income as reasons for the BoJ to be thinking about the time when interest rates will finally flip from the negative 0.1 percent that they are currently at back to positive rates. However, he warned that inflation remains stubbornly below the 2 percent target rate in Japan, much like it does in the US economy. The ECB also left rates alone at the meeting last week, which are at least a positive 0.25 percent. One interesting aspect of the press conference that ECB President Mario Draghi spoke about at length was the strength of the Euro versus the US dollar. The US dollar has been pushing lower over the past several months as fears of trade wars led by the US has put downward pressure on the currency. However, a strong Euro versus the US dollar presents an interesting problem for the ECB as it hurts exporters, which are the primary driving force of economic growth in key countries such as Germany, France and Spain. However, exchange rates are something that central banks have very little ability to control and thus they present a risk going forward.

 

China also made a few headlines last week as more and more information about potential cheating on economic growth figures by outlying provinces are starting to be revised downward in big ways. Last year, the Liaoning province announced that it had cheated on its growth figures and punished those involved in the cheating. Earlier this year, Inner Mongolia province announced essentially the same thing and, last week, Tianjin made its embarrassing announcement. These revisions are not small amounts. Liaoning admitted to inflating figures by 20 percent for four years. Inner Mongolia cheated by between 25 and 40 percent in just 2016 and Tianjin cut its 2016 growth number by more than 30 percent. This province was one of the fast and highly regarded regions as it had been reported to have grown by 14 percent per year from 2002 through 2016. While fraudulent growth reporting is nothing new in China, the level to which they are saying they cheated is eye opening. Much like most of the previous negative news about China, however, this revelation was largely ignored by the global financial markets as they marched onward last week.

 

Hybrid model performance and update

For the trading week ending on 1/26/2018, returns in the hybrid and quant hypothetical models* (net of a 1% annual management fee) were as follows:

 

  Last Week 2018 YTD Since 6/30/2015
Aggressive Model 1.54% 4.31% 23.92%
Aggressive Benchmark 1.84% 6.53% 26.92%
Growth Model 1.46% 4.01% 20.68%
Growth Benchmark 1.43% 5.06% 20.97%
Moderate Model 1.34% 3.66% 16.65%
Moderate Benchmark 1.03% 3.62% 15.15%
Income Model 1.33% 3.54% 15.07%
Income Benchmark 0.53% 1.84% 8.07%
Quant Model 1.29% 3.60%
S&P 500 2.23% 7.45% 39.25%

*Model performance does not represent any specific account performance but rather a model of holdings based on risk levels that are like my actual holdings, the hypothetical models are rebalanced daily to model targets.

 

There were no changes to the hybrid models over the course of the previous week, as many of the stocks in the models continued to run at an amazing pace. Last week, we had five positions gain more than six percent, with the top performing position being Arthur J Gallagher as it jumped 9.6 percent, thanks to a strong earnings surprise, and raised its forward guidance. The hybrid models all remain nearly fully invested. There were no trailing stops hit during the week, while there were numerous all-time highs hit on various holdings.

 

Market Statistics:

 

Index Change Volume
NASDAQ 2.31% Above Average
S&P 500 2.23% Above Average
Dow 2.09% Above Average

 

With earnings season in full swing and the bull market pushing higher last week, it was not surprising to see that the volume was above average on all three of the major US indexes. The order of performance last week was also not surprising as the NASDAQ typically leads the way higher as the stocks in the index are more volatile than other indexes. The S&P 500 was in the middle, as usual, in a strong upward moving week and the Dow brought up the rear in terms of performance, despite getting a significant bump from Intel on Friday as the stock was up more than 10 percent.

 

The following were the top 5 and bottom 5 performing sectors over the course of the previous week:

 

Top 5 Sectors Change   Bottom 5 Sectors Change
Biotechnology 5.39%   Multimedia Networking -0.06%
Healthcare 3.80%   Global Real Estate -0.53%
Medical Devices 3.78%   Semiconductors -0.54%
Consumer Service 2.90%   Transportation -1.72%
Pharmaceuticals 2.88%   Home Construction -2.67%

 

There was strong movement in the NASDAQ as investors wanting to increase exposure to risky assets helped directly propel three of the top five performing sectors last week, those being Biotechnology, Medical Devices and Pharmaceuticals. Strong performance in those three sectors also drove overall strong performance in the more broad Healthcare sector, which turned in the second best performance of the week. Consumer Services rounded out the top five performing sectors thanks to a few key earnings surprises that pushed the relatively small sector higher. On the downside last week, the Home Construction sector led the way lower as investors seemed to be pulling profits made over the past few weeks in the sector. Transportation moved noticeably lower, thanks to a significant decline in the airline stocks as United Airlines warned of fare compression due to increasing competition around the US. The performance of Semiconductors last week was surprising, especially with such a large move in Intel on Friday, but fears of global trade wars seemed to overpower the positive news about the sector last week. Global Real Estate came next in the list of negative performing sectors last week as investors moved away from the tradition safety of the sector. Multimedia Networking rounded out the list last week with very little movement overall for the week.

 

Overall, trading in government bonds was back to normal levels last week as the US was back to a full five-day trading week:

 

Fixed Income Change
Long (20+ years) 0.43%
Middle (7-10 years) -0.02%
Short (less than 1 year) 0.04%
TIPS 0.15%

 

Best and Worst Currencies Change
US Dollar -1.65%
Switzerland franc 3.41%
Venezuela bolivar -4.63%

 

 

Overall, the US dollar decreased by 1.65 percent last week against the value of a basket of foreign currencies, as the Euro in particular had a big impact on the US dollar as it climbed to a three year high. Last week was the fourth week in a row of declines for the US dollar as we have yet to see gains on a weekly basis in 2018. The best performing currency last week was found in Switzerland and was the Franc, which gained 3.41 percent; maybe it was just that many of the world’s most wealthy people were in Davos spending money. The worst performing currency last week is no stranger to the list and was found in Venezuela, the Bolivar. President Maduro called for the election that was supposed to be held later this year to be sped up as he looks very likely to win. It is difficult for any of his political opponents to launch any significant challenge to his power as most are either banned from running for political office, in jail, missing or living in self imposed exile out of the country.

 

Commodities were all positive over the course of the previous week as oil rebounded:

Metals Change   Commodity Change
Gold 1.31%   GS Commodity Index 2.75%
Silver 2.24%   Oil 4.09%
Copper 0.41%   Livestock 0.17%
      Grains 2.36%
      Agriculture 1.40%

 

The GS Commodity index increased 2.75 percent last week thanks in large part to a significant gain in the price of oil. Oil jumped a little more than four percent last week, as global reserves came in slightly lower than expected. Gold, Silver and Copper all posted gains last week, increasing by 1.31, 2.24 and 0.14 percent, respectively. Soft commodities were positive last week as Livestock increased 0.17 percent, while Agriculture overall increased by 1.40 percent and Grains posted a gain of 2.36 percent.

 

Top 2 Indexes Country Change   Bottom 2 Indexes Country Change
Sao Paulo Bovespa Brazil 5.31%   All-Shares Norway -0.99%
BIST 100 Turkey 4.82%   OMX Helsinki Finland -1.06%

Last week was a mixed week for the global stock indexes, with 67 percent of the global markets posting gains. Brazil saw the largest gains with the Sao Paulo based Bovespa index posting a gain of 5.31 percent for the week as the country gets ready for another round of political elections. On the negative side, Finland posted the largest decline globally last week as it declined by 1.06 percent. Other Nordic region countries such as Norway and Denmark also had difficult weeks last week as the strengthening of the Euro had a negative impact on the region as they are not on the Euro for their currencies.

The VIX last week saw the least amount of movement that we have seen on the index since the middle of October 2017. Overall, the VIX declined 1.69 percent for the week as the fear gauge didn’t measure much of a change given the large amount of gains seen on the equity indexes. The current reading of 11.08 implies that a move of 3.20 percent is likely to occur over the next 30 days. As always, the direction of the move over the next 30 days is unknown.

Economic Release Calendar:

 

Last week, the economic news releases focused on GDP and durable goods orders, with only a single release coming in significantly above or below market expectations:

 

Economic Impact Date Economic News Release Date Range Actual Expectation
Neutral 1/24/2018 Existing Home Sales December 2017 5.6M 5.7M
Neutral 1/25/2018 New Home Sales December 2017 625K 680K
Negative 1/26/2018 GDP-Advanced Estimate Q4 2017 2.6% 2.9%
Positive 1/26/2018 Durable Orders December 2017 2.9% 0.9%
Neutral 1/26/2018 Durable Goods –ex transportation December 2017 0.6% 0.6%

Data for table from Econoday.com, Bloomberg and Yahoo Finance

 

Last week, the economic news releases started on Wednesday as the existing home sales figure for the month of December was released, coming in very close to market expectations. On Thursday, new home sales came in below market expectations, but not by enough to cause any alarm. On Friday, the big releases of the week were released with the first being the estimate of fourth quarter GDP for the US, which was expected to come in at 2.9 percent and missed expectations, coming in at 2.6 percent growth. With the 2.6 percent print being below expectations, it will make the growth of the US economy in 2018 more heavily dependent on the tax reform actually causing companies to increase spending during the year to hit the government year-end growth targets. Durable goods orders for the month of December, both including and excluding transportation, were also released on Friday with overall durable goods orders coming in significantly higher than expectations at 2.9 percent versus the expected 0.9 percent. Nearly all of the increase, however, was a few very large plane orders from the Middle East to US airlines manufacturers. Durable goods orders excluding transportation came in exactly in line with market expectations at 0.6 percent growth during the month of December.

 

This week, the economic news releases pick up significantly as it is employment week in the US combined with the January FOMC meeting. The releases with the greatest potential to impact the markets are highlighted in green below:

 

Date Release Release Range Market Expectation
1/29/2018 Personal Income December 2017 0.40%
1/29/2018 Personal Spending December 2017 0.50%
1/29/2018 PCE Prices December 2017 0.20%
1/29/2018 PCE Prices – Core December 2017 0.20%
1/30/2018 Consumer Confidence January 2018 124
1/31/2018 Chicago PMI January 2018 61
1/31/2018 FOMC Rate Decision January 2018 1.38%
2/1/2018 ISM Index January 2018 58.5
2/2/2018 Nonfarm Payrolls January 2018 180K
2/2/2018 Nonfarm Private Payrolls January 2018 175K
2/2/2018 Unemployment Rate January 2018 4.10%
2/2/2018 Avg. Hourly Earnings January 2018 0.30%
2/2/2018 University of Michigan Consumer Sentiment Index January 2018 95

Data for table from Econoday.com, Bloomberg and Yahoo Finance

 

This week, the economic news releases start on Monday with the release of personal income and spending for the month of December. These two releases are a bit stale at this point, but they could reaffirm the expected strong holiday sales and maybe even some of the year-end holiday bonuses that were announced. Also released on Monday is the latest reading of PCE prices, both overall and core, which are significant since they are some of the key factors in the Fed’s look at inflation levels in the US when making rate decisions. On Tuesday, consumer confidence as measured by the US government is set to be released and expectations are for a little rebound from the decline seen in December. On Wednesday, the big news of the day will be the outcome of Fed Chair Yellen’s last FOMC meeting as she passes the baton on to Jerome Powell early next month as the new Chairman of the Federal Reserve. On Thursday, the overall ISM index for the month of January is set to be released with expectations that the index will have posted slightly slower growth in January than it did in December, as inventories declines likely played a key role in the slowdown. Friday is a busy day for economic news releases as all the standard employment related data for the month of January is released by the government. Both payroll figures could have an impact on the markets, but it will likely be less impactful than the overall unemployment rate, which is expected to be released as 4.1 percent, unchanged from the December level. The markets will also be paying close attention to the average hourly earnings that are reported on Friday as they have been moving higher now over the past three months and are developing a nice upward trend, which will be key for future economic growth in the US. Average hourly earnings for the month of January could be the first test of the tax reform to see if Americans are actually seeing more money in their paychecks or not. This week wraps up on Friday with the release of the University of Michigan’s Consumer Sentiment Index for the month of January (final estimate), which is expected to be little changed over the December level.

 

Interesting Fact IKEA’s Ingvar Kamprad

 

Ingvar Kamprad, the founder of IKEA passed away on Sunday at the age of 91. Despite his vast wealth, estimated at almost $59 billion at the time of his death, he was so concerned with saving money that he was widely nicknamed “Uncle Scrooge” and “The Miser.” He owned a Volvo, always flew coach and made sure that when his leadership team traveled for business, they stayed in the least expensive hotels. He eschewed a more corporate look of suits and ties, and if there was an opportunity to recycle something or snag some condiments from a restaurant, he would.

 

Source: entrepreneur.com

For a PDF version of the below commentary please click here Weekly Letter 1-22-2018

Commentary quick take:

 

  • Major developments:
    • Bull market continues to run
    • US government has been shutdown
    • Volatility increased

 

  • US:
    • Government shutdown finally happened
    • Growth in manufacturing slowing down
    • Consumer Sentiment moving lower
    • Financials decimated earnings growth
    • 4th Quarter Earnings Season
      • 11 percent complete
      • Blended earnings growth rate fell to -0.2 percent from 10 percent

 

  • Global:
    • China saw GDP increase for 2017 over 2016
    • Canada raised interest rates
    • Grand Coalition in Germany still in the works

 

  • Hybrid investments strategy update:
    • No changes last week
    • Models remain fully invested

 

  • This week for the markets:
    • Government shutdown debate and likely resolution
    • Earnings season rolls onward

 

  • Interesting Fact: GE: Too many business lines

 

Major theme of the markets last week: Government shutdown

The primary focus of the financial markets here in the US last week was the looming government shutdown, which went into place at midnight on Friday night. At the start of the week, it looked like a short term stop gap spending bill would emerge from the negotiations taking place in Washington DC. As the week drug on, it became clear that neither the Democrats nor the Republicans were in the mood to negotiate. The two primary sticking points between the two sides are immigrations laws and building the wall with Mexico. Previously, going into a government shutdown, the US financial markets have turned very volatile as uncertainty over how long the shutdown will drag out weighs heavily on short term personal spending. However, this time around, the US financial markets seemed to hardly take notice that the government was likely headed to a shut down on Friday; the bull market just kept moving forward. This market movement means one of two things: the markets think any shutdown that may occur will be very short lived or there will end up being very little negative impact on the markets from an extended shutdown, as was the case the last time the government was shut down for an extended period of time (13 days).

 

US news impacting the financial markets:

 

Last week, ahead of a potential shutdown of the US government, the markets were focused on economic data and on earnings reports. In looking at the economic data released last week, the focal points were manufacturing and consumer sentiment. The data released last week regarding manufacturing pointed to a continuing slowdown in growth that commenced back in August of 2017. Manufacturing is still growing in the US, but growing at an ever-slower pace. Consumer Sentiment, released last week in the form of the latest University of Michigan survey, is also starting to show some weakness as last week saw the index post the fourth consecutive weakening figure. Consumer confidence is one of the keys to the US economy continuing to grow and it should be watched closely for signs of significant breakdown as that could foretell a slowdown in an already slow growing economy. In addition to the news surrounding the potential showdown and the economic data, the markets last week focused on earnings season, which hit a major bump in the road when looking at blended earnings growth for the S&P 500.

 

Last week was the second week of the fourth quarter 2017 earnings season. Below is a table of the well-known companies that released earnings last week with earnings that missed expectations highlighted in red, while earnings that beat expectations by more than 10 percent are highlighted in green:

 

ALCOA -15% CSX 14% Charles Schwab 7%
American Express 3% Goldman Sachs 16% Schlumberger 9%
Bank of America 7% IBM 0% Taiwan Semiconductor 2%
Bank of New York 0% Kinder Morgan 17% UnitedHealth 4%
Citigroup 8% Morgan Stanley 9% US Bancorp 1%

 

Alcoa kicked things off last week with a miss on its earnings as increasing aluminum prices during the quarter were more than offset by rising input costs. The company also increased its guidance for 2018, but the increase was smaller than many investors were expecting. Goldman Sachs beat its market estimate, but after including one-time items such as reforms from the tax code changes, the company posted a dismal quarter. Goldman did say that the future for the company looked strong, however, as the negative impact from the tax reforms would be lessened over the longer term. Kinder Morgan and CSX both benefited from the rising cost of oil during the fourth quarter, helping to bump their earnings double digits ahead of expectations.

 

According to Factset, we have seen 56 (11 percent) of the S&P 500 companies release results for the fourth quarter of 2017. Of the 56 companies that have released earnings, 68 percent have beaten earnings estimates, while 11 percent have met expectations and 21 percent have fallen short of expectations. When looking at revenue, of the companies that have reported, 85 percent of the companies have beaten estimates, while 15 percent have fallen short. The overall blended earnings growth rate for the S&P 500 thus far stands at -0.2 percent. This is an amazing decline, as depicted in the chart below, from the 10 percent blended earnings growth rate that was seen at this time last week.

Thinking the number must be a typo, I dug into the numbers a little more and found that it is indeed correct. The reason for the decline, as alluded to in last week’s commentary, is the financial sector. Citigroup happens to be the biggest culprit behind the earnings decline as the company reported earnings of -$7.50 when the street had been expecting earnings of $0.56. However, many other financial institutions also turned in some ugly numbers, such as Goldman Sachs reporting -$5.51 versus expectations of $4.92 and American Express posting a -$1.41 versus expectations of $1.55. You may be wondering why the major financial companies are not all highlighted in red in the above table of earnings performance last week. The table above shows earnings excluding one-time items, such as massive hits to the earnings from changes in the tax code, which happens to be what occurred for this reporting season. The blended earnings growth rate does not remove the one-time negative items and thus bore the full brunt of the tax code changes impacting the financial sector. If the financial drags had not been there last week, the S&P 500 would have seen its blended earnings growth rate increase from 10 percent up to 11.2 percent.

 

The number of companies reporting earnings continues to pick up this week with more than 330 companies reporting results. The table below shows the companies that will be releasing their earnings this week with those that have the greatest potential to move the markets highlighted in green:

 

American Airlines Halliburton Progressive
Abbott Laboratories Honeywell International Royal Caribbean Cruises
Arthur J Gallagher Intel Raytheon
Baker Hughes J&J Snack Foods Starbucks
Biogen Idec Johnson & Johnson Sherwin-Williams
Caterpillar Kimberly-Clark Stanley Black & Decker
Celgene Southwest Airlines Texas Instruments
Colgate-Palmolive Las Vegas Sands Union Pacific
Comcast McCormick United Rentals
Canadian National Railway 3M Company United Technologies
Capital One Financial Netflix Verizon Communications
Ford Motor Northrop Grumman Western Digital
General Dynamics Norfolk Southern Whirlpool
General Electric Procter & Gamble Wynn Resorts

 

This week, the companies that report earnings will be several of the sector leaders in their respective sectors. Netflix, after a very strong run last year, will be closely watched as it is one of the FAANG stocks that helped drive the overall market performance last year. As is always the case, new subscribers will be the key number that investors are looking for, as well as the total amount of money spent on original content by the company. Caterpillar is a good bellwether company for the overall industrial sector as so many of their products are used across many different industries. Intel could be interesting this week as everyone waits to see if they will comment on the newly announced flaw in its kernel chip security. General Electric is always a company to watch as many investors have long been calling for the company to be broken up into more manageable parts, though the company is reluctant to do so. With the poor news that came out last week about GE, it seems the break up may be closer than it ever has been in the past. Starbucks presents an earnings announcement that is closely followed by economists for an overall indicator of health of the US consumer as the company touches such a wide range of customers on a very regular basis. Consumer staple companies Johnson & Johnson, Procter & Gamble, Colgate-Palmolive and Kimberly-Clark all report earnings this week and could have a material impact on the consumer staples sector.

 

Global news impacting the markets:

 

China made some of the largest headlines last week in the global financial media as the country officially announced its growth rate for 2017. According to China’s National Bureau of Statistics, China grew at a rate of 6.9 percent during 2017. While this is only a small improvement from the 6.7 percent growth seen in 2016, it does represent a turnaround in GDP as the country’s GDP had been consistently moving lower every year since 2011, as depicted in the chart from Bloomberg and BBC to the right. This uptick in GDP in China during 2017 was due to several different factors, including increasing exports, construction, real estate and consumer spending. This turnaround may provide the government with the wiggle room needed to try to deal with some of the underlying problems in the economy, such as the housing bubble and other types of bubbles the government has been seeing, but has largely been failing to act upon for the past several years. With the “turn” seen in GDP, it becomes very unlikely that China will see any sort of “hard landing” that was feared in 2016 and at the start of 2017. While there is no set target for future growth rates in China, 6.9 percent is now certainly the unwritten bar the country will try to stay above.

Elsewhere last week, Canada became the first of the major central banks to follow the US central bank’s lead in rising interest rates. Part of the reason for the rate increase could have to do with the NAFTA negotiations that are ongoing as the increase gives the central bank one more step backwards that it could take if something were to hit the Canadian economy. With the strength of the global growth figures coming in from various parts of the world, many economists are now openly wondering how much longer several of the other key central banks, such as the Bank of Japan and the European Central Bank, will be able to keep their stimulus plans running and if they will or will not need to start raising rates themselves.

 

Germany also made some headlines last week as the Social Democrats (SPD) officially voted to begin talks on forming a coalition with Chancellor Merkel’s Christian Democrat (CDU) party. The announcement that the two sides would once again talk came out a few weeks ago, but it was not formally voted upon by the SPD until late last week, in a vote that saw a lot more opposition to the talks than was initially expected. While the talks are now moving forward, there is still a great deal of uncertainty in German politics as the 400,000 plus members of the SPD will ultimately have a vote on any deal struck between the two sides in the formation of the coalition.

 

Hybrid model performance and update

For the shortened trading week ending on 1/19/2018, returns in the hybrid and quant hypothetical models* (net of a 1% annual management fee) were as follows:

 

  Last Week 2018 YTD Since 6/30/2015
Aggressive Model 0.94% 2.71% 21.97%
Aggressive Benchmark 1.02% 4.60% 24.62%
Growth Model 0.75% 2.50% 18.89%
Growth Benchmark 0.80% 3.58% 19.26%
Moderate Model 0.56% 2.27% 15.05%
Moderate Benchmark 0.57% 2.56% 13.97%
Income Model 0.53% 2.15% 13.50%
Income Benchmark 0.30% 1.30% 7.51%
Quant Model 0.56% 2.26%
S&P 500 0.86% 5.11% 36.22%

*Model performance does not represent any specific account performance but rather a model of holdings based on risk levels that are like my actual holdings, the hypothetical models are rebalanced daily to model targets.

 

There were no changes to the hybrid models over the course of the previous week. The hybrid models all remain nearly fully invested. There were no trailing stops that were hit during the week, while there were numerous all-time highs hit on various holdings.

 

Market Statistics:

 

Index Change Volume
Dow 1.04% Average
NASDAQ 1.04% Below Average
S&P 500 0.86% Below Average

 

Volume was surprisingly strong last week on the Dow as the index managed to make it to average volume levels for a full trading week, though last week was a four-day holiday shortened trading week. Overall, the bull market rally continued last week. However, the speed with which the markets went up was slower than they went up to start the year and half of the trading days last week resulted in the markets moving lower.

 

The following were the top 5 and bottom 5 performing sectors over the course of the previous week:

 

Top 5 Sectors Change   Bottom 5 Sectors Change
Semiconductors 3.94%   Transportation -0.64%
Healthcare Providers 2.22%   Telecommunications -1.18%
Technology 1.97%   Natural Resources -1.41%
Consumer Goods 1.80%   Oil & Gas Exploration -1.41%
Consumer Staples 1.80%   Energy -1.43%

 

The top five performing sectors last week were an interesting mix of sectors as the high technology Semiconductors sector and Technology overall paired up with Consumer Staples and Consumer Goods to take four of the top five spots. These four sectors very rarely make the top performing list during the same week as two of them are very defensive, while the other two are very aggressive sectors of the markets. Earnings season and the updated projections from corporate America played the largest part in the market movements seen in the positive performing sectors last week. With the decline in the price of oil last week, it was not surprising to see that three of the five bottom performing sectors—Energy, Oil & Gas Exploration and Natural Resources—were oil related. Telecommunications and transportation rounded out the bottom five with both being driven primarily by earnings reports.

 

Overall, trading in government bonds was low last week as the US had only a four day trading week:

 

Fixed Income Change
Long (20+ years) -1.17%
Middle (7-10 years) -0.75%
Short (less than 1 year) 0.03%
TIPS -0.16%

 

Best and Worst Currencies Change
US Dollar -0.25%
Mexico peso 2.29%
Argentina peso -1.68%

 

 

Overall, the US dollar decreased by 0.25 percent last week against the value of a basket of foreign currencies. Last week was the third week in a row of declines for the US dollar as we have yet to see gains on a weekly basis in 2018. The best performing currency last week was found in Mexico and was the Peso, which gained 2.29 percent. A second form of peso turned in the worst performance of the week last week as the Argentinean peso declined by 1.68 percent against the US dollar. The start of the year seasonality negative impacts on the Argentinean peso do not seem to be abating yet, continuing to put downward pressure on the peso.

 

Commodities were mixed over the course of the previous week as oil moved lower:

Metals Change   Commodity Change
Gold -0.43%   GS Commodity Index -0.60%
Silver -1.35%   Oil -1.17%
Copper -1.17%   Livestock 2.68%
      Grains 1.07%
      Agriculture 0.38%

 

The GS Commodity index broke its streak of four weeks in a row with gains last week as the index declined by 0.6 percent. Oil was the primary driving force behind the declines on the GSCI as the commodity moved lower by 1.17 percent. OPEC now finds itself in the precarious position of trying to increase production quotas while at the same time not having a negative impact on the price of oil now or into the future. It seems it will be very difficult for OPEC to increase production, however, because increasing prices will only bring about more pressure from swing producers such as US shale, which can increase or decrease production very quickly. Gold and Silver broke their winning streaks last week, joining Copper in moving lower by 0.43, 1.35 and 1.17 percent, respectively. Soft commodities were positive last week as Livestock increased 2.68 percent, while Agriculture overall increased by 0.38 percent and Grains posted a gain of 1.07 percent.

 

Top 2 Indexes Country Change   Bottom 2 Indexes Country Change
Hang Seng Hong Kong 2.68%   FTSE 250 U.K. -0.99%
Merval Argentina 2.67%   S & P/ASX 200 Australia -1.06%

Last week was a largely positive week for the global stock indexes, with 85 percent of the global markets posting gains. Hong Kong saw the largest gains last week as the Hang Seng index typically does very well when the news out of neighboring China is positive. With China growing, it is logical to think that the wealth will spill over and positively impact the country’s investments. On the negative side, Australia’s ASX 200 posted the worst performance of the global markets, declining by 1.06 percent, as the country’s dependence on the mining sector was hit last week by falling metal prices.

No more pendulum swinging for the VIX; last week, the pattern needed a double-digit decline and instead we saw a double-digit gain as the VIX increased by 10.93 percent. It is unusual to see the VIX move in the same direction as the overall markets, but with how the VIX has been moving over the past year, the historically “unusual” seems to be the new normal. The current reading of 11.27 implies that a move of 3.25 percent is likely to occur over the next 30 days. As always, the direction of the move over the next 30 days is unknown.

Economic Release Calendar:

 

Last week, the economic news releases focused on manufacturing and consumer sentiment, in addition to the US housing market, with no releases coming in significantly above or below expectations:

 

Economic Impact Date Economic News Release Date Range Actual Expectation
Slightly Negative 1/16/2018 Empire Manufacturing January 2018 17.7 19.0
Neutral 1/18/2018 Housing Starts December 2017 1192K 1280K
Neutral 1/18/2018 Building Permits December 2017 1302K 1290K
Slightly Negative 1/18/2018 Philadelphia Fed January 2018 22.2 24.5
Slightly Negative 1/19/2018 University of Michigan Consumer Sentiment Index January 2018 94.4 97

Data for table from Econoday.com, Bloomberg and Yahoo Finance

 

On Tuesday, the Empire manufacturing index for the month of January was released and came in slightly below expectations, as the slowing down of growth in manufacturing in the greater New York region continues. On Thursday, housing starts and building permits for the month of December were released with housing starts slightly missing expectations while building permits slightly beat expectations, leading to the two releases having offsetting impacts on the markets. Later during the day on Thursday, the Philadelphia Fed released its business activity index for the month of January and, much like the Empire manufacturing index released earlier during the week, growth was shown to be slowing down. Wrapping up the week last week was the release of the University of Michigan’s Consumer Sentiment Index for the month of January (mid-month reading), which came in lower than was expected, matching the decline that was seen two weeks ago on the government’s reading for consumer confidence.

 

This week, the economic news releases remain slow, but they could have a noticeable impact on the overall markets. The releases with the greatest potential to impact the markets are highlighted in green below:

 

Date Release Release Range Market Expectation
1/24/2018 Existing Home Sales December 2017 5.7M
1/25/2018 New Home Sales December 2017 680K
1/26/2018 GDP-Advanced Estimate Q4 2017 2.9%
1/26/2018 Durable Orders December 2017 0.9%
1/26/2018 Durable Goods –ex transportation December 2017 0.6%

Data for table from Econoday.com, Bloomberg and Yahoo Finance

 

This week, the economic news releases start on Wednesday as the existing home sales figure for the month of December is set to be released with expectations of a small decrease of about 100,000 units during the month. On Thursday, new home sales are expected to print 680,000 homes sold during December, which is a small decrease from the 733,000 that were sold in November. These two data points combined with the housing data released last week point toward the US housing market moving ahead slowly. On Friday, the big releases of the week are released with the first being the estimate of fourth quarter GDP for the US, which is expected to come in at 2.9 percent, a full three tenths of a percent lower than the 3.2 percent GDP growth rate seen in the third quarter of 2017. Durable goods orders for the month of December, both including and excluding transportation, will be released. Durable goods orders excluding transportation are expected to rebound to a gain of 0.6 percent from the decline of 0.1 percent seen in November. Overall durable goods orders for the month of December are expected to post an increase of 0.9 percent, slightly slower than the 1.3 percent growth seen in November. In addition to the economic news releases, there is one speech being given by a Fed official as FOMC member James Bullard provides a speech about the growth of the US economy on Friday.

 

Interesting FactGE: Too many business lines

 

After the dismal performance of GE stocks over the last 15 months, many investors have been calling for a break up of GE’s core businesses. These businesses include:

 

Baker Hughes, a GE company
Current powered by GE
GE Aviation
GE Capital
GE Digital
GE Energy Connections
GE Healthcare
GE Lighting
GE Power
GE Renewable Energy
GE Transportation

 

The majority of these business segments could easily stand on their own and very well could be worth more to investors as individual pieces than as one business combined.

 

Source: www.ge.com

 

For a PDF version of the below commentary please click here Weekly Letter 1-16-2018

Commentary quick take:

 

  • Major developments:
    • Bull market continues to run
    • We saw a dip!
    • Bickering over government shutdown

 

  • US:
    • Fight over immigration reform
    • Markets looking toward a shut down
    • Earnings season is once again upon us
      • Current blended earnings growth 10.2 percent
      • 5 % of S&P 500 component companies have reported

 

  • Global:
    • China may change US bond buying program
    • Japan changed its own bond buying program
    • Grand Coalition in Germany possible

 

  • Hybrid investments strategy update:
    • Several changes last week
    • Models fully invested

 

  • This week for the markets:
    • Potential government shutdown at weekend
    • Earnings season rolls onward

 

  • Interesting Fact: China’s foreign reserves have come a very long way

 

 

Major theme of the markets last week: Dip; there was a dip in the markets last week!

Last Wednesday, we saw something in the market that has become increasingly rare—a down day for all three of the major indexes. It was the first coordinated down day for the US markets so far in 2018 as the bull market that we saw in 2017 continues to run in 2018. The dip in the markets was very temporary, however, as the markets bounced right back on Thursday, running hard through the end of the week. The lack of declines in the markets is starting to be very concerning to many professional investors as markets typically do not just move in one direction. Headlines last week on Bloomberg and in other financial media referenced a bull market that seemingly never declines, a negative omen for future performance of the markets. When investors become so complacent that they believe investing in the equity markets is a risk-free way of making money, it is typically the time the markets remind everyone that investing is not a risk-free way to make money. There is no denying that, so far, 2018 has been a very strong start for equity investments as the first nine trading days have produced one of the top five best starts to any year going back to 1989 for all three of the major US indexes.

 

US news impacting the financial markets:

 

Last week, the US financial media focused on the looming fight over a potential government shutdown that could happen as early as this Friday. Adding to the already confusing time of a potential government shutdown is the fact that President Trump and some Republicans want to use this budget fight opportunity to try to pass through immigration reform and make changes to the Deferred Action for Childhood Arrivals (DACA) program. In a sign of trying to work with the other side, President Trump last week said that if he gets his border wall funded, he would only make minimal changes to DACA. The immigration/wall debate currently taking up most of the floor time in Washington DC has little impact on the financial markets, but it is taking up time that could otherwise be spent on trying to keep the government open and funded past Friday. There have been 18 government shutdowns since 1976, according to the Congressional Research Service. Some of these have had a large negative impact on the financial markets; others have had minor impacts thanks to the timing of the shutdowns, which typically occur on Friday night at midnight, meaning that Congress has a whole weekend to reopen the government before many government employees are negatively impacted. If the government were to shut down for an extended period, the impact on the financial markets here in the US would likely be negative. There have already been rumblings that a stop gap measure that would fund the government for a brief period may not be in the cards this time around as the House Freedom Caucus, a powerful conservative Republican group, is likely to withhold its support for a short-term bill, holding out for an actual budget that covers 2018. If the Freedom Caucus does in fact not vote for a stop gap measure, Speaker Ryan would have a very difficult time getting the votes in the House to pass any spending measure as he would have to find democratic support for the bill, which seems highly unlikely. As we get closer to the end of the week this week, if there is no deal on the table, the volatility in the US financial markets will likely increase. Aside from focusing on the potential shutdown throughout much of this week, the media will also likely turn its attention to earnings season as it gets more fully under way.

 

Last week was the official start to the fourth quarter 2017 earnings season as large financial corporations kicked things off near the end of the week. Below is a table of the well-known companies that released earnings last week with earnings that missed expectations highlighted in red, while earnings that beat expectations by more than 10 percent are highlighted in green:

 

Blackrock 3% JPMorgan Chase 4% Wd-40 8%
Delta Air Lines 9% KB Home 9% Wells Fargo -7%
Helen of Troy 15% Lennar -14%  

 

Helen of Troy, the maker of many personal care products, saw a nice boost in fourth quarter sales due to the holiday shopping season as consumers spent more than expected during the quarter. Two of the nationwide home builders reported their earnings last week. Lennar missed expectations while KB homes beat expectations. For home builders during the fourth quarter of 2017, it was all about geographic concentration with builders in the deep south turning in strong results, while more northern builders had a tougher time. Large financial institutions were the first of the major sectors to report a meaningful number of component earnings last week, as is always the case. JP Morgan and Blackrock both beat earnings expectations, while Wells Fargo missed expectations. All the major financial earnings releases last week were adversely impacted by the tax law changes, as has been discussed numerous times over the past several weeks in this commentary. After the one-time charges that the companies took during the fourth quarter, they should begin to see the benefits of the tax law changes starting in the first quarter of 2018.

 

According to Factset, we have seen 26 (5 percent) of the S&P 500 companies release results for the fourth quarter of 2017. Of the 26 companies that have released earnings, 69 percent have beaten earnings estimates, while 12 percent have met expectations and 19 percent have fallen short of expectations. When looking at revenue, of the companies that have reported, 85 percent of the companies have beaten estimates, while 15 percent have fallen short. The overall blended earnings growth rate for the S&P 500 thus far stands at 10.2 percent. Energy continues to be the strongest of the sectors in terms of adding to the growth rate of the overall S&P 500. Financials are expected to contribute much less to overall earnings for the S&P 500 during the fourth quarter as one-time hits from the tax law changes will temporarily hurt the group’s contribution.

 

The number of companies reporting earnings continues to pick up this week as we are in the second full week of fourth quarter 2017 earnings, with the large financial institutions still being the primary focus of the markets. The table below shows the companies that will be releasing their earnings this week, with those that have the greatest potential to move the markets highlighted in green:

ALCOA CSX Charles Schwab
American Express Goldman Sachs Schlumberger
Bank of America IBM Taiwan Semiconductor
Bank of New York Kinder Morgan UnitedHealth
Citigroup Morgan Stanley US Bancorp

 

This week, Bank of America, Goldman Sachs, Citigroup and US Bancorp all report earnings and their results could meaningfully impact the overall markets. Alcoa, which in the past has kicked off the quarter reporting seasons, will report earnings this week with expectations of a very strong quarter as earnings of $1.23 are expected. This would be an improvement of a little more than $1.00 when compared to the fourth quarter of 2016 and an improvement of almost $0.50 compared to the third quarter of 2017. The increase is due to increasing global demand for aluminum as Chinese demand combined with increasing US demand is driving a significant increase in volume for Alcoa. UnitedHealth is the first of the major healthcare stocks to post results this quarter later this week with many investors looking to the company for any guidance as to how the sector performed during the quarter, which saw its fair share of ups and downs as Congress continued to try to make changes to the Affordable Care Act.

 

Global news impacting the markets:

 

The biggest news on the international front last week came out of China. There was a report that senior government officials in Beijing were reviewing the nation’s foreign-exchange holdings and, in conclusion, are recommending slowing or halting purchases of U.S. Treasuries. This report immediately impacted US government bonds as well as the US dollar and was the driving force behind the decline we saw on Wednesday in the US financial markets. For decades, China has been the second largest buyer of US government debt behind the US government itself. With China currently holding $3.1 trillion in foreign exchange reserves (largest reserves of any country in the world), if China does in fact slow down or halt purchases of US government bonds, it could make the US government’s funding in the future more expensive. Late in the week last week, China said it had not changed its policy toward US government bond buying and that the report was only an assessment and recommendations made may or may not be followed in the future. The Bank of Japan also made a few waves last week as it announced that it would change the maturity of Japanese government bonds that it would be buying in the future, lowering the average maturity of the bonds it would purchase. While this change is mainly an internal change, there was an impact on the US dollar and the Euro as investors sold these in favor of the Japanese Yen, which turned in a strong week of performance last week.

In Germany last week, Chancellor Angela Merkel finally received some good news after several months of bad news regarding her trying to form a coalition government and stay in power without calling for another snap election. The leader of the Social Democrat Party (SDP) on Friday announced that he would go back to talks with Merkel’s CDU party to form a grand coalition government, which is the same government coalition that has governed in Germany for the past several years. Apparently, after seeing Chancellor Merkel fail at making a coalition with any other political parties, SDP party leader Martin Schultz had a change of heart and thinks that a new round of elections would be bad enough for his party and the CDU party that they would be better off working together. While there is still a way to go before an actual agreement on the grand coalition is reached, at least there is a much higher chance of the agreement occurring than there was this time last week. The European markets jumped higher on the news out of Germany at the end of the week last week and continued to move higher during Monday trading.

 

Hybrid model performance and update

For the trading week ending on 1/12/2018, returns in the hybrid and quant hypothetical models* (net of a 1% annual management fee) were as follows:

 

  Last Week 2018 YTD Since 6/30/2015
Aggressive Model 0.71% 1.75% 20.79%
Aggressive Benchmark 1.12% 3.54% 23.36%
Growth Model 0.70% 1.73% 17.96%
Growth Benchmark 0.87% 2.76% 18.31%
Moderate Model 0.69% 1.69% 14.37%
Moderate Benchmark 0.63% 1.97% 13.32%
Income Model 0.63% 1.61% 12.86%
Income Benchmark 0.33% 1.00% 7.19%
Quant Model 0.58% 1.69%
S&P 500 1.57% 4.21% 35.05%

*Model performance does not represent any specific account performance but rather a model of holdings based on risk levels that are like my actual holdings, the hypothetical models are rebalanced daily to model targets.

 

There were two changes to the hybrid models over the course of the previous week. The first change was to sell part or all the Rydex High Yield bond fund (RYHGX) depending on risk level. The fund was sold completely in the most aggressive hybrid models, while the position was trimmed in the less aggressive models. The second change last week was to increase the position in emerging markets across all of the hybrid models. In the Aggressive model, the addition was made to the Direxion Funds Emerging Markets fund (DXELX). In the Growth model, additions were made to both DXELX and the Schwab Emerging Markets Large cap fund (SFENX). In both the Moderate and Income hybrid models, SFENX was purchased. With the additions last week, and considering the leverage that is on a few of the positions in the models, all hybrid models are currently fully invested. As has been the case since the middle of last year, all tradable positions currently have a trailing stop under them, meaning the positions will be sold if we see a significant downturn in the holdings start to occur.

 

Market Statistics:

 

Index Change Volume
Dow 2.01% Average
NASDAQ 1.74% Average
S&P 500 1.57% Below Average

 

Last week we finally saw volume move back to average levels on both the Dow and the NASDAQ, while the S&P 500 continued to see lagging volume. Performance continued to be strong with last week closing out the best two week stretch for the US markets since November of 2016, the two week period immediately following Trump’s surprise win on election night.

 

The following were the top 5 and bottom 5 performing sectors over the course of the previous week:

 

Top 5 Sectors Change   Bottom 5 Sectors Change
Regional Banks 4.32%   Semiconductors -0.67%
Transportation 4.29%   Telecommunications -0.89%
Aerospace & Defense 3.67%   Infrastructure -1.11%
Consumer Services 3.36%   Utilities -2.19%
Broker Dealers 3.26%   Residential Real Estate -3.97%

 

Regional Banking and Broker Dealers last week rode the coat tails of the good earnings reports of some of the major financial corporations as well as their upbeat outlooks for 2018, managing to push both sectors into the top five performing sectors of the markets. Transportation turned in the second-best performance in terms of sectors last week, gaining more than 4 percent. Aerospace and Defense had a good week last week as increased sales globally helped push the sector to a gain of more than 3.5 percent. Consumer Services rounded out the top five performing sectors as consumer spending increased during the month of December, with the service sector garnering a significant increase in spending. On the negative side last week, the sectors that underperformed are almost the same as they were last week. Classic safe haven sectors that were sold last week in favor of higher risk sectors included Real Estate, Utilities, Infrastructure and Telecommunications. Semiconductors was the outlier last week as this sector typically performs well in a risk-on environment. With so much uncertainty over the security of the computer chips that have been made for many years, the sector was under pressure last week rather than flying high, as would typically have been the case.

 

Overall, trading in government bonds picked up a lot last week in terms of overall volume as traders and institutional holders adjusted to the comments about China’s future buying as well as the buying habits of the Bank of Japan:

 

Fixed Income Change
Long (20+ years) -0.95%
Middle (7-10 years) -0.55%
Short (less than 1 year) 0.01%
TIPS -0.47%

 

Best and Worst Currencies Change
US Dollar -1.04%
Japan yen 1.81%
Ukraine hryvnia -1.96%

 

 

Overall, the US dollar decreased by 1.04 percent last week against the value of a basket of foreign currencies. The best performing currency last week was found in Japan and was the yen, which gained 1.81 percent. The movement of the yen was due to the announced change in bond buying maturities by the Bank of Japan. The Ukrainian hryvnia turned in the worst performance of any of the major global currencies for the second week in a row last week, declining by 1.96 percent against the US dollar. The National Bank of Ukraine is saying that the downward pressure the hryvnia has been under so far in 2018 is due to seasonal factors of the country’s importers stocking their shelves for the holidays with imported goods. Apparently, this decline in the hryvnia occurs at the start of most years and then slowly moves higher through the rest of the year, according to the National Bank.

 

Commodities were mixed over the course of the previous week as oil continued to push higher:

Metals Change   Commodity Change
Gold 1.30%   GS Commodity Index 2.44%
Silver 0.31%   Oil 4.55%
Copper -0.27%   Livestock -0.99%
      Grains -1.26%
      Agriculture -1.43%

 

The GS Commodity index made it four weeks in a row of gains last week, advancing 2.44 percent thanks to a more than four and a half percent increase in the price of oil. Oil increased by 4.55 percent last week as crude oil continued to move higher with Brent Crude closing out the week last week above $70 per barrel. Unrest in Iran continues to be a primary driving force behind the movement in the price of oil globally, but the cold snap in the US also helped increase demand for heating oil, which put upward pressure on oil as well. Gold and Silver kept their winning streaks alive again last week, while Copper made it two weeks in a row of declines. Gold and Silver gained 1.3 and 0.31 percent, respectively, while Copper declined by 0.27 percent. Soft commodities were negative last week as Livestock decreased 0.99 percent, while Agriculture overall decreased by 1.43 percent and Grains posted a loss of 1.26 percent.

 

Top 2 Indexes Country Change   Bottom 2 Indexes Country Change
RTS Index Russia 3.38%   BIST 100 Turkey -1.71%
Dow Jones China 88 China 3.15%   S & P/NZX 50 New Zealand -2.52%

Last week was a mixed week for the global stock indexes, with 69 percent of the global markets posting gains. Russia’s RTS Index took top position, gaining 3.38 percent last week, as Russia managed to stay out of the political spotlight in Washington DC last week as policy makers were much more interested in what the President did or did not call some of the poor African nations with immigrants coming to the US. On the negative side, New Zealand’s NZX 50 posted the worst performance of the global markets, declining by 2.52 percent.

The continued pendulum swing of double digit movements in the VIX continued last week as the VIX advanced by 10.02 percent. We have now seen three consecutive weeks of the VIX either increasing or decreasing by 10 percent or more. For this trend to continue this week, we would need to see the VIX decline by more than 10 percent. The current reading of 10.16 implies that a move of 2.93 percent is likely to occur over the next 30 days. As always, the direction of the move over the next 30 days is unknown.

Economic Release Calendar:

 

Last week, the economic news releases focused on different readings of inflation in the US economy, which was shown to still be running painfully low, despite the increase in the price of oil:

 

Economic Impact Date Economic News Release Date Range Actual Expectation
Negative 1/11/2018 PPI December 2017 -0.10% 0.20%
Negative 1/11/2018 Core PPI December 2017 -0.10% 0.20%
Neutral 1/12/2018 CPI December 2017 0.10% 0.20%
Neutral 1/12/2018 Core CPI December 2017 0.30% 0.20%
Neutral 1/12/2018 Retail Sales December 2017 0.40% 0.40%
Neutral 1/12/2018 Retail Sales ex-auto December 2017 0.40% 0.40%

Data for table from Econoday.com, Bloomberg and Yahoo Finance

 

Last week, the economic news releases started on Thursday with the release of the Producer Price Index (PPI) for the month of December. Both the overall PPI and the core PPI missed market expectations with negative 0.1 percent changes in prices at the producer level being posted. This is exactly the opposite of what the Fed was hoping it would see in this release. Deflation (falling price indexes) is something that is feared by many economists because falling prices is something that is very difficult to turn around. With interest rates already near historic lows, the Fed would be left with very meager tools to fight deflation if we saw it fully kick in. This decline at the producer level comes despite the inflationary, upward movement in the price of oil that was experienced during the month. Both figures would have likely been more negative had oil prices not increased. On Friday, the Consumer Price Index (CPI) for the month of December was released and, unlike the PPI releases on Thursday, came in very close to market expectations and, perhaps more importantly, did not show any signs of deflationary forces at the consumer level. The PPI is a leading indicator of the CPI, however, so if we see a sustained downtrend in the PPI, it is logical to think that the CPI would likely follow suit in the proceeding months. Wrapping up the week on Friday this week was the release of the retail sales figures for the month of December, which came in as expected, showing a reading of 0.4 percent. This growth is positive for the overall US economy as it shows that the US consumer still believes in the economic growth story that has been pushing the financial markets higher.

 

This week, the economic news releases are a little slow with the focus being on the manufacturing sector in the US. The releases with the greatest potential to impact the markets are highlighted in green below:

 

Date Release Release Range Market Expectation
1/16/2018 Empire Manufacturing January 2018 19.0
1/18/2018 Housing Starts December 2017 1280K
1/18/2018 Building Permits December 2017 1290K
1/18/2018 Philadelphia Fed January 2018 24.5
1/19/2018 University of Michigan Consumer Sentiment Index January 2018 97

Data for table from Econoday.com, Bloomberg and Yahoo Finance

 

On Tuesday, the Empire manufacturing index for the month of January is set to be released with expectations of a slight decrease in the speed of manufacturing activity in the greater New York region when compared to December’s level. On Thursday, housing starts and building permits for the month of December are set to be released with the cold spell that impacted the US during the later part of December likely having a negative impact on these releases, potentially even pushing both readings below the 1 million level. Later during the day on Thursday, the Philadelphia Fed releases its business activity index for the month of January and, much like the Empire manufacturing index released earlier during the week, expectations are for a little slowdown in business activity growth in the Philly region when compared to December levels. Wrapping up the week this week is the release of the University of Michigan’s Consumer Sentiment Index for the month of January (mid-month reading), which is expected to show that sentiment has increased slightly when compared to the end of 2017.

 

Interesting FactChina’s foreign reserves have come a very long way

 

China’s foreign reserves were only $80.8 billion in 2001. Edward Chancellor wrote in the Wall Street Journal: “In 1974, the future Chinese premier Deng Xiaoping led a large delegation to the United Nations in New York. Chinese officials discovered, as they prepared for the expensive trip, that they could muster only $38,000 in foreign cash.”

 

Source: Factsanddetails.com

For a PDF version of the below commentary please click here Weekly Letter 1-8-2018

Commentary quick take:

 

  • Major developments:
    • Second slow week for the markets
    • New all-time highs!
    • Global markets enthusiastic about the start of 2018
    • VIX touching new all-time lows

 

  • US:
    • Labor market data
    • Weak wage growth
    • Fed rate speculation

 

  • Global:
    • Germany still without a government

 

  • Hybrid investments strategy update:
    • Several changes last week
    • Decreased cash holdings

 

  • This week for the markets:
    • Washington DC back to work
    • Budget battle ahead—AGAIN

 

  • Interesting Fact: Where on Earth felt colder than Mars last week?

 

 

Major theme of the markets last week: Bulls run for the start of 2018

2018 started much the same way that 2017 ended with the bulls running hard, propelling the US markets to new all-time highs. The upward movement was not limited to the US markets alone, however. There was only a single global index (Indonesia) that posted a loss last week. While some markets were open for more trading days than others, one thing remained clear—markets want to keep pushing higher. The Dow experienced an increase of 2.3 percent during the first four days of trading, making 2018 the fourth best start to a year that we have seen looking back to 1989. The S&P 500 also experienced the fourth best start to a year that we have seen looking back to 1989, with a gain of 2.6 percent. The NASDAQ, which turned in the best return last week, gaining 3.4 percent, only managed its sixth best start to a year going back to 1989. While the start of the year may have been fast, when looking back at the data, a fast start to the trading year rarely persists, as the average returns for the 5 days following such a fast start are negative on all three of the major US indexes. However, the longer-term outlook for 2018 given the start of the year is positive, as each of the years during which the Dow and the S&P 500 have started at or better than they started 2018 has turned into double digits gains of at least 15 percent for the indexes. The NASDAQ is a little more uncertain, as only four of the five years of better performance than we started 2018 have resulted in positive returns. The problem year was 2002 when the NASDAQ started the year with a gain of 4.45 percent only to end the year with a loss that was greater than 30 percent.

 

US news impacting the financial markets:

There was very little on the US financial news front last week as President Trump largely spent the week gearing up for a less than flattering book release about his White House and most of the rest of Washington DC was not yet back to work following the holidays. With so little going on in politics, the media turned its attention to the fast start of the markets, discussed above, and to the economic data that was released. Last week, a trove of data about the US labor market was released and most of the data did not show the strength that many economists had been expecting. The piece of data the markets seemed to latch onto the most last week was the persistently low increase in average hourly earnings. Average hourly earnings were shown to have increased at a 0.3 percent rate in December; annualized, it is 2.5 percent. As you can see in the chart to the right, this was an increase when compared to the previous two months, but the overall trend of wage growth is still falling, as represented by the dashed line. It has been the lack of wage growth that the Fed has called out numerous times in the past as one of the reasons inflation has remained so persistently low when all other economic indicators have been pointing to what should be higher inflation levels than we have been seeing. The big debate currently is how many times the Fed will raise rates in 2018, especially following the release of the previous meeting minutes on Wednesday last week. However, raising rates in the very low rate environment that is currently lacking any meaningful form of inflation is a dangerous predicament for the incoming Fed chair. For its part, the White House over the weekend put out a press release that it doesn’t see the need for the Fed to undertake faster rate hikes in 2018. This announcement itself was a little odd as it is difficult to remember a time when the White House has put out a statement about what it thinks the Fed should do with monetary policy.

 

Global news impacting the markets:

With New Year celebrations going on around the world last week, there was not a lot in the way of global news that moved any of the markets. Global markets pushed higher with Japan seeing some of the strongest movement, gaining a little more than 4 percent in the two days of trading during that it was open last week. The Nikkei pushed to a 26-year high point, but remains more than 50 percent below the index’s all time high reached back in December of 1989. Germany also made headlines last week as current Chancellor Merkel, seen to the right, has still not successfully formed a government three months after the German vote. Chancellor Merkel’s party (CDU/CSU), which has been governing Germany’s politics for the last 12 years, is struggling to build a government after falling well short of expectations in the latest election. Historically, the CDU has partnered with the Liberal FDP and the Green party to achieve the needed 50 percent of the seats in parliament. However, talks broke down last month between the three groups, leaving Chancellor Merkel forced to talk with the Social Democratic Party (SPD), a party that would like to distance itself from the CDU, feeling that alignment with the CDU is costing the party votes as voters defect to smaller fringe parties. Negotiations between the CDU and the SPD started on Sunday, with some success and some failure, but with no clear signal as to how the five days of negotiations might ultimately turn out. Europe needs to have a functioning government in Germany, more so than Germany needs a functioning government. With Germany being the strongest and largest economy in the Eurozone, all the other smaller countries look to Germany as the leader of the union. Should something arise that needs leadership in Europe, like the Brexit negotiations falling apart, it would not be good to have Germany be rudderless and drifting politically.

 

Hybrid model performance and update

For the holiday shortened trading week ending on 1/5/2018, returns in the hybrid and quant hypothetical models* (net of a 1% annual management fee) were as follows:

 

Last Week 2018 YTD Since 6/30/2015
Aggressive Model 1.03% 1.03% 19.90%
Aggressive Benchmark 2.39% 2.39% 21.99%
Growth Model 1.02% 1.02% 17.09%
Growth Benchmark 1.86% 1.86% 17.29%
Moderate Model 1.00% 1.00% 13.55%
Moderate Benchmark 1.34% 1.34% 12.62%
Income Model 0.98% 0.98% 12.12%
Income Benchmark 0.67% 0.67% 6.84%
Quant Model 1.10% 1.10%
S&P 500 2.60% 2.60% 32.96%

*Model performance does not represent any specific account performance but rather a model of holdings based on risk levels that are like my actual holdings, the hypothetical models are rebalanced daily to model targets.

 

There were several changes to the hybrid models over the course of last week. Allocating cash holdings and rotating toward higher risk assets in the higher risk hybrid models were the primary focuses of the changes last week. The first change was to add positions in emerging markets as these countries look ripe for a strong 2018 and still present good valuations on a relative basis when compared to the more developed markets. Two different funds were utilized, depending on risk level, with the high-risk models using Direxion Funds’ Emerging Markets fund (DXELX), while the lower risk level models used the Schwab emerging markets large cap fund (SFENX). Positions were also added in all of the hybrid models in the Schwab Large cap growth ETF, as this fund offers a good counterbalance to the value tilt in the hybrid models that is present in all of the individual equity holdings. Large cap growth looks set up to see persistent out performance compared to other areas of the markets. The final adjustment made last week was moving out of the Rydex banking fund (RYKIX) and into the Profunds Banks fund (BKPIX) in the higher risk models. BKPIX is a 1.5 times leveraged mutual fund, meaning the returns will be more magnified when compared to the unlevered fund. Banking still looks like one of the potentially largest winners from the tax reform act, after the initial hit due to the end of year accounting adjustments in December. Large banks also look to gain from the potential for three or four rate hikes in 2018. Currently, cash levels in the hybrid models are some of the lowest they have been for a very long time and there are a few more adjustments that will likely be made in the models over the coming weeks.

 

Market Statistics:

 

Index Change Volume
NASDAQ 3.38% Below Average
S&P 500 2.60% Below Average
Dow 2.33% Below Average

 

With last week being a holiday week, it was not surprising to see that volume remained below average on all three of the major US indexes. However, last week was right about average for a 4-day trading week. Large cap technology companies were once again in the driver seat.

 

The following were the top 5 and bottom 5 performing sectors over the course of the previous week:

 

Top 5 Sectors Change Bottom 5 Sectors Change
Semiconductors 5.81% Consumer Staples 0.45%
Technology 4.26% Insurance 0.09%
Software 4.19% Telecommunications -0.41%
Materials 3.85% Utilities -2.41%
Medical Devices 3.83% Residential Real Estate -2.96%

 

The classic “risk on trade” was in full force last week when looking at sector performance. Semiconductors led the way higher, despite news of a potential security breach in the kernel memory for almost all computer chips for the last 10 years being discovered. Technology in general came in second place last week, followed by the Software sector; both posted gains of more than four percent. Materials came in fourth best as infrastructure spending appears to remain one of the core items of the Trump administration’s 2018 agenda. Medical Devices rounded out the top five performing sectors last week after gaining almost four percent after the sector had been one of the hardest hit sectors in the last few weeks of December. On the negative side, the risk on trade was clear as Real Estate, Utilities, Telecommunications, Insurance and Consumer Staples made up the bottom five performing sectors. These sectors are all defensive in nature and all were sold indiscriminately as investors moved toward higher risk and potentially higher reward areas of the markets.

 

Overall, trading in government bonds remained light last week with many of the major international buyers taking extended New Year’s holiday weeks:

 

Fixed Income Change
Long (20+ years) -0.91%
Middle (7-10 years) -0.40%
Short (less than 1 year) 0.01%
TIPS -0.14%

 

Best and Worst Currencies Change
US Dollar -0.29%
Venezuela bolivar 3.43%
Argentina peso -1.49%

 

 

Overall, the US dollar decreased by 0.29 percent last week against the value of a basket of foreign currencies. The best performing currency last week was found in Venezuela and was the bolivar, which gained 3.43 percent. The movement in both the Venezuelan stock market as well as the bolivar has been very wild as the country continues to deal with hyperinflation that is likely running at more than 1,400 percent per year. The Argentinian peso turned in the worst performance of any of the major global currencies for the second week in a row last week, declining by 1.49 percent against the US dollar. The seasonal pressures that are currently on the peso will start to subside over the next month, so we will likely see a reversal of the downtrend that has occurred on the peso.

 

Commodities were mixed over the course of the previous week as oil led the way higher:

Metals Change Commodity Change
Gold 1.36% GS Commodity Index 0.74%
Silver 1.44% Oil 2.50%
Copper -1.86% Livestock -1.69%
Grains 0.94%
Agriculture 0.37%

 

The GS Commodity index made it three weeks in a row of gains last week, advancing 0.74 percent thanks to a more than two percent increase in the price of oil. Oil increased by 2.5 percent last week as crude oil continued to plug higher after breaking above $60 per barrel two weeks ago. One of the primary reasons that oil moved higher last week was the continued unrest occurring in Iran. Gold and Silver kept their winning streaks alive last week, while Copper fell back. Gold and Silver gained 1.36 and 1.44 percent, respectively, while Copper declined by 1.86 percent. Soft commodities were mixed last week as Livestock decreased 1.69 percent, while Agriculture overall increased by 0.37 percent. Grains posted a gain of 0.94 percent last week as the wintery weather being experienced in much of the eastern US did not have a noticeable adverse impact on the grain trade in the US.

 

Top 2 Indexes Country Change Bottom 2 Indexes Country Change
Merval Argentina 7.07% S & P BSE Sensex India 0.28%
RTS Index Russia 5.67% Jakarta Composite Indonesia -0.03%

Last week was an almost uniformly positive week for the global stock indexes, with 98 percent of the global markets posting gains. Argentina’s Merval index made it three weeks in a row at the top position, gaining 7.07 percent last week, as the new President continues to enjoy a honeymoon with the local stock market. On the negative side, Indonesia’s Jakarta Composite index turned in the only negative performance globally last week as it saw a decline of 0.03 percent.

After being up more than 10 percent two weeks ago to close out 2017, the VIX last week fell right back down to some of the lowest levels ever recorded. The VIX declined last week by 16.49 percent for the week, but on Wednesday it hit the second lowest intraday point ever. The current reading of 9.22 implies that a move of 2.66 percent is likely to occur over the next 30 days. As always, the direction of the move over the next 30 days is unknown.

Economic Release Calendar:

 

The New Year’s shortened week last week was a week that focused on the US labor market as well as the current state of manufacturing in the US:

 

Economic Impact Date Economic News Release Date Range Actual Expectation
Neutral 1/3/2017 ISM Index December 2017 59.7 58.2
Neutral 1/3/2017 Construction Spending November 2017 0.80% 0.70%
Positive 1/4/2017 ADP Employment Change December 2017 250K 190K
Slightly Negative 1/5/2017 Nonfarm Payrolls December 2017 148K 188K
Slightly Negative 1/5/2017 Nonfarm Private Payrolls December 2017 146K 185K
Neutral 1/5/2017 Unemployment Rate December 2017 4.10% 4.10%
Neutral 1/5/2017 Avg. Hourly Earnings December 2017 0.30% 0.30%
Neutral 1/5/2017 ISM Services December 2017 55.9 57.6

Data for table from Econoday.com, Bloomberg and Yahoo Finance

 

Last week, the economic news releases started on Wednesday, with the release of the ISM index for the month of December, which came in slightly above market expectations. On Thursday the surprisingly upbeat ADP employment change figure got some investors very excited for a potentially very positive release by the government on Friday in terms of the payroll figures as well as the overall unemployment rate. Friday was the big day of the week last week as all the standard employment related data for the month of December was released by the government. However, the upbeat feeling that the ADP data on Thursday provided investors was quickly dashed when the payroll figures missed expectations by meaningful amounts on both public and private readings. The overall unemployment rate was shown to be unchanged at 4.1 percent as average hourly earnings were also unchanged from the November reading, coming in exactly as expected with a 0.3 percent increase. While all the employment data that was released on Friday pointed to a steady labor market in the US, it did not provide the catalyst that some economists had been looking for to better provide a framework for what the Fed should do in 2018. Wrapping up the week on Friday was the services side of the ISM index, which posted a small miss, coming in at 55.9 versus the expected 57.6, but the market attention was focused on new all-time highs on Friday, overlooking this release.

 

As everyone gets back to the swing of things in 2018, this week is a slow week for economic data releases in terms of the numbers of releases, but the potential significance of the releases is pretty high. The releases with the greatest potential to impact the markets are highlighted in green below:

 

Date Release Release Range Market Expectation
1/11/2018 PPI December 2017 0.20%
1/11/2018 Core PPI December 2017 0.20%
1/12/2018 CPI December 2017 0.20%
1/12/2018 Core CPI December 2017 0.20%
1/12/2018 Retail Sales December 2017 0.40%
1/12/2018 Retail Sales ex-auto December 2017 0.40%

Data for table from Econoday.com, Bloomberg and Yahoo Finance

 

This week, the economic news releases start on Thursday with the release of the Producer Price Index (PPI) for the month of December. Both the overall PPI and the core PPI are expected to post readings of 0.2 percent for the month, which is below the November readings of 0.4 and 0.3 percent. This decline in prices at the producer level comes during a month that saw the price of oil increase more than 4.7 percent. If we had not seen oil prices increase, the overall expected PPI figure would likely be negative. On Friday, the Consumer Price Index (CPI) for the month of December is set to be released and much like the PPI on Thursday, expectations for these two releases are low. Overall inflation remains mysteriously low and this trend will likely be continued following the PPI and CPI releases this week. Wrapping up the week on Friday this week is the release of the retail sales figures for the month of December, which is a key month for all retailers. Expectations for these figures are an increase of 0.4 percent, both including and excluding auto sales. The November readings for comparison were 0.8 percent overall and 1 percent excluding auto sales. From what we have seen so far about the holiday shopping season, it looks like both figures are too low. Federal Reserve officials get back to work this week as there are 9 speeches scheduled to be made, with the number of rate hikes in 2018 and the incoming Chair likely to be the main topics in the question and answer section of each of the speeches.

 

Interesting FactWhere on Earth felt colder than Mars last week?

 

Mount Washington Observatory in New Hampshire isn’t just cold — at minus 36 degrees with a wind-chill of 94 below, it’s tied for the second-coldest place on Earth, according to a tweet from the observatory. In fact, according to the latest data available from the Curiosity rover on Mars, Mount Washington feels colder than the surface of our celestial neighbor, which was measured at minus 78 degrees.

 

Source: Boston Globe