Market Recap

On Economy

Voluntary job separations continue to trend higher in the U.S., which is a healthy sign. Additionally, the NAHB housing market index hit a new cycle high in March.

The Fed is picking up the pace in its quest for normalization. The central bank raised rates +25bp, putting the fed funds rate target in a 0.75%-1.0% band. The Fed remained committed to a gradual pace of rate hikes in 2017. The neutral level of the federal funds rate remains low, and just a few more rate hikes will move to that neutral rate quickly.

While the data-dependent Fed is in a tightening cycle, and the data is good enough to continue. The Fed’s forecasts haven’t changed much, and the FOMC members are still not discussing in detail particular fiscal policy measures. Chair Yellen did note that the Fed balance sheet was discussed at last week’s meeting, but no decisions were made and more work needs to be done. There is no specific fed funds rate that would trigger a balance sheet decline, but rather a sense that the economy will continue to make progress plus confidence that there is no particular concern about adverse risks.

On Energy

European stocks and U.S. futures edged lower Monday as a pullback in oil prices pressured shares of oil and gas companies. Declines in the oil price kept shares of energy companies depressed with Brent crude oil last down 0.4% at $51.55 a barrel, weighed by signs of increased drilling activity in the U.S. Italian bank shares edged up 0.3%.

On Stocks

Stocks in Europe and Asia pulled back Wednesday after major U.S. indexes posted their steepest decline of the year. The Stoxx Europe 600 was down 0.8% in the early minutes of trading and Asian markets were lower across the board amid a retreat in global bank shares. Futures pointed to a 0.3% opening dip for the S&P 500. Continued weakness for the dollar this year is likely contributing to the strength in many global markets. Consumer Discretionary is about as scattered of a group as we can remember in some time. On one side, the Retail stocks remain in pronounced downtrends with many on the verge of or hitting new lows this week. Aside from Internet Retail, it remains a difficult space to be.

The small-cap rally that took Wall Street by storm late last year has petered out. Shares of smaller companies have lagged behind the market this year, underscoring investor concern over the likely timing of economic-policy changes by President Donald Trump’s administration and rising U.S. interest rates. The Russell 2000 index of small-cap companies is up 2.5% this year, while the S&P 500 is up 6.2%. Small-caps rose 14% between Election Day and the end of 2016, while the S&P 500 climbed 4.6% over the same timeframe.

White House Preps Pair of Executive Orders on Trade

Trade is likely to move back into the spotlight in the next few weeks as the White House prepares to release two new executive orders: one ordering a reexamination of all existing trade deals, and one aiming to review and change procurement policies. Both orders would represent steps toward fulfilling some of Trump’s signature pledges. The executive orders also have added the benefit of changing the current narrative from more damaging stories involving the White House to a place where the president can really shine.

Interesting Charts

Lipper Large-Cap Core Ave Return Relative S&P 500 Total Return vs. CPI

Annual S&P 500 Performance vs. % of Active Managers Outperforming

Sector Performance during Fed’s Balance Sheet Expansion

A Look at the Markets Eight Years Later

S&P 500 Historical Bull Markets 1928 to Present

Tax Reform High on Trump Agenda as U.S. is Least Competitive

Source: Strategas Research

A Few Thoughts

Higher bond yields, whether they signal a healthy economy or stretched stock valuations, appear to have staying power. U.S. bond yields are topping a key measure of the dividends that large U.S. companies pay, which is a shift that has broad implications for investors who have viewed higher stock yields as underpinning an eight-year-long bull market. According to FactSet, at 2.50%, the yield on the 10-year U.S. Treasury note last Friday exceeded the 1.91% dividend yield on the S&P 500. The dividend figure reflects annualized payouts by companies in the index as a proportion of their current share price. Rising bond yields generally send a signal that the economy is healthy and that demand for goods and services is rising. But increases in long-term yields over time also stand to shift investor preferences that recently have been strongly skewed in favor of stock investments.

Credit risk is a strong driver of both bond and equity performance. What is more, the fear that a weak credit will continue to slide is one of the most pronounced risks to individual stocks. Simply put, liquidity cannot solve a solvency problem, but lack of liquidity can make solvent credits insolvent, thereby drastically reducing the equity stake in an otherwise viable name. As such, when credit markets close in on a name, equity investors need to take notice. The names and sectors may not surprise, with energy still the highest risk sector. High yield default rates hit a near-term peak of about 4.6% for 2016, and appear to be heading lower in 2017. Currently, high yield spreads imply about a 3% default rate for the next 12 months. Energy is still the outlier group within the S&P, with estimated default risk of about 1.5%. This is still 3 times the next closest sector, basic materials, and is reflective of still high debt loads and volatile asset prices. Financials come in as the third most at risk sector, at roughly 0.35%.