After an exceptionally strong start to the year fueled by above-trend global economic and corporate earnings growth, the S&P 500 finished January with a 5.6% total return.
In the last two trading days, equity markets around the globe sold-off after digesting Friday’s very strong January payroll report, among other reasons. In addition to the economy adding 200,000 jobs, average hourly earnings jumped 2.9% on an annualized basis. This was the best gain since the early days of this remarkably sluggish recovery which began in March 2009.
While this wage growth is still markedly below the long-term average, it fueled investor worry that inflation, as measured by personal consumption expenditures (PCE), may rise past the Federal Reserve’s desired target of 2%. PCE checked in at 1.67% in the most recent reading, quite a bit lower than the wage growth number referenced earlier.
Fixed income markets, particularly in the U.S., have already begun adjusting for this above-trend growth in the early part of this year. The 10-Year Treasury yield, a bellwether benchmark for borrowing costs around the globe, began the year at 2.40% and breached 2.85% as recently as last Friday. Bond yields move inversely to bond prices. An important thing to note in recent days is that credit spreads have not widened suggesting bond investors do not think company or economic fundamentals are deteriorating.
We noted that increasing interest rates are a potential risk to the markets in our 2018 Investment Currents released earlier this year. A strengthening global economy, a weaker U.S. dollar, quantitative tightening from the Federal Reserve due to unwinding its balance sheet, and an expansion of Federal borrowing, as a result of a widened deficit from tax reform, are the key drivers of higher yields from historic lows.
We have been forecasting low interest rates for many years now as certain long-term secular forces show little sign of abating. This includes an aging world population that is past its peak spending years, low productivity gains, and meaningfully lower population growth. Despite recent tightening posture around the globe, financial conditions are still very easy.
Essentially, in the last three trading days, we’ve seen the market adjust for these higher rates. Our Investment Committee interprets this good economic news as bad news in the short-term, leading to this volatility. This inflation, interest rate theme has also been compounded by volatility products, high frequency and algorithmic trading that have become a source of liquidity, and also the norm in recent years.
In summary, as we’ve mentioned in media appearances and in our forecasts, the fundamentals of the global economy and corporate earnings continue to look increasingly strong. Recession risks and excesses are difficult to find and our investment team expects the storm to pass soon. We are optimistic for a return to a market critically focused on fundamentals and valuations.
Securities and insurance products are offered through Univest Investments, Inc., member FINRA/SIPC and a licensed insurance agency. Investment advisory services are offered through Girard Partners, a Univest Wealth Management Firm. These affiliated companies are licensed subsidiaries of Univest Corporation of Pennsylvania. Products and services offered are not FDIC insured, are not a deposit of or bank guaranteed, and are subject to risks, including possible loss of any principal amount invested.
Trust services are offered through Univest Bank and Trust Co.