published: May, 01st 2017
Market Update – May 1, 2017
By: Rick Wedell, CIO
On the markets front, today will likely be a quiet day as the market digests the weekend news and prepares for the Open Markets Committee meeting on Wednesday. Many international markets, including Europe / London, are closed for the day as a celebration of May 1. Not too much happened over the weekend. Employment numbers were inline from Friday, showing strong wage growth (Employment Cost Index up 0.8% in the first quarter which is the highest growth since 2007), and the Federal government is now funded through September which removes a modest risk from the market. The administration has turned their full attention to tax reform, and is expected to spend roughly six weeks filling out the blueprint laid out last Wednesday before hitting the road to attempt to sell the proposal. Wednesday’s Fed meeting is expected to be a non-event, although the market is looking for the Fed to raise rates in June (68% odds*). Their commentary is unlikely to turn more hawkish given the relatively lackluster macro economic growth data that has come out recently. In the meantime, equity market performance over the past week has been largely earnings driven, and earnings have been good – just over half of the S&P500 constituents have reported and EPS** growth has been 15.6% yoy***, with revenue growth of 8.1%. Once again, this is in part driven by weak compares in 1Q’16.
The concept of tax reform and increased infrastructure spending is something I would like to take a brief minute on. There is some question at this point around whether or not this round of fiscal stimulus is really a good idea. The US economy is actually in pretty good shape at this point. Unemployment is at 4.5% and wage growth, as noted above, is faster than anything we have seen since the great recession. While we’ve previously discussed why it’s impossible to time market cycles, and we don’t typically see them just die of old age, it is relatively clear that we are long in the tooth on this particular bout of economic expansion. As a rule, the criticism of fiscal policy as it relates to being a tool to drive economic expansions, or compensated for economic contractions, is that it comes too late in the cycle to actually occur when it’s needed, and that can certainly be argued here. At best, it has little impact since the economy is already operating at full employment, and at worse it actually overheats the system and moves us closer to the next bubble. Think of it this way – if the economy is growing quickly enough that the Fed feels able to embark on interest rate tightening and balance sheet contraction, then adding fuel to the fire from a deficit fueled tax cut / infrastructure package is actually fighting what the Fed is trying to accomplish. Now, one could argue that a fiscal policy response would enable the Fed to raise rates / contract their balance sheet more quickly, and given how exposed they are at this point it makes a lot of sense to allow them to reload, but the simple fact of the matter is that we are unlikely to see unemployment numbers go significantly lower than 4.5%, and so throwing fuel on the fire right now may actually hasten the appearance of the next economic contraction by fueling the next bubble. In any event, market participants who expect a fiscal spending / tax package to fuel significant economic expansion should keep in mind that the Fed will be working against any fiscal response, and may do so aggressively in an effort to 1) keep the economy from over-heating and 2) reload their quiver.
Rick Wedell is neither affiliated with nor endorsed by LPL Financial.
*Odds are based on current prices of interest rate futures as provided by Bloomberg
**Earnings per share
***Year over year
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. No strategy assures success or protects against loss. Investing involves risk including loss of principal.