Please find the next blog in our monthly series that provides timely market data as well as perspectives on the current state of the economy and the global financial markets.
The impact of exchange rates on individual economies is becoming increasingly relevant. As market participants anticipate rising inflation in the US, the weakening of the US dollar against most major currencies may ultimately become a driving factor. Conversely, the strengthening Euro, which hurts exports, is a headwind to growth in the Eurozone.
The US economy continues to display solid fundamentals, with strong consumer and business confidence. While the advanced estimate of 4Q-17 domestic real GDP came in below expectations at 2.6%, consumer spending and fixed investment both recorded impressive gains. Core PCE, the Federal Reserve’s preferred measure of inflation, still remains below the 2% target at 1.5% on a year-over-year basis.
As expected, the Federal Open Market Committee (FOMC) left rates unchanged at its late January meeting, which was the final under Chair Yellen. Though inflation continues to be lower than anticipated (and desired), three additional rate hikes are expected in 2018, as financial conditions continue to be favorable and asset values continue to rise.
The unemployment rate remained at 4.1% for the fourth consecutive month and the participation rate held steady at 62.7%. Nonfarm payrolls increased by 200,000 overall in January. Although this exceeded expectations, downward revisions for the prior two months provided an offset. Average hourly earnings finally showed some spark, with the year-over-year gain of 2.9% representing the highest rate of wage growth since 2009. Additional pressure in the labor market could force employers to raise wages, pushing up inflation, and causing the Fed to accelerate rate hiking plans.
Outside the US, modest growth continues. China’s Caixin-Markit purchasing managers’ index remained at 51.5 in January, signaling continued economic expansion. The International Monetary Fund’s (IMF) global growth forecast has risen to 3.9% for 2018 and 2019.
Although market volatility returned in February dampening year to date returns, US equities posted a very strong showing in January. Despite a brief government shut down, the benchmark S&P 500 returned +5.7%, completing its 15th straight month of positive returns. Consumer Discretionary (+9.2%) and IT (+7.6%) led the way, with Utilities (-3.1%), Real Estate (-1.9%) and Telecom (-0.6%) losing ground.
Small cap returns were positive, albeit relatively modest with the Russell 2000 up +2.6%. While viewed as a positive for more domestically-oriented small cap companies, recent performance suggests the impact of tax reform is largely priced in. Growth stocks (+3.9%) again led the way, ahead of value stocks (+1.2%) by a comfortable margin.
Overseas, the MSCI EAFE index was up +5.0%. International developed markets were positive across the board, with most industry sectors and countries/regions advancing within the +3% to +7% range. Developing economies rallied in January, with MSCI Emerging Markets up +8.3%. Within the index, Latin America (+13.2%) and Eastern Europe (+11.2%) led the way, with all regions showing notable strength.
Real estate lagged in January, with the FTSE EPRA/NAREIT Developed index flat (+0.0%) and the FTSE NAREIT US Real Estate index down (-3.2%). Despite solid economic fundamentals, rising interest rates hampered returns. The Alerian MLP index (+5.8%) advanced for a second consecutive month amid firming energy prices (WTI oil +7.1%) and rising domestic production, which benefits volume-driven cash flows.
Continuing the strong finish to 2017, commodities opened the year on a positive note. The Bloomberg Commodity index was +2.0%, supported by the weak US dollar, rising inflation expectations, and solid economic growth.
Currency returns are having a meaningful impact on total returns in this period of low global bond yields. Although the Bloombar Global Aggregate index posted a gain of +1.2% during the month in USD terms, the local returns were actually down 0.7% due to rising yields. In this case, US dollar weakness was a major benefit for US investors.
The US Treasury (UST) market suffered its worst losses since the post-election disruptions of November 2016. Optimism regarding inflation, surging equities, and signals that China may slow its UST purchases just as domestic tax cuts promise to widen government deficits, all contributed to UST weakness. As expected, Jerome Powell was confirmed by the Senate as the next Chair of the Federal Reserve, and he will oversee the March 20-21 meeting. Markets are currently pricing ~90% likelihood of a March rate increase and ~25% chance of four rate hikes in 2018.
The Bloombar US Aggregate index lost 1.2% in January. With the exception of mortgage-backed securities, government issues trailed the primary market’s other key sectors on a duration-matched basis. IG corporate credit spreads tightened by another 7 bps, led by BBB-rated issues. Overall yields for IG corporates increased to 3.45%.
The Bloombar 1-15-Year Municipal index returned -0.9%. Despite a history of strong January returns and healthy retail mutual fund inflows, elevated dealer inventories and weaker corporate demand softened the technical environment. The yield curve steepened materially and valuations for longer-dated municipals have become more attractive.
The Bloombar US Corporate High Yield index produced a gain of 0.6% in January. With CCC-rated issues driving another 24 bps of spread tightening, the category has established new 10-year lows. Local currency emerging market bonds returned an impressive 4.5%, dramatically outperforming sovereign and corporate issues, which are more sensitive to US rates.
Disclaimers: The data contained in this report is provided from Asset Consulting Group (ACG). This is not an offer to buy or sell securities. No investment process is free of risk and there is no guarantee that the investment process described herein will be profitable. Past performance is not indicative of current or future performance and is not a guarantee. In preparing these materials, we have relied upon and assumed without independent verification, the accuracy and completeness of all information available from public and internal sources. Gryphon Financial Partners shall not in any way be liable for claims and make no expressed or implied representations or warranties as to their accuracy or completeness or for statements or errors contained in or omissions from them. This was created for informational purposes only. Gryphon Financial Partners, LLC is a Registered Investment Adviser.