Waiting for Clarity on Taxes and the Fed
Since the U.S. presidential election, the S&P has risen in eleven of sixteen weeks, on its way to a 10.6 percent return. Over much of the same time period, the yield on the ten-year note traced a similar trajectory, climbing from 1.86 percent to a peak of 2.60 on December 15, and as recently as February 15 was 2.50 percent. Since then, the complexion of the rally in stocks has changed. And, following Fed Chair Yellen’s congressional testimony, the direction of fixed-income yield has diverged, plunging to 2.31 percent, with the majority of that move coming over just the past two and a half days. This activity followed the release of the minutes from the Fed’s most recent meeting, generally read as signaling a dovish stance toward the upcoming March meeting.
Between the election and February 15, before the recent reversal in yields, financial stocks had surged. The BKX bank ETF had climbed 29 percent, as the yield spread between the two and ten-year notes widened from 100 basis points to 124, peaking at 136 in late December. Cyclical stocks in general were among the best performers, while defensive stocks lagged. Since February 15, however, the BKX has slipped 1.1 percent, with most of that decline coming last Friday, as the two and ten-year spread fell to 116 basis points. The rate-sensitive utilities sector had declined fractionally between the election and February 15, but since it has climbed 5.2 percent. REITs and consumer staples have also been among the best performers.
The recent outperformance of these defensive groups has been enough to allow the rally in the broader S&P 500 to continue, but it does raise questions about the strength of the underlying reflationary trade that drove most of the initial post-election move. A lack of clarity regarding the timing and details of the administration’s plans for tax reform and infrastructure spending may have sapped some of the enthusiasm for the more economically sensitive sectors, although we may learn more about both this week. And stocks may simply be pausing to digest the sheer extent of the move already enjoyed. The economic data has been generally solid of late, but not so robust as to overcome possible market fatigue.
The economic calendar this week will provide a good current reading, as it includes durable goods, consumer confidence, personal spending and income, ISM manufacturing and services, vehicle sales, and importantly for the Fed, the PCE deflator. The February jobs report will have to wait until the following Friday.
Earnings expectations for both the first quarter and full year remain healthy, although they have edged lower since the start of the year. According to Factset, growth in the first quarter now projects to 9.3 percent, down from 12.5 percent. Two sectors that have seen expectations come down are industrials and materials. For the full year, earnings are now forecast to grow by 10 percent, down from 11 percent. Nevertheless, credit markets continue to exhibit economic confidence. The spread over Treasuries of the Bank of America Merrill Lynch High Yield Master II fell to its lowest level in two and a half years at 384 percent last week, as its yield-to-maturity fell to 6.03 percent, also its lowest in the same time frame.
The Fed will certainly have a lot to say about how sanguine investors continue to feel about the economic outlook, the prospect for earnings growth, and elevated valuations when it meets on March 14-15. For now, the possibility of lower corporate tax rates contributing to both rising earnings and rising confidence is contributing to the optimism that has sent stock prices higher. But the Fed could be closer to raising rates than the market seems to think. The PCE deflator report on Wednesday will be the next clue as to how the Fed may proceed.
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The S&P 500 is an index containing the stocks of 500 large-cap corporations, most of which are American. The index is the most notable of the many indices owned and maintained by Standard & Poor's, a division of McGraw-Hill.
The BKX Bank Index is designed to track the performance of the leading banks and thrifts that are publicly-traded in the U.S. The Index includes 24 banking stocks representing the large U.S. national money centers, regional banks and thrift institutions.
The Bank of America Merrill Lynch High-Yield Bond Master II Index is an unmanaged index that tracks the performance of below investment grade U.S. dollar-denominated corporate bonds publicly issued in the U.S. domestic market.
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