Investors continued to focus on the new trade tariffs announced by President Trump, but there was not much clarity regarding specifics or other countries’ reactions. This week’s Federal Reserve policy meeting also garnered attention, as the market expects another 25 basis point increase in the fed funds rate.1 The general tone was negative for stocks last week, as the S&P 500 fell Monday through Thursday and produced a -1.2 percent loss for the week.1 Treasury bond yields also declined last week and pulled further away from the 3 percent mark.1
Weekly Top Themes
1. Economic growth appears to have hit a soft patch in the first quarter. February retail sales showed a 0.1 percent dip and housing starts were down 7 percent,2 although industrial production and manufacturing levels improved.3 Consensus expectations for first quarter gross domestic product growth have declined from the 2.5 percent to 3 percent range to 2 percent to 2.5 percent.1
2. Despite this modest decline, the probability of a recession seems low in the next 12 months. Based on the many recession forecasting models available, our view of the current data and our forward expectations, we peg the odds of a recession occurring over the next year as being less than 20 percent.
3. We expect government bond yields to climb unevenly before this economic expansion ends. Over time, we expect the 10-year Treasury yield to approach 3.75 percent to 4 percent, levels last seen in 2010/2011.1 But this process is unlikely to occur in a straight line. In the immediate term, we think yields are likely to move sideways after their strong advance last month.
4. The U.S. political backdrop continues to contribute to overall uncertainty. In addition to tariff-related confusion, White House personnel changes continue to rattle investors. The latest moves include firing Secretary of State Rex Tillerson, naming Mike Pompeo to replace him and appointing Larry Kudlow to head the National Economic Council.
5. The 2018 midterm elections are shaping up for a possible wave election by the Democrats. Congressional special elections and state legislative races have shown that Democrats have been able to more than hold their own in traditionally strong Republican areas. Absent a significant shift in the political landscape, we expect Democrats will be able to take the House of Representatives in November, although the Senate is less likely to see a leadership shift.
2018: A Mirror Image Of 2016?
In many ways, 2018 started off almost exactly the opposite of 2016. Between 2016 and 2018, the world moved from a profits recession to an environment of profits euphoria, from worries about deflation to a strong reflationary backdrop and from an environment of historically low government bond yields to yields moving unevenly higher.
Two years ago, we cautioned against taking too negative a stance and thought sentiment was overly pessimistic. Likewise, we thought investor optimism was too high at the beginning of this year. This is not to say we had or have a negative view toward equities in 2018, but we think caution is warranted and volatility will remain elevated. The move from sharp negativity to a more constructive outlook over the past two years is a negative sign for stocks from a contrarian perspective, especially since it is occurring while valuations have become more rich.