April 2018

Stock Market Observations 

The S&P 500 closed down for the quarter, 1.2% and -2.69 % for March. Sentiment and prices peaked at 2872.87 on January 26th. U.S. 10-year note yields made their highs on Feb. 21 at 2.94% and closed the first quarter at 2.74%.

Euphoria over tax cuts and rising earnings in January have faded. Concern over trade wars with China, NAFTA and a slower global economy have taken over the news. Negative reports on tariffs and response to tariffs has sunk sentiment along with investor confidence. After passage of the Omnibus budget, deficits are sure to increase, Treasury bond sales will expand and the Fed will not be there to pick up slack as they run off their balance sheet.

U.S. stocks are undergoing a period of correction and global markets have gone along for the ride. European stocks trail the U.S. market.

Emerging markets plus Asia are somewhat better due to faster growth and lower P/E multiples. China appears ready for the tariff battle should it escalate. We await Q1 earnings reports and subsequent conference calls to flesh out future business prospects. A risk off atmosphere is manifesting itself with the rise of gold prices and a rise in long term government bond prices that began on Feb 22. AGG-iShares Core Aggregated Bond ETF started the year at 109.32 and now traders at 106.9. The yield there is 2.73% with nearly 6 years duration on that portfolio. Today a 2-year Treasury note yields 2.27%, with the 10 year at 2.76%, the spread between the two has narrowed to 49 basis points. A flattening yield curve is concerning for bank profits. Banks prefer a rising rate environment, along with a steepening yield curve.  Today's 30-year UST's yield is 3.0%.

S&P 500 earnings estimates for 2018 remain in the area of $154.00. This translates to a 5.9% earnings yield and a P/E ratio of 16.9x on a 2600 base for the index. On an historical basis P/E s are on the high end of their range. Compared with the "risk free" yield of 2.76% on 10-year governments, stock prices are not excessive. If we devolve into a global trade war all bets are off. We will experience a peak in earnings and global GDP. If market leaders give more ground, market averages will follow suit. Hopefully, negative rhetoric cools down and negotiations on trade make progress and stock will rise after a normal, though painful, 10% setback. Mid-term election years are known for below average returns, 2018 may be no exception. Trade negotiations are ongoing and a 60-day period has begun to strike a deal with China. NAFTA is on a tighter timeline.

Financials are the second biggest sector in the SPX only exceeded by Technology which is suffering from a new set of problems including regulation fears, market dominance and trust issues. 

In 2000, when Technology last reached these levels, profits were only 13% of the SPX, now they are 23%.  Nevertheless, profits and market capitalization are heavily weighted in growth stocks versus the broader market.

The top 3 stocks in the S&P 500 are worth $2.2 trillion while the entire Russell 2000 Index is valued at $2.5 trillion. Top 10 stocks in the SPX are worth $5.1 trillion. The top 50 stocks are 50% of the total index value.

Volatility, which had gone away in 2017, has returned. VIX spent most of 2017 around 10 and is now 21, having burst over 50 on Feb 6 of this year, in a flash crash of stocks and reverse VIX, ETF's. 

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