Quotes of the week
And go to’t with delight.”
– Marc Antony (“Antony & Cleopatra”)
The Lead Story: A “ho-hum” employment report to close 2017
In a sign that investors are taking this jobs data in stride, market-implied odds of a Fed rate hike in March remained at 79%, the same level where they were on January 4, the day before the report’s release. Amazingly, the odds were a mere 10% only four months ago.
After finishing 2017 at 2.40%, the 10-year Treasury yield closed the first week of the new year at 2.47%, a rise that reflected less demand for low-risk assets as the equity bull market continued. (Yield and price move in opposite directions.) In determining the 10-year’s future path, we will monitor a number of factors. These include demand for U.S. assets, the likelihood of higher domestic inflation, and movement in the labor-force participation rate (LFPR), which could heavily influence the magnitude of wage gains. A higher LFPR should reduce wage pressure, enabling the Fed to raise rates more slowly. This, in turn, could extend the economy’s late-stage momentum. Should the LFPR not increase, though, stronger wage growth may soon follow. That might encourage the Fed to tighten more aggressively over time, possibly triggering an economic slowdown.
Returns for non-Treasury sectors were largely negative for the week through January 4. High-yield bonds rallied, however, benefiting from the “risk-on” mood and oil’s rise above $60/barrel for the first time in 2½ years.
In other news: No holiday hangover for global equities
2017 was quite a year for U.S. equity investors. Amid serene, almost bond-like volatility, the S&P 500 Index notched 62 record-high closes en route to a 21.83% gain. The index capped the year with a healthy 6.64% fourth-quarter return, as investors’ focus on corporate tax cuts fueled optimism about 2018 earnings.
That optimism has spilled over into January’s first four trading days. Driven by last year’s top- performing sector, Technology, the S&P 500 rose more than 2.5% for the week shortened by the New Year’s holiday.
What can we expect over the remaining 250 or so trading days? We believe the new 21% corporate tax rate (down from 35%) will boost 2018 corporate profits by an average of 5%-7% beyond what they would have been otherwise. We therefore expect S&P 500 earnings per share to rise by a total of 17% in 2018.
Below the fold: Global manufacturing heats up in December
The Back Page: The S&P 500 Index looked "Sharpe" in 2017
A combination of strong returns with low volatility was a defining characteristic of the S&P 500 in 2017. Indeed, its Sharpe ratio, a widely used measure of risk-adjusted performance devised by Nobel Laureate William F. Sharpe in 1966, reached its second-highest level ever last year, at 4.82. (The higher the ratio, the more attractive the risk-adjusted return.) In stark contrast, the S&P 500’s average Sharpe ratio over the past 40 years was only 0.81.
The unusually high Sharpe ratio for 2017 indicates that equity investors enjoyed a remarkably stress-free rally last year. In fact, there were just eight days in which the S&P 500 rose or fell by 1% or more in a single trading session. On a daily basis, the index rose or fell by 50 basis points (0.50%) or less 80% of the time. Moreover, it provided a positive return in every month of the year for the first time ever, without a single correction of 5% or more.
Because volatility is notoriously challenging to forecast, it’s hard to predict how the S&P 500’s Sharpe ratio will fare this year. Even if it turns out to be a little less “sharp” than it was in 2017, we expect risk-adjusted returns will be anything but dull in 2018.