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Weekly Market Review | Week Ending May 3, 2019

07 May 2019

Clint McGarvin, CFA® | Portfolio Manager/Research Analyst

U.S.

U.S. large caps increased about 0.2% while small caps were up about 1.5% last week in a fairly volatile week of trading. Investors, as we know, hate surprises and this week, the Fed supplied a surprise with a small change in wording related to interest rates. Chairman Powell stated, “We don’t see a strong case for moving in either direction.[i]” Many investors were expecting to see a rate cut this year based upon a weakening economy. However, the economy is likely too strong, and inflation likely too low for a rate cut. Following Mr. Powell’s comments, large caps declined about 1% through close on Thursday though a strong April jobs report contributed to nearly a 1% increase on Friday. Job creation surged to 263,000 in April and growth occurred in the highest wage-earning categories. Workers 25 and over, saw an increase of 294,000, while those under 25 saw a significant decrease in jobs.[ii] Growth in the 25 and over category will likely benefit the economy through higher consumer spending relative to job creation for those younger than 25 who typically earn lower wages.

The unemployment rate declined to the lowest level since December 1969 to 3.6%. Nonfarm worker productivity data released last week, showed a strong 3.6% annualized increase, the strongest since 2014. Productivity is the difference between output per worker and the increase in the number of hours worked. Thus, in the first quarter, the number indicates output increased faster than the number of hours worked. The strong productivity growth reduces unit labor costs, which is the price of labor per unit of output, to 0.9%.[iii] Currently, labor markets are considered very tight which normally signals rising inflation pressures.

However, inflation, as measured by the Personal Consumption Expenditures (PCE) price index, increased by 1.5% year-over-year in April.[iv] Low inflation when labor markets are tight can be partially explained by strong productivity growth. Higher productivity typically increases corporate profit margins, so even as wages are rising, productivity is rising at a faster rate, helping to expand profit margins, which in turn can act to tamp down inflation through greater competition for market share, the fight for market share usually limits price increases. If productivity remains strong then the low inflation environment we are currently in will likely prove less transitory and more persistent than the Fed’s most recent stance regarding their position on the economy.

Other economic news out last week includes manufacturing indexes the ISM index and the IHS Markit Purchasing Managers’ Index (PMI). Both indexes showed continued expansion in the manufacturing sector of the economy, albeit it at a slower pace than in 2018. The ISM manufacturing index declined from 55.3 to 52.8 from March to April as new orders and employment saw big declines, yet they remained in expansion territory.[v] The IHS Markit PMI grew at a slightly faster pace in April, rising to 52.6 from 52.4 in March, and the new orders component accelerated slightly, boosting the overall index.[vi] The ISM services index pointed to an economy that is expanding at a rate below that of 2018 but still posting solid growth. The index declined to 55.5 to 56.1 from April to March as new orders and employment fell.[vii] Inflation pressures in all three indices declined in April as well.

International

International equity markets were positive last week, as both developed and emerging markets rose about 0.8%. Helping to boost emerging market stocks was the Chinese manufacturing sector, which expanded in April for the third consecutive month. The Caixin China manufacturing PMI fell to 50.2 from 50.8. Recall that 50 represents the dividing point between expansion and contraction. A level of 50.2 should illustrate an improvement in the Chinese manufacturing economy despite the lower number.[viii] The weakness could be attributed to new orders from international markets and softened inflation pressures in April. The European manufacturing sector remains in contraction territory as the IHS Markit Eurozone PMI ended April at 47.9, but this is up from the 47.5 reading at the end of March. The weakness in Europe seems mostly driven by the contraction in Germany where the manufacturing PMI sits at 44.4,[ix] a recent high. Thus, the manufacturing sectors around the world appear to be moving in the right direction, if only weakly.

Summary

The economic and market data out last week appears to support rising equity prices. Based on trade and industry indicators, the U.S. economy continues to expand at a moderate pace. Labor markets, manufacturing, and services suggest the economy is likely to remain in growth mode. Corporate earnings have surprised to the upside as margins remain relatively high despite rising wages. Inflation remains below expectations as productivity has exceeded expectations. Volatility in equity markets has declined, but prices have increased at a faster rate than earnings growth. Increased valuations can help reduce long-term return expectations limiting opportunities in equities. Yields in fixed income markets have declined so far this year which normally reduces long-term return expectations for bonds.

[i] CNBC (2019), Powell says Fed doesn’t see strong case for rate cut or hike. Retrieved from https://www.cnbc.com/2019/05/01/powell-says-fed-doesnt-see-strong-case-for-rate-cut-or-hike.html
[ii] Bureau of Labor Statistics (2019), The Employment Situation – April 2019. Retrieved from https://www.bls.gov/news.release/pdf/empsit.pdf
[iii] CNBC (2019), US First-Quarter Productivity Rises at the Fastest Pace Since 2014; Labor Costs Fall. Retrieved from https://www.cnbc.com/2019/05/02/productivity-and-labor-costs-q1-2019.html
[iv] Bureau of Economic Analysis (2019), Personal Income and Outlays, March 2019. Retrieved from https://www.bea.gov/news/2019/personal-income-and-outlays-march-2019
[v] Institute for Supply Management (2019), April 2019 Manufacturing ISM® Report On Business®. Retrieved from https://www.instituteforsupplymanagement.org/ISMReport/MfgROB.cfm?navItemNumber=31133&SSO=1
[vi] PMI by IHS Markit (2019), IHS Markit US Manufacturing PMI™. Retrieved from https://www.markiteconomics.com/Public/Home/PressRelease/5ee0f9d3951b4934a3184f60a086c474
[vii] Institute for Supply Management (2019), April 2019 Non-Manufacturing ISM® Report On Business®. Retrieved from https://www.instituteforsupplymanagement.org/ISMReport/NonMfgROB.cfm?navItemNumber=31134
[viii] Caixin Purchasing Managers’ Index™ (2019), Caixin China General Manufacturing PMI™. Retrieved from https://www.markiteconomics.com/Public/Home/PressRelease/26c51700cb5f4224bda8595676615fdb
[ix] PMI by IHS Markit (2019), IHS Markit Eurozone Manufacturing PMI® – final data. Retrieved from https://www.markiteconomics.com/Public/Home/PressRelease/a4c26f8d7ba44a21ab350938d4eab0a3
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