Market volatility has persisted as wide intraday swings in stock prices have continued to be the norm following the stock market correction in early February.
There has been a tug-of-war for the market's attention between higher interest rates and strong earnings growth. On one side the interest rate on a 10-year U.S. Treasury Bond topped 3% this week for the first time since early 2014. Coming into 2018 the 10-year rate was 2.40%. Remember that when interest rates go up that means that bond prices are declining. The Barclays Aggregate Bond Index, which is viewed as the S&P 500 of the bond market, is down 2.67% year-to-date and Long-Term U.S. Treasuries have declined 7.07% year-to-date. It has been several years since we owned Long-Term Treasuries as the risk of interest rates going higher outweighs the reward of earning a slightly higher yield.
Also taking it on the chin this year:
Consumer Staples -10.20%
What these investments have in common is that all three doubled in price between 2011 and 2016, outperforming the S&P 500 as investors searched for high-paying dividend stocks with bond rates and money market rates extremely low.
The valuation of these "bond-proxies" are still not cheap and if interest rates continue to go higher there will likely be more pain ahead for this group.
The high yield for the 10-year U.S. Treasury in 2014 was 3.03%. Earlier this week that level was tested again and rates subsequently backed down to under 3%. The issue for some investors isn't necessarily higher interest rates, but the concern is the potential for interest rates to quickly move higher making it more difficult for the market to adjust.
As we approach the halfway point for first quarter earnings reports, revenue and earnings growth continue to be sensational. Earnings are on pace to grow 21.1% with revenue increasing 7.6%. It was not too long ago that some analysts said that low single digits growth was the best that could be expected and that the days of faster growth across the board were gone.
As of January 1st, 2018 the projected growth rate for first quarter earnings was 12.2%. Actual results are going to be nearly double those projections.
A theme from 2011-2016 was that analysts were overly optimistic each year in their forecasts for earnings growth (and economic growth as well) and as the year progressed would have to cut their forecasts. 2017 earnings growth came in slightly below the initial forecast and so far in 2018 analysts have significantly raised their forecasts.
Let's briefly touch on a few more issues.
The Cass Freight Index gives valuable insight into the level of economic activity by tracking freight expenditures and freight volumes. This chart does a good job of illustrating the dramatic turnaround that has taken place in the U.S. economy since the beginning of 2017.
This index is a leading indicator of economic activity so the March reading is a positive for future economic growth.
The U.S. consumer continues to feel very good about the economic outlook. When consumers are more confident in the economy they tend to spend more.
Part of the reason for the consumer's positive outlook is that their take home pay is increasing at the highest rate in over ten years thanks to the recent tax cut. March saw an increase of 7.5%, up from the 2%-3% range previously seen.
As first quarter earnings season continues to unfold we will closely track not only the earnings themselves, but also companies outlook for the rest of 2018. We will also monitor interest rates with particular attention around the 2014 high yield of 3.03%. Keep in mind that strong economic data does not guarantee more upside for the stock market. That said, 20% earnings growth on the back of double-digit earnings growth in 2017 provides a strong foundation for stocks.