The Long Winter
I’m writing this in April, during the winter that is taking forever to
end. We braved the cold of December and
January, were teased with some warm days in February, and then found ourselves
in March, with its four nor’easters, cursing the snow each week and shivering
in the cold. We have had quite
enough! And I’ve said it before, that
snow covered roads and potholes destroy productivity. I’m sure we won’t get much sympathy from
places like Chicago, Buffalo, and Erie, but they signed up for winters like
this, not us here in Philly. Only one
thing made winter bearable this year- the fact that the Eagles won Super Bowl
LII and the celebrations began. Now, if
Mother Nature would cooperate…
Volatility
The markets have been incredibly volatile in the first quarter of
2018. This may be the understatement of
the year! The spike in volatility was a
wake-up call to every investor and market participant that thought “vols” would
stay historically low forever. Welcome
to 2018! Stocks, bonds, and commodities
spike up and down in large percentage changes almost daily, leaving investors
wondering what is next. Nearly everyone
expects periodic market corrections, but no one expected to have whiplash!
What prompted volatility to rise so much? The first sign that markets were about to be
rocked was an inflation scare concerning wages in early February. Wage growth was reported at +2.9% on a
year-over-year basis. Wow! The Federal Reserve thinks unemployment is
too low, which could lead to higher wages and inflation, and they are raising
rates. Aren’t they proven right? Stocks fell dramatically, rose, fell, rose,
fell, rose, well, you get the idea.
Hundreds of points in price changes in the Dow Jones Industrial Average
got headlines every day. Several unusual
hedge funds that were based on market volatility levels collapsed, most notably
funds from Nomura and Credit Suisse, leading to 90% losses for those
“investors.” Who even knew they were
there?
Alas, inflation was not to be- not yet, anyway. The year-over-year wage growth fell back in
March and April to +2.6% to +2.7%, closer to where it had been in 2017. This only gives proof that the Fed is still
looking at the Phillips Curve (unemployment-inflation tradeoff) to set
policy. During March, we also had the
opportunity to see new Fed Chairman, Jerome Powell, in action. He gave a press conference and was confident
and concise. He is a man with financial
markets experience and should understand the effect of Fed policy on the
markets. His recent predecessors were
academics. During March, 2018, Powell
and the Fed increased rates by .25% for the sixth time since December, 2015. Chairman Powell reiterated continued slow and
steady rate increases. At some point,
and I believe soon, the Fed will pause.
Tech stocks added to the volatile environment during the past few
months. Facebook continues to be
whipsawed and other major names like Google, Amazon, Netflix, and Microsoft fell
in sympathy with their social media favorite.
Volatility continued when the Trump Administration announced tariffs on
steel and aluminum imports, mostly directed at China, who responded in kind by
slapping tariffs on 125 products exported by the US. The markets hate the idea of tariffs and the trade
wars that can be a result and the market price action reflects it.
The Economy
All indications are that the economy will continue to improve, albeit
slowly and at a lesser pace than that of previous recoveries. Tax cuts are adding stimulus and leading to
improved business and consumer optimism, but there are some offsetting factors
in the form of Fed tightening, low productivity, and large levels of debt,
especially at the federal government as they fund what could be a $1 trillion
plus deficit this fiscal year. Fourth
quarter GDP was +2.9% and was +2.3% for all of 2017. In March, 2018, the Fed revised their GDP
forecast for all of 2018 to +2.7%, which is hardly worth writing home about
compared to growth in 2017, but is still at a level that I consider to be
sustained. When GDP growth is stuck in
the 2s and overall inflation is around the Fed target of 2%, raising interest
rates too much can lead to an unhappy ending.
Not only are short term rates rising, but long term ones did, too, in
response to the inflation scare and the Fed unwinding some of their balance
sheet investments.
Housing, construction, and the auto industry are projected to do well in
2018, as long as rates do not rise too much or too rapidly. Don’t get me wrong, the US economy is doing
well, given the environment and volatility and is expected to outperform Europe
and Japan. Consumer spending and retail
sales have shown weakness since the fourth quarter of 2017 but we should see
improvement. Gas prices remain below
$3.00 per gallon, adding to a positive consumer spending outlook; let’s hope
prices do not rise too much into the summer travel season. Businesses should do well as they bask in the
lower corporate tax rate, which fell from 35% to 21% at the beginning of 2018.
National housing indices continue to rise by +6% on a year-over-year
basis and are projected to rise at least +5% during 2018, provided that long
term mortgage rates do not spike and cut off demand. Locally, Bucks County has seen its best
year-over-year increases in the last two quarters of 2017, rising +5% and
+6%. One factor that is impacting prices
is limited supply compared to prior years.
In many cases, inventories of unsold homes represent three to four
months’ worth of sales, compared to a more normal level of six months.
The Federal Reserve Beige Book is released in advance of the Federal
Reserve meetings. The recent March, 2018
report for our Philadelphia Region was overall quite positive; the words
“modest” or “moderately” were used 16 times on two pages. The implication is that the economy here is
okay and still growing. The Philadelphia
Fed’s Business Outlook survey confirms this, with most of the survey results positive. And most of all, it is a great time to be a
Philadelphia sports fan! The Eagles won
the Super Bowl, bringing joy to fans who were experiencing their first Super
Bowl win for their city in their lifetimes.
Villanova won the NCAA title again, the Sixers just completed a 16 game
winning streak to end the regular season and have made the playoffs, the
Phillies have been hitting lots of grand slams and show promise, and the Flyers
made the playoffs, however faltering in their first game but it is a long
series, as they say…
Thanks for reading! DJ 04/12/18
Dorothy Jaworski has worked at large and small banks for over 30 years; much of that time has been spent in investment portfolio management, risk management, and financial analysis. Dorothy has been with Penn Community Bank and its predecessor since November, 2004. She is the author of Just Another Good Soldier, and Honoring Stephen Jaworski, which details the 11th Infantry Regiment's WWII crossing of the Moselle River where her uncle, Pfc. Stephen W. Jaworski, gave his last full measure of devotion.