U.S. stocks are bouncing around all-time highs as the S&P 500 ended the week at 2,105. The index roared higher during the first half of the month, but has been fairly calm lately and was down just a quarter of a percent this week. Nevertheless, the S&P 500 was up 5.8% in February and is now up 2.6% year to date. European stocks have done even better, as the STOXX 600 Index has gained over 14% in local currency and 6% in dollars during 2015.
The tech heavy NASDAQ rose to 4,964 which is only about 1% below its record high of 5,048 reached on March 2000 at the peak of the Dotcom boom. It has now taken 15 years to get back to that high, reflecting quite a bubble back in the 90’s!
Ten year Treasury yields dropped twelve basis points over the week to close at 1.99%.
ISI notes: The spread between 10 year U.S. Treasuries at 1.99% and German bunds at 0.30% is a record, which suggests U.S. yields won’t go up further unless German yields go up. Because the spread is so wide, daily changes in U.S. bond yields and German bunds have been highly correlated lately.
An agreement reached on Monday between Greece and the Troika (ECB, EU and IMF) effectively delays until summer the risk of Greece leaving the euro. Blackrock says Greece will remain a chronic issue for investors for some time. Yep.
The House and Senate passed legislation paving the way for construction of the Keystone XL pipeline from Canada to refineries on the U.S. Gulf Coast. It was vetoed, as expected, by President Obama.
In testimony to congress on Tuesday Fed chair Janet Yellen said:
“Provided that labor market conditions continue to improve and further improvement is expected, the Federal Reserve anticipates that it will be appropriate to raise the target range for the federal funds rate when, on the basis of incoming data, the Fed is reasonably confident that inflation will move back over the medium term toward our 2% objective.”
Most Fed watchers interpret her comments as consistent with a hike in short rates during the third quarter. Although, the inflation rate has been below 2% for 31 straight months and even the core rate is unlikely to be at 2% before year end.
The monthly CPI inflation rate fell a more than expected -0.7%. It was the third monthly decline in a row. This puts the y/y number in deflation territory of -0.1%. Gasoline prices dropped 18.7% in January after falling 9.2% in December. (Note: gas prices have rebounded 30 cents from their lows a month ago, so the February CPI could be up.)
The steadier core CPI (ex food and energy) rose a more-than-expected 0.2%. This puts the y/y gain at 1.6%.
Walmart increased wages for its 1.3 million employees by 3.3%. TJ Max is boosting worker pay by 9%. Baird notes that this reflects big changes in the labor markets especially the drop in the unemployment rate from over 10% during the Great Recession to 5.7% now. It means more competition for good workers and perhaps pressure for wage inflation.
JP Morgan reflects that rapidly diminishing slack in the labor markets could lead to rising wages soon and inflation in 2016. They think the Fed may tighten sooner than people think.
Anecdotal signs of inflation. USA Today: Disney hikes ticket prices +6% to $105 at theme parks.
U.S. Real GDP growth in the fourth quarter was revised down to 2.2% from a previous estimate of 2.6%. No big deal. The economy is still ok.
A number of us from AIMS had a nice dinner with Paul Erlendson on Wednesday. He is a SVP with Callan, the investment consultant for the Alaska Permanent Fund, the Alaska Retirement Management Board (which has fiduciary responsibility for the assets of the state’s retirement systems, like PRS/TRS), and many other clients across the country. Paul discussed Callan’s long term outlook for the economy and capital market assumptions. These projections are used for long term planning out 10 years.
Callan thinks most asset classes are at least fairly valued or overpriced. Their assumptions for long term 10 year annual returns are:
- Broad bond market returns of 3.0% (bonds will suffer losses before higher yields kick in)
- U.S. Domestic Equity at 7.6% (small cap slightly better than large)
- Non-U.S. Equity at 7.8% (slight premium to U.S. largely from Emerging Markets)
- Real Estate at 6.15% (dinner conversation noted low cap rates)
- Inflation is forecast to be 2.25%
Paul cautions that while the estimates seem precise, they are not. You should think of them as a central tendency. No kidding – forecasting is hard! However, you have to start somewhere and these numbers seem “in the ballpark” to us. Callan also notes that returns have been coming down over time (especially interest rates) and investors need to be cautious about “taking more risk in pursuit of return (and yield).”
The big number next week is the employment report for February out Friday. Capital Economics expects 230,000 new jobs, down from an average monthly gain of 336,000 over the preceding three months.
They say: “It is worth bearing in mind that those earlier gains were the fastest pace of job growth since 1997. Accordingly, rather than signaling any weakness in the economy that could push the Fed’s first rate hike back into the second half of this year, a drop back to 230,000 should be viewed as a return to a more sustainable trend. It should still be sufficient to push the unemployment rate back down to 5.6%.”
Have a great weekend everyone.
Jeff Pantages, CFA®
Chief Investment Officer