Market Commentary, Week Ending in 3/21/2017

BY COLIN SUVAK & VEDANT ARORA

 

SUMMARY

Markets in the United States and abroad were flat this week, with the S&P500 closing at the exact same value as last week and other major indices finishing just basis points higher. It seems as though the so-called “Trump Rally” has eased off this week as the President seeks to begin pushing some of his more ambitious plans through Congress, including the tax reform plan that is highly anticipated by markets due to indications that rates will be severely cut. Meanwhile, since the Federal Reserve raised its Federal Funds rate last week by 25 basis points to 0.75%-1%, the US 30 Yr. Fixed Rate Mortgage average increased by over 2%, while 10 Yr. Treasury bonds actually fell. Most commodities finished the week higher with Gold prices increasing 2.77% and Oil seeing a gain of 0.77%. Industrial commodities like Zinc, up over 5%, lead the way on the back of strong economic data from China.

 

MARKETS (AS OF 3/20/17; CHANGE SINCE 3/13/17)

Equities

  • S&P 500: 2,373.47 (0.00 UNCH)
  • Dow Jones: 20,095.86 (+0.12%)
  • Russell 2000: 1,384.10 (+1.01%)

Interest Rates

  • UST-10 Yr.: 2.48% (-0.08%)
  • US 30 Yr. Fixed Rate: 4.30% (+2.14%)
  • GER Bund 10 Yr.: 0.44% (+0.09%)

Commodities

  • Gold (spot): $1233.97/oz (+2.77%)
  • Oil (Brent): $51.72/barrel (+0.72%)
  • Zinc: $2882/MT (+5.03%)

Currencies (app.: +, dep.: -)

  • € (EUR/USD): 1.0738 (+0.82%)
  • ¥ (USD/JPY): 112.4960 (-2.11%)
  • £ (GBP/USD): 1.2359 (+1.26%)

 

ECONOMIC HIGHLIGHTS

On Wednesday morning, US inflation data showed that the Consumer Price Index (CPI) grew 0.1% in February. This amounts to an annual rate of inflation of about 1.2%. However, after removing the
typically volatile food and energy components, Core CPI increased 0.2% during the month of February, annual rate of 2.43%. As these number indicate, the US economy has experienced a rising rate of inflation over the last year with the CPI rising 2.7% since last February and the Core CPI rose 2.2% over the same period. In comparison, in 2015, the CPI only grew 0.1%. These strong inflation numbers all but cemented a rate hike for the month of March in the minds of investors. The Federal Reserve duly followed through with their hike later the same day citing strong employment numbers, economic growth and inflation figures. The Fed has maintained a long-term inflation target of 2% and raised their inflation forecast for the year to 1.9% from 1.8%.


On the other side of the Atlantic, Inflation has been in the minds of British investors as well. On Tuesday morning, the British government will release UK CPI figures that are expected to show an annual inflation rate of 0.5% for February. If CPI figures are in line with forecasts, the UK CPI will have grown 2.1% in the year since last February. This would put inflation above the 2% target rate of the Bank of England with might convince them to tighten monetary policy.


A slew of positive economic data came out of China this week. Chinese home sales surged 23% in
January and February. These figures were far better than most investors expected and came after top Chinese policymakers reiterated their pledge to curb property speculation during March’s National People’s Congress. As a part of this recent initiative, most 1st and 2nd tier cities in China (Shanghai, Beijing, etc.) have imposed home buying restrictions. Analysts expect a tightening of these restrictions in light of this unexpected growth in sales. Elsewhere, economic performance was largely in line with expectations. Industrial production grew 6.3% and retail sales increased 9.5% in January and February. All of these figures point to a solid and steady Chinese economy, calming the recently-frayed nerves of investors.

POLICY AND POLITICS

Most notably for markets, the Federal Open Market Committee (FOMC) raised its target Federal Funds Rate last week to between 0.75% and 1%, a widely expected move. Janet Yellen, furthermore, signaled that potentially two more rate hikes this year were on the cards, as the Fed’s inflation target of 2% seems more and more realistic and as labor market conditions continue to tighten. It remains to be seen what impact, if any, this will have on Trump’s aggressive plan of achieving 4% economic growth in the coming years, though, and whether this will alter his legislative strategy.


Meanwhile, the news has been dominated by The American Health Care Act, Trump’s budget proposal, the FBI probe into Russian interference in the 2016 US Election and the predicted invocation of Article 50 by Theresa May on March 29th. The AHCA proposal would have a significant impact on American healthcare, at least until 2024. The bill would replace Obama Care subsidies and replace them with tax credits based on age rather than income, scale down Federal Medicaid expansion to block grants that would place more of the financial burden on states, end the individual mandate and make it possible to purchase insurance across state lines. According to the Congressional Budget Office, 24 million fewer people would be insured by 2024, and the federal deficit would be reduced by around $340 billion over a decade. The bill is attractive to rank-and-file conservatives like Paul Ryan who, among other things, campaigned solely on the motif of “repeal and replace” during 2016. However, members of the House Freedom Caucus and more conservative members of the senate, including Rand Paul, argue that the bill is simply “Obama Care Lite”, and that more must be done to curb entitlements. These members, along with
more moderate Republicans who ally with Governors such as John Kasich in arguing that their
constituencies would be the ones affected by the initial repeal effort, are pulling the bill to the right and left respectively, and threaten to derail its movement through Congress. Some Trump aides, furthermore, are asserting to the President that the three-stage bill could be a political trap, and could define his Presidency, especially if done incorrectly. Thus, investors will be eagerly watching the coming few weeks for indications as to where not only the health insurance and other markets will be headed, but also how effectively the Trump Administration will be able to approach legislation related to financial markets.


Meanwhile, Trump also proposed his FY 2018 budget. The budget, among other things, increases
Defense discretionary spending by $54 billion, particularly on hard assets to escalate the fight against ISIS. Spending also increases for homeland security, presumably to build Trump’s “Yuuuge Wall”, while spending decreases for foreign aid, environmental protection and agriculture. Revenues are purported to increase though from healthcare companies seeking to pass their drugs and devices through the FDA. Companies in these industries may be interesting to monitor based on the interactions they have with governments in terms of contracts. The FBI probe into Russian interference in the 2016 US election continues to pester the Trump administration, furthermore, and, as usual, continues to make Sean Spicer look foolish. It remains to be
seen what effect, if any, this will have on the markets, particularly since the final conclusions have not been reached by any government agency, or the House and Senate Intelligence Committees, but one thing is certain: the Trump Administration’s reputation continues to slide amidst both allegations that he and/or his team colluded with Russian officials, and the unsubstantiated claims (confirmed by FBI Director Comey) that the previous administration “wiretapped” Trump tower. Trump’s approval rating has hit a low of 37%, lower than any report of former President Obama. The moving average of these polls will be important to monitor in the coming weeks, to see whether the approval of the administration has any effect on its ability to pass legislation, and thus its impact on the markets.


Meanwhile in Britain, the House of Commons and Lords, as well as the Queen, recently approved the right of the government to trigger Article 50 and remove Great Britain from the European Union. Theresa May has indicated that her government will invoke the Article, formally beginning negotiations for Britain’s exit (Brexit) from the EU, on March 29th. If all goes according to plan, Brexit should go through by March 2019. However, many uncertainties remain, including the trade deals that will be struck by the EU and the new independent Great Britain, as well as, more generally, the access to markets and other benefits of the EU, while still retaining Britain’s complete autonomy. Many EU lawmakers have taken a firm stance against a free trade deal without compliance from Britain on many key issues, including immigration and regulations, so it remains to be seen what a new deal will look like. Markets will likely react to the formal triggering next week, as free trade, for obvious reasons, plays a substantial role in markets across the world. This is certainly something to watch.

INVESTMENT IDEA

Short pharmaceuticals. During the 2016 election cycle, Trump and his team continually campaigned on the harm that Obama Care has done to insurance markets, and, in particular, the effect that increasing drug prices have had on Americans and their ability to gain access to affordable care. Drugs are not always covered under Medicare plans, and must be sometimes covered through supplement plans, further raising the costs for consumers. With an expansion of Health Savings Accounts (HSA’s) and a strict emphasis placed on lowering drug places by Trump during his first major address to Congress and the American people, though - as well as the proposed increase in restrictions and “taxes” that must be paid by drug- and device-makers to push their products through the FDA’s review - it may be the case that pharmaceutical companies’ ability to perform research and expand their product lines may be limited. This, of course, may lead to a decline in firms’ bottom lines. This may propose an interesting investment idea, therefore, in the short- to medium-term as the new healthcare bill and budget work their way through Congress and, assuming at least some form of them passes, begin to affect markets.

WHAT TO WATCH

In economic news, UK’s CPI figures will be released Tuesday morning as aforementioned. A high level of inflation could pressure the Bank of England into adopting a more hawkish tone. In the political arena, the fate of the AHCA should be closely watched, in particular it’s anticipated impact on the pharmaceutical and health insurance industry. It remains to be seen how more conservative and more centrist members of the Republican party will try to influence the shape the AHCA will take as it winds its way through Congress.