The days of kicking back and watching the equity market hit new record highs came to an abrupt halt in 2018. Instead of cheering yet another record level for the Dow Jones Industrial Average, the S&P 500 or the Nasdaq Composite Index a new trend emerged: wild swings that would propel equity averages higher one day and then pull them lower the next. It is no longer abnormal to see several sessions of losses followed by a day or two of recovery and a convoluted mix of ups and downs.
Volatility finally returned from its extended vacation this year and announced its presence with unabashed intensity. The low volatility stock market rally chose to exit stage left as we embarked on our year-end holiday celebrations and cheered the annual growth in our portfolios. Little did we know how soon the calm would be coming to a screeching halt.
WHIPSAW MARKET: HANG ON TIGHT FOR ROLLER COASTER RIDE
The first quarter started out on a positive note with January’s stock market performance bringing yet another record high and further gains for the equity indexes. The popular narrative included caution over the heightened euphoria and grumblings over the impossibility of an extended bull market run. At the same time many market players opined that strong equity market gains at the beginning of the year usually equate to gains for the rest of the year.
Fiscal stimulus measures and optimism over U.S. tax cuts helped lift global bourses and bond yields in the first month of the year. While global growth continued, the potential for mild risks to the business cycle began to garner attention. Expectations of monetary policy changes by the world’s central banks hang amid the backdrop of trade tensions and uncertainty over regulation and policy over technology companies.
The first week of February kicked off with unexpected velocity as bond rates spiked and equity markets nosedived. The global growth story and corporate profits were intact but inflation fears became prominent and volatility instruments took a hit. On Feb. 5 the Dow Industrials tumbled 1,175 points after sliding as much as 1,600 points marking the largest intraday decline on record.
Ahead of the Easter holiday weekend U.S. equity averages settled in negative territory.
For Q1 2018 the Dow Jones Industrial Average lost 2.3% while the S&P 500 declined 1.2% and the Nasdaq Composite extended its seventh straight quarter of gains adding 2.3%. The Dow and S&P 500 failed to notch ten consecutive quarters of gains while the Nasdaqmanaged to advance for seven straight quarters.
Now that the DJIA snapped its longest winning streak since 1997 what does this mean going forward? More reasonable stock market valuations can be expected but for now it would make sense to pare back on expectations for long-term returns.
EARNINGS MOMENTUM RELIEF SHORT-LIVED
The beginning of earnings season brought focus back to factors affecting corporate fundamentals. Performance for most corporations beat estimates as widely expected but it is telling that profit forecasts for the upcoming quarters have been eased.
According to the latest data from FactSet, the S&P 500 forward 12-month PE ratio stands at 16.6 as of April 20, 2018.[i] The level is above the 10-year average of 16.1. At the same time the debt to total equity ratio is at its highest level since 1999. So keep an eye on how credit conditions affect buybacks.
S&P 500 Forward 12M PE Ratio. Source: FactSet, Date: April 20, 2018.
The 10-year Treasury note yield topped the 3% level on April 24, 2018. The psychological level had been eyed with plenty of frenzied anticipation. This is the first time since January 2014 that the yield cleared 3%. As the yield rose and U.S. equity averages declined there was plenty of dissent about the Fed tightening cycle, economic growth and inflation expectations. It is important to keep in mind that global bonds will also feel the effects of central banks removing stimulus measures.
GOLD: WATCH THE VOLUME
Gold futures managed to post a gain in Q1 2018 to mark its third consecutive quarterly advance. To put the uptick in perspective it should be noted that the latest quarterly gain was the smallest recorded since 2011. Gold managed a gain of just 1.03% while other precious metals failed to post a gain. Silver lost 5.1% while platinum pulled back by nearly 1.2% and palladium slid a staggering 11%.
Prices hit a two-year high in the second week of Q2 pushing gold’s advance over the 3% mark for the year.
Gold prices are utilized as a gauge of investor risk appetite under normal trading conditions. As a new quarter gets under way the equity markets continue to see plenty of swings to the upside and downside. Traditionally gold is seen as a hedge against inflation.
Gold prices are a long way from their all-time record high of $1,917.90 an ounce seen in 2011. Nevertheless, gold has outperformed the stock market in Q1 2018 and continues to edge higher. Any breakout to the upside will be eyed as, perhaps, an indication of the broader market outlook.
In addition, gold contracts continued to see record volume in Q1 2018. Surprisingly the latest quarter extended volume records to mark the fifth consecutive quarter of an increase in volume. While volume itself is not an indicator of future price action it is telling of the conviction of any move, especially when there is a technical level that is surpassed or broken.
Despite the extended increase in volume for gold contracts and the slow trek higher for prices, the move into the precious metals and related ETFs has not been as positive as one would expect. This may be another sign that there are no major issues on the horizon for the equity markets.
Spot gold may seem to be stuck in a perpetual consolidation range while prices play tug-of-war with bullish and bearish phases. In the meantime, the technical levels will continue to serve as a test of strength over the central line.
OUTLOOK:TOLERANCE FOR RISK OR IMMUNE TO WARNING SIGNS?
Q2 2018 got underway with notable volatility in the broader market. Fears of a trade war and geopolitical risk kept investors on their toes. The market-moving headlines and accompanying uncertainty continued to push and pull the tide. Trade developments between the U.S. and China, ongoing geopolitical disputes over Iran and Syria, and sanctions on Russia will remain in the headlines for the foreseeable future. Ahead of Trumps’ meeting with North Korean leader Kim Jong Un it appears as though de-escalation of hostilities between North Korea and South Korea is unfolding by the hour. For the time being, the pause button has been hit on saber-rattling.
The first reading of Q1 2018 U.S. GDP expanded at an annual rate of 2.3%, surpassing expectations but coming in below the prior quarter’s reading of 2.9%.[ii] A slowdown in consumer spending contributed to the pullback in the latest quarter. The Trump administration’s tax package has yet to be fully realized by American households as paychecks didn’t reflect the cuts until well into the first quarter. With the trifecta of the labor market nearing full employment, lowered tax rates and an uptick in government spending, U.S. GDP may reach 3% in 2018.
At the same time, Fed economic forecasts are on the horizon and, in turn, their implications for the broader market. The Federal Reserve will meet on May 1-2 and its policymakers are sure to incorporate the data from the first Q1 GDP reading. At the March meeting the FOMC raised interest rates and announced expectations to raise rate two more times in 2018. The Fed also increased its median estimate for annual GDP to 2.7% at its latest meeting.
Corporate earnings season will soon draw to a close with ongoing observations about valuation relative to earnings. Market volatility will continue but it is the fundamentals that will shape the bigger picture.
[i] S&P 500 Earnings Season Update. Source: FactSet Insight, Date: April 20, 2018.
Sprott U.S. Media, Inc. is a wholly owned subsidiary of Sprott Inc., which is a public company listed on the Toronto Stock Exchange and operates through its wholly-owned direct and indirect subsidiaries: Sprott Asset Management LP, an adviser registered with the Ontario Securities Commission; Sprott Private Wealth LP, an investment dealer and member of the Investment Industry Regulatory Organization of Canada; Sprott Global Resource Investments Ltd., a US full service broker-dealer and member FINRA/SIPC; Sprott Asset Management USA Inc., an SEC Registered Investment Advisor; and Resource Capital Investment Corp., also an SEC Registered Investment Advisor. We refer to the above entities collectively as “Sprott”. The information contained herein does not constitute an offer or solicitation by anyone in any jurisdiction in which such an offer or solicitation is not authorized or to any person to whom it is unlawful to make such an offer or solicitation. Forward-Looking Statement This report contains forward-looking statements which reflect the current expectations of management regarding future growth, results of operations, performance and business prospects and opportunities. Wherever possible, words such as “may”, “would”, “could”, “will”, “anticipate”, “believe”, “plan”, “expect”, “intend”, “estimate”, and similar expressions have been used to identify these forward-looking statements. These statements reflect management’s current beliefs with respect to future events and are based on information currently available to management. Forward-looking statements involve significant known and unknown risks, uncertainties and assumptions. Many factors could cause actual results, performance or achievements to be materially different from any future results, performance or achievements that may be expressed or implied by such forward-looking statements. Should one or more of these risks or uncertainties materialize, or should assumptions underlying the forward-looking statements prove incorrect, actual results, performance or achievements could vary materially from those expressed or implied by the forward-looking statements contained in this document. These factors should be considered carefully and undue reliance should not be placed on these forward-looking statements. Although the forward-looking statements contained in this document are based upon what management currently believes to be reasonable assumptions, there is no assurance that actual results, performance or achievements will be consistent with these forward-looking statements. These forward-looking statements are made as of the date of this presentation and Sprott does not assume any obligation to update or revise. Views expressed regarding a particular company, security, industry or market sector should not be considered an indication of trading intent of any fund or account managed by Sprott. Any reference to a particular company is for illustrative purposes only and should not to be considered as investment advice or a recommendation to buy or sell nor should it be considered as an indication of how the portfolio of any fund or account managed by Sprott will be invested. Past performance does not guarantee future results. The views and opinions expressed herein are those of the author’s as of the date of this commentary, and are subject to change without notice. This information is for information purposes only and is not intended to be an offer or solicitation for the sale of any financial product or service or a recommendation or determination by Sprott Global Resource Investments Ltd. that any investment strategy is suitable for a specific investor. Investors should seek financial advice regarding the suitability of any investment strategy based on the objectives of the investor, financial situation, investment horizon, and their particular needs. This information is not intended to provide financial, tax, legal, accounting or other professional advice since such advice always requires consideration of individual circumstances. The products discussed herein are not insured by the FDIC or any other governmental agency, are subject to risks, including a possible loss of the principal amountinvested. Generally, natural resources investments are more volatile on a daily basis and have higher headline risk than other sectors as they tend to be more sensitive to economic data, political and regulatory events as well as underlying commodity prices. Natural resource investments are influenced by the price of underlying commodities like oil, gas, metals, coal, etc.; several of which trade on various exchanges and have price fluctuations based on short-term dynamics partly driven by demand/supply and also by investment flows. Natural resource investments tend to react more sensitively to global events and economic data than other sectors, whether it is a natural disaster like an earthquake, political upheaval in the Middle East or release of employment data in the U.S. Low priced securities can be very risky and may result in the loss of part or all of your investment. Because of significant volatility, large dealer spreads and very limited market liquidity, typically you will not be able to sell a low priced security immediately back to the dealer at the same price it sold the stock to you. In some cases, the stock may fall quickly in value. Investing in foreign markets may entail greater risks than those normally associated with domestic markets, such as political, currency, economic and market risks. You should carefully consider whether trading in low priced and international securities is suitable for you in light of your circumstances and financial resources. Past performance is no guarantee of future returns. Sprott Global, entities that it controls, family, friends, employees, associates, and others may hold positions in the securities it recommends to clients, and may sell the same at any time.