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Week in Review

Week Ending: February 9, 2018

U.S. equity markets, as measured by the S&P 500, suffered their worst week since January 2016. On Thursday, the S&P 500 officially entered correction territory—down 10% or more from prior high—having fallen -10.2% from its record high set on January 26. A subsequent rebound on Friday left the S&P 500 down -8.8%. Whether or not the index re-tests its Thursday lows remains to be seen. According to Goldman Sachs, the average correction experiences a -13% sell-off over the course of four months and then takes four months to recover.

Fears of higher inflation were identified as the primary culprit for the initial sell-off. However, several other factors seemed to play a role. Specifically, volatility-linked investments designed to profit when volatility falls received considerable attention. In 2017, these products generated outsized returns as volatility languished, leading to significant investor inflows. On Monday, when the S&P 500 fell by more than 4% and volatility spiked 115%, the two largest exchange-traded products that shorted volatility each fell by ~90%, losing a collective $3B in the process. While significant in absolute terms, the $3B was minuscule compared to the nearly $2.5T the S&P 500 has lost since late January. However, the funds were reflective of the broader short-volatility trade taking place in the markets. When volatility spiked, those trades were quickly unwound, thereby exacerbating volatility, and thus the broader selloff.

Another factor at work seemed to be growing concerns about ballooning budget deficits which will require the U.S. in 2018 to sell the most amount of debt since 2010. At the same time, the U.S. Federal Reserve is reducing its purchases of government debt. As a result, rates may need to move higher in order to entice buyers. More government debt and higher rates would likely have a dampening effect on economic growth.

Through Friday, 68% of S&P 500 companies had reported 4Q earnings. To date, 74% and 79% of companies that have reported have beaten their earnings and sales estimate, respectively. Full-quarter earnings growth is currently estimated at 14%.

Economic Bullet Points

Service sector data was extremely strong with the ISM Non-Manufacturing Index reporting some of the best conditions in its 20-year history, and a new cycle high. Strength was broad based with 15 out of 18 industries reporting growth. New orders and employment were particularly strong. The report bodes well for the economy entering 2018.

The International Trade gap widened more than expected in the month, as growth in exports failed to offset strong imports growth. While a negative in terms of how GDP is calculated, strong imports point to improving U.S. consumer demand. Net exports held down the initial estimate of Q4 GDP, and after this report, it looks like net exports will be an even larger negative in the second estimate.

Consumer Credit saw a healthy gain in the month, on the heels of a record gain in November. Revolving credit, i.e. credit cards, rose sizably, suggesting that shoppers who were strapped for cash turned to their credit cards to fund the strong holiday shopping season. As for future performance, banks expect a slight deterioration in credit loans over the course of 2018 due to higher fed funds rates.

Initial Jobless Claims posted their fourth straight very favorable reading offering an early sign of strength for February’s employment report.

Of Note

The recent market pullback ended a streak of 404 trading days without a 5% drop in stock prices, the longest such streak in market’s history.

Market Indices Week of 2/09

S&P 500                    -5.2%

Russell 2000             -4.5%

MSCI EAFE              -6.2%

MSCI EM                   -7.1%

Commodities           -3.9%

Barclay’s Agg.           -0.1%

US Dollar Index            1.4%

10-Yr Yield                   2.84%

Oil ($/bl)                          $59

Gold ($/oz)                 $1,314

The Week Ahead

  • Empire State Mfg. Survey
  • Philly Fed Business Outlook
  • Industrial Production
  •  Producer Price Index
  • Consumer Price Index
  • Business Inventories
  • NFIB Small Bus. Optimism
  • Housing Market Index
  • Housing Starts
  • Retail Sales
  • Consumer Sentiment
  • Jobless Claims
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