March Madness For Central Banks

The month of March is generally eventful and provides us with multiple potential market-moving events to monitor. It has been a roller coaster of a year so far, with one of the strongest January returns ever for the S&P 500 Index, only to be followed by the fastest descent ever from record highs to a correction (nine days) in early February. As we turn the calendar to March, the days will get longer and a little warmer, and basketball brackets will be released. (Villanova and Xavier are fighting to finish first in the Big East; those two schools happen to be the alma maters of the two authors of this piece.)

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Raising 2018 Earnings Forecasts

Fourth quarter earnings season has been outstanding. As good as it has been, perhaps most impressive is the strong guidance corporate America has provided. In response, we have raised our S&P 500 Index earnings forecast for 2018 and our S&P 500 year-end fair value target proportionately. Our revised year-end S&P 500 fair value range of 2950–3000, approximately 7–9% above Friday’s close, represents a 19.5 price-to-earnings (PE) ratio on $152.50 in earnings per share (EPS).

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The Valentine’s Day Index

Inflation and economic growth are key drivers of long-term rates, and rising rates can lead to higher borrowing costs for individuals and businesses, potentially impacting consumer spending and profit margins for businesses. Given the recent market volatility, the January Consumer Price Index (CPI) report, which will be released on Wednesday, February 14, could become a focal point for markets. Consensus forecasts expect that both headline and core CPI (which excludes volatile food and energy prices) may slow down on a year-over-year basis to 1.9% and 1.7%, respectively, but given the focus on rising rates and their potential impact for equity prices, any upside surprise in CPI could lead to additional volatility.

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Correction Perspectives

After an extraordinary two-year period of market calm, the major U.S. equity markets slipped into correction territory last week. A perfect storm of investor worries collided over the past six trading days, including inflation, monetary policy, and the unwinding of crowded, complex trades. The result was an unprecedented bout of market volatility, highlighted by 1,000-point swings in the Dow Jones Industrial Average and the fastest retreat ever (nine days) from a record level in the S&P 500 Index to a correction.

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GDP, PCE, and Jobs

U.S. stocks and bonds were hit by inflation concerns over the past week, but what is the economic data telling us? A barrage of U.S. economic data was released over the past two weeks, including major reports such as fourth quarter gross domestic product (GDP), personal consumption expenditure (PCE) inflation, and the January employment situation report. We will discuss the impact of each individual report in more detail later, but overall the data deluge has signaled that the U.S. economy remains on stable footing. Signs of rising inflation were present in all three reports, which is one of the factors behind both stock and bond weakness over the past week. However, we would remind investors that, for nowat least, inflation readings remain below the Federal Reserve’s (Fed) 2.0% target, and we would need to see continued acceleration before we would expect a more aggressive path of Fed rate hikes.

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Melt-Up or Melt-Down?

Did stocks just melt-up, setting up a possible melt-down? Friday’s sharp decline, the biggest since the Brexit vote in June 2016, might have led us to forget that just a few days ago many claimed the stock market was melting up. The strong finish to 2017 followed by big gains in January certainly made this a reasonable characterization. (Though we continue to believe stock valuations are well supported by fundamentals here.)

Concerns have now turned to whether last week’s sell-off is the start of something much bigger, or dare we say a meltdown. This week we discuss whether stocks have melted up or if they are about to melt-down.

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