Federal Reserve and Interest Rates
The Federal Reserve and the U.S. bond market appear to be in agreement about the direction of interest rates. For more years than anyone cares to count, investment professionals have been predicting the end of the bull market in bonds. Bond guru Bill Gross called the end of the bond bull in 2011 and called it again in 2013. He wasn’t alone. Strategists who participated in Barron’s Outlooks anticipated rising interest rates in 2014 and 2015, too.
The Federal Reserve began encouraging interest rates higher in December 2015 when it increased the Fed funds rate for the first time in a decade. However, the yield on 10-year Treasuries remained stubbornly low. In fact, it fell below 2 percent following the rate hike and stayed there until November 2016.
Since 2015, the Fed has raised rates six times. The latest increase, along with signs of higher inflation, helped push bond rates higher. Higher interest rates could shift investors’ preferences in some significant ways, according to sources cited by Barron’s:
“Two years ago, dividend stocks provided investors a one-percentage point advantage over risk-free rates…Now those places have been swapped…this ability to get a “safe yield” for the first time in a decade, with no risk from falling stock or bond prices, represents a ‘seminal shift and a huge source of competition for the dividend allure of the stock market.’”
The S&P 500 last week had its 17th session with close at least 1% higher so far in 2018. There were only four such sessions during the entire 2017. It also was the 31st session to close at least 1% higher or lower so far in 2018. There were only eight such sessions in 2017.
According to FactSet, with a little over half of the S&P 500
About 80% of S&P 500 reporting companies have exceeded consensus earnings estimates, better than the 74% average over the past four quarters. If the quarter finishes with operating earnings growth of 20%, it will be first 20% growth quarter since 2Q11.
There has been a total of 18 quarters since 1989 with 20% operating EPS growth (spread across 1993, 1994, 1995, 2003, 2004, 2005, 2010, and 2011. See the chart below of the S&P 500 with the quarters with 20% earnings growth marked by the black bars. Historically, this has been a bullish indicator for U.S. stocks.
We also have been talking about rising interest rates over the last year or so. One common question asked by clients is the effect rising interest rates have on stocks. As you can see in the chart below, stocks tend to rise in periods of rising interest rates. We by no means expect a 50% rise in stock prices like we experienced in 1998. However, those saying that stocks have to fall when interest rates rise simply don’t have history on their side. As we often say, history does not repeat, but it does rhyme.
First-quarter GDP (Gross Domestic Product) growth was moderate relative to 2017 at 2.3 percent but still beat expectations (1.8 percent). Growth was fueled by cheaper commodity prices and reduced corporate taxes.
The first quarter is typically slow as consumer spending growth stagnates after the holiday season. This quarter’s consumer spending growth was the lowest in five years even though jobs are plentiful. Initial jobless claims hit their lowest levels in the last 50 years. The strong jobs environment and recently passed fiscal stimulus give analysts reason to believe the sluggish consumer spending is temporary.
Does it seem like the pace of change seems to be accelerating? When it comes to the average company lifespan in the S&P 500 Index, it is. According to research firm Innosight:
“Imagine a world in which the average company lasted just 12 years on the S&P 500. That’s the reality we could be living in by 2027, according to Innosight’s biennial corporate longevity forecast.
There are a variety of reasons why companies drop off the list. They can be overtaken by a faster growing company and fall below the market cap size threshold (currently that cutoff is about $6 billion). Or they can enter into a merger, acquisition or buyout deal. At the current and forecasted turnover rate, the Innosight study shows that nearly 50% of the current S&P 500 will be replaced over the next ten years. This projection is consistent with our previous analysis from 2012 and 2016, which Innosight originally conducted with Creative Destruction author Richard Foster.
By tracking all the additions and deletions from the S&P 500 over the past half century, our study shows that lifespans of companies tend to fluctuate in cycles that often mirror the state of the economy and reflect disruption from technologies, ranging from biotech breakthroughs to social media to cloud computing. Over time, the larger trendline is for average longevity to continue to slope downward.”
Key Insights from the study are:
- The S&P 500 in 1964 narrowed to 24 years by 2016 and is forecast to shrink to just 12 years by 2027 (Chart 1).
- Record private equity activity, a robust M&A market, and the growth of startups with billion-dollar valuations are leading indicators of future turbulence.
- A gale force warning to leaders: at the current churn rate, about half of S&P 500 companies will be replaced over the next ten years.
- Retailers were especially hit hard by disruptive forces, and there are strong signs of restructuring in financial services, healthcare, energy, travel, and real estate.
- The turbulence points to the need for companies to embrace a dual transformation, to focus on changing customer needs, and other strategic interventions.
Key points for the week
- U.S. GDP beat expectations on strong investment results.
- Results were lower than the fourth quarter but surpassed previous first quarters.
- Initial jobless claims hit a 50-year low.
What are we reading?
Below are some articles we paid particularly close attention to this week. We encourage our readers to follow the links.
IRS Provides Relief for Excess HSA Contributions. The IRS announced the 2018 HSA contribution limits for family coverage prior to the passage of the Tax Cuts and Jobs Act. One of the changes we have presented to clients and potential
We Will Need an Umbrella for This.
In February, a new research paper disclosed a finding no one wants to hear about: Viruses are falling from the sky. Literally. Science Daily summarized a report from the University of British Columbia. The report said:
“An astonishing number of viruses are circulating around the Earth's atmosphere – and falling from it – according to new research…‘Roughly 20 years ago we began finding genetically similar viruses occurring in very different environments around the globe,’ says [University of British Columbia virologist Curtis Suttle.] ‘This preponderance of long-residence viruses travelling the atmosphere likely explains why – it's quite conceivable to have a virus swept up into the atmosphere on one continent and deposited on another.’”
The New York Times reported the researchers journeyed to Spain and used buckets on mountaintops to catch whatever might fall from the sky. The scientists weren’t surprised to find viruses, but they were surprised by the quantity of viruses captured. Best estimates suggest 800 million viruses shower every square meter of the Earth every day.
Don’t panic! Viruses are responsible for a lot more than diseases. Scientists theorize viruses and humans may have a symbiotic relationship. According to Popular Science:
“Each of us has a unique collection of viruses although there are some species common to us all…endogenous viruses make up some 8 percent of our genetic material. Originally, they were thought to be nothing more than junk pieces of evolutionary history. But we now know they have a variety of functions. One of the most studied topics…focuses on reproduction. A particular protein encoded by one particular virus…appears to be imperative for proper formation of the placenta.”
Good or bad, the question remains: where do atmospheric viruses originate? No one knows for sure. There are a variety of theories. One theory is viruses are swept from the planet into the atmosphere. Another is viruses originate in the atmosphere. A third is viruses arrive from outer space.
The truth is out there!
Story of the week
Some workplaces participate in “Take Your Dog to Work Day” to make the office more enjoyable for employees. But, at Amazon, bring your dog to work day is every day. During a typical workday, approximately 6,000 dogs are present in Amazon headquarters. The dog who pioneered the dog-friendly corporate culture was Rufus, a Welsh corgi, who became such a beloved presence his colleagues used his paw to click the mouse and launch important projects. There’s even a building named after him!
Weekly Focus – Think About It
“The diversity of the phenomena of nature is so great, and the treasures hidden in the heavens so rich, precisely in order that the human mind shall never be lacking in fresh nourishment.”
~ Johannes Kepler, German scientist
Links & Disclaimers
RJFS and SPC do not offer or provide legal or tax advice. Tax services and analysis are provided by the related firm, S&M through a separate engagement letter with clients. Portions of this newsletter were prepared by Carson Group Coaching. Carson Group Coaching is not affiliated with RJFS, SPC or S&M. The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. This information is not intended as a solicitation of an offer to buy, hold or sell any security referred to herein. There is no assurance any of the trends mentioned will continue in the future. Any opinions are those of the author and not necessarily those of RJFS. Any expression of opinion is as of this date and is subject to change without notice.
Opinions expressed are not intended as investment advice or to predict future performance. Economic forecasts set forth may not develop as predicted and there can be no guarantee that strategies promoted will be successful. Past performance does not guarantee future results. Investing involves risk, including loss of principal. Consult your financial professional before making any investment decision. Stock investing involves risk including loss of principal. The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market. The Dow Jones Industrial Average (DJIA), commonly known as “The Dow” is an index representing 30 stock companies maintained and reviewed by the editors of the Wall Street Journal. Please note direct investment in any index is not possible.
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