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Financial Markets Updates

Monday, April 16th 2018

Equity markets rebounded last week as international trade tensions appeared to ease. The Dow gained 1.8%, the Nasdaq climbed 2.8% and S&P 500 rose 2% and closed about 7% off its all-time high on Friday. Energy was the strongest performing sector last week with oil prices rising in reaction to the re-emergence of geopolitical risks with Syria and reports that Saudi Arabia is targeting $80 per barrel ahead of the IPO of state oil giant Saudi Aramco later this year or in 2019. For the week, oil increased 8.5% a barrel of West Texas Intermediate. The Technology space also outperformed following Facebook CEO Mark Zuckerberg’s appearance before Congress. Mark did a good job responding to questions and his testimony outlined steps that the company is getting a better handle on third party access to user data. However, the industry still faces the prospect of digital privacy regulations as well as increased expenses for monitoring potentially illicit activities.

First quarter earnings season started last week with Delta Airlines and financial companies JP Morgan, Citigroup, Wells Fargo, and BlackRock exceeding analysts’ sales and earnings per share (EPS) estimates. Jamie Dimon, CEO of JP Morgan, noted that “The global economy continues to do well and we remain optimistic about the positive impact of tax reform in the U.S. as business sentiment remains upbeat, and consumers benefit from job and wage growth.” Glen Hauenstein, President of Delta Airlines, commented “We are seeing our strongest revenue momentum since 2014, driven by improvements in all geographic regions, strong corporate results, and double-digit increases in loyalty revenue.” I believe that these positive results are the first of many positive observations that will bode well for the equity markets. Real estate and utilities shares lagged last week as longer-term bond yields increased, making their relatively high dividends less appealing in comparison.

Stock prices have appreciated during every earnings season since 2013 as investors react positively to improving corporate performance and optimistic management outlooks which is what I believe really drives stock prices over the long-term. The first quarter earnings reporting period may continue to delight investors as analysts expect earnings to grow at their fastest pace in seven years and business and consumer confidence are at their highest levels since 2004!  Corporate earnings per share and the S&P 500 have risen in concert since 2009 as noted in the following chart. However, when corporate earnings growth starts to fade as a result of restrictive higher interest rates, that will be the signal for the end of this bull stock market run. It is all about corporate earnings growth and price earnings multiple expansion – it always been and always will be that way. Yes, the low interest rates from Central Banks matters, but earning growth is the main factor driving stocks.

Source: J.P. Morgan Asset Management

Let’s also take a look at the technical picture for stocks and the following chart, focusing on the price action that occurred on April 2nd. At that point there were daily Relative Strength Index (RSI) positive divergences on all four major stock market indices which is usually a good indication of a significant low for stock prices. April 4th also had a 70 point swing in the S&P off the lows that day which is a classic sign that the selling was probably exhausted. If that low of 2,573 of April 4th on the S&P holds for this week, it increases the chances that the lows are indeed in for the equity markets and new highs may be again in the cards.

On the World Stage - In his speech last week at the Boao Forum, China’s President Xi Jinping’s reiterated past promises to increase imports, reduce import duties on automobiles, expand access to China’s financial sector, and enforce intellectual property rights for foreign firms. Unfortunately, China is notorious for making promises that it does not keep - time will tell if this time is different. Investors also responded positively to the prospects of a negotiated resolution to the tariff dispute as reports revealed that the U.S. and China had engaged in trade negotiations as recently as last week even though they were unsuccessful. President Trump ordered officials to look into rejoining the Trans Pacific Partnership, a multilateral trade agreement with eleven other countries that could lower tariffs and counter China’s growing influence in the region and also multilateral trade agreements that could offer lower trade barriers to U.S. exporters.

Last week, negative political developments included an escalation of the Syrian conflict with the country’s use of chemical weapons on its citizens culminating in the U.S., Great Britain and France attacking Syrian targets over the weekend. The FBI’s ad- nauseam Russian collusion charade, the FBI’s investigation of President Trump’s personal lawyer and the announcement by House Speaker Paul Ryan that he will not seek re-election also captured headlines, but had a negligible impact on financial markets.

March may have come in like a lion, but consumer inflation was more of a whimper than a roar last month as noted in the following chart:

The Consumer Price Index (CPI) fell 0.1 percent in March, below the expected gain of 0.1 percent, the Bureau of Labor Statistics reported. Lower gas prices at the pump were to blame for the first decline in 10 months. When stripping out volatile food and energy prices, Core CPI was in line with expectations at 0.2 percent. However, Core CPI rose 2.1 percent on an annual basis, a 12-month high. Inflation at the wholesale level was a bit hotter than expected. Though inflation remained tame in March, the minutes from the Fed's March meeting showed that the Fed still expects inflation to rise in 2018. Inflation hurts the value of fixed investments like Bonds, meaning a rise in inflation can cause Bond prices to decline. Home loan rates are tied to Mortgage Bonds, so a rise in inflation can cause rates to rise as well.

Weak economic news normally causes money to flow out of Stocks and into Bonds, helping Bonds and home loan rates improve. In contrast, strong economic news normally has the opposite result. The chart below shows Mortgage Backed Securities (MBS), which are the type of Bond on which home loan rates are based. When you see these Bond prices moving higher, it means home loan rates are improving. When Bond prices are moving lower, home loan rates are getting worse. To go one step further, a red "candle" means that MBS worsened during the day, while a green "candle" means MBS improved during the day. As you can see in the chart below, Mortgage Bonds declined in recent days though, overall, they remain in a sideways trading pattern. Home loan rates are still historically attractive.

Chart: Fannie Mae 4% Bond Friday April 13th 2018

OIL - The price of black gold increased 8.5% last week with the military conflict in Syria pushing prices higher. Pursuant to the below chart, crude oil inventories are the dramatically below their five week average for this part of the year since the plunge in 2008. Oil markets are relatively tight because U.S. crude oil inventories are flowing offshore with record exports, while U.S. crude demand is relatively strong as well. For now, the oil rally is ongoing and the path of least resistance is higher for oil prices, but continued growth in U.S. output remains the biggest risk to the energy market in 2018. Meanwhile, OPEC's production discipline remains supportive as there are still supply declines in several non-OPEC geographies (Mexico), alongside ongoing supply disruptions/challenges (especially Venezuela), and the picture for global demand growth is broadly upbeat with the worldwide global economic expansion which I think will continue to prop-up the price of oil.

Gold - The price of the precious yellow metal closed up 0.8% last week at $1348.60 a troy ounce. The outlook for gold remains neutral as futures are still pinned between $1310 and $1360 and the market outlook remains the same. Gold is range-bound, but trading with an upside bias on the charts. We have not yet seen a catalyst capable of sending gold materially through resistance at $1360, which remains a very stubborn price level. An escalation in negative geopolitics could be enough to see gold break out, but for a sustainable gold move, we would need to see a more defined development in real interest rates. Also, as I have noted in past updates, the exploding government deficits will keep a prop under the price of gold which is the only surviving legitimate currency of the ages. Bitcoin is a new type of currency currently being used by the rich Russians to move their wealth quickly out of Russia. Bitcoin caught the Russian bid last week after dramatically falling in value.

However, I think gold will ultimately be a part of the final destination for that money. The big story was not Russian warships leaving ports last week, it was Russian wealth looking for ways to exit Russia with its currency and stock markets sinking. The VanEck Vectors Russia exchange traded fund, symbol RSX, lost 9% last week.

In closing, With an eventful and volatile first quarter of 2018 behind us, questions abound around what lies ahead for the remainder of 2018 and beyond. Last week contained a range of themes - from trade talk to geopolitical tensions to corporate earnings results that are likely to remain key issues for the financial markets. Global stocks tumbled more than 10% into correction territory in February and March, but are now attempting to rebound. Most equity asset classes were down slightly at the end of the first quarter of 2018, but had double-digit returns over the past year, outperforming bonds which are declining in price as interest rates rise. I think the tariff negotiations and noise will ultimately wind down and the fundamental outlook for global growth remains positive. Tariff announcements have been disruptive to stock prices, but in the long-run I think the effects of improving economic and earnings growth should be far stronger for both U.S. and international equity investments. Stay tuned.

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Information contained herein is obtained from industry sources believed to be reliable. The information presented comes from different sources on a weekly basis and is intended to provide a commentary related to market events and is not intended to be used as investment advice or represent any specific product or service. Market information and performance information is provided from different industry sources including, but not limited to TD Ameritrade; MMG; Barron’s; BBC; NPR; Reuters; MFS Research; CNBC; CME; The Wall Street Journal Online; Bloomberg News; Financial Times; Forbes; CNNMoney; J.D. Power Valuation Services; The Economic Times; USA Today; stockcharts; CotSignals; Bespoke; Manheim; FreeStockCharts; The Fed; LPL Research; FactSet; Econoday; U.S Bureau of Economic Analysis; Hulbert Ratings; World Development Indicators database from the World Bank and the Internet.