Last Week in Markets: Strong Growth Data but Incoming Market Correction?

Editor’s note: This article was initially published in The Daily Gazette, Swarthmore’s online, daily newspaper founded in Fall 1996. As of Fall 2018, the DG has merged with The Phoenix. See the about page to read more about the DG.

Last week’s top five stories…

• The Dow Jones Industrial Average (DJIA) suffered its biggest weekly point loss since the Great Recession, shedding over 1,095 points (4.1%), 666 of which were lost on Friday. The other major benchmarks, the Nasdaq Composite (COMP) and the S&P 500 (SPX) did not fare much better, with the S&P 500 posting its worst week in 15 months, and the Nasdaq finishing down 3.5% for the week. Most analysts blame rising inflation concerns and appreciating bond yields, with the 10-year Treasury bill yield rising sharply to 2.84% and the 30-year rate rising to 3.08%. As bond yields increase, investors with lower risk appetite tend to move out of riskier equities like stocks.

• The US economy added 200,000 jobs in January, carrying its strong performance from 2017 into 2018. The unemployment rate held steady at 4.1%, and wages saw a sharp increase, with average hourly wages up 2.9% from where they were a year ago. Economists expect this increase in wages to continue as the labor market tightens and the economy remains near full employment. The increase in wages, however, did stoke fears of inflation.

• The Atlanta branch of the Federal Reserve expects GDP to grow at an annualized rate of 5.4% in Q1 of 2018, which would be its best growth rate since Q3 of 2014. It should be noted, however, that the Atlanta Fed’s GDP tracker has been known to overestimate GDP growth due to its sensitivity to the ISM (Institute for Supply Management) manufacturing index. The strong performance of the index as of late is primarily what led to the high GDP growth projection.

• Bitcoin suffered its largest weekly loss since December 2013, closing down 40% year-to-date at $8,498. The sell-off has affected other cryptocurrencies as well, with Ethereum and Ripple both down significantly as of close on Friday. The drop came as cryptocurrencies have started to face strong regulatory headwinds. On Thursday, India vowed to eliminate the use of cryptocurrencies, which the government has likened to a Ponzi scheme, and Facebook announced it will ban ads related to cryptocurrencies and initial coin offerings (ICOs).

• Deutsche Bank’s chief strategist says that cross-asset correlations have hit a six-year high of 90%. While this has bode well for most assets, as many stocks have been carried up by the skyrocketing U.S. benchmarks, it also increases the risk of a sell-off in one asset spilling over into the broader market, called “asset contagion.”

Last week in markets…

• Major U.S. benchmarks suffered their worst weekly performance in years, in spite of strong economic growth data. The Dow Jones Industrial Average (DJIA) finished down 4.1% for the week, the Nasdaq Composite (COMP) closed down 3.5%, and the S&P 500 (SPX) finished down 3.9%.
• European benchmarks, weighed down by the U.S. equities market, suffered significant weekly losses as well. The UK’s FTSE 100 Index (FTSE) finished down 2.9%, its worst week since April 2017, and the German DAX Index (DAX) closed down 4.2%, its worst week since February 2016.
• Asian markets, dragged down by both earnings worries and U.S. equities, also finished the week with poor performances. Japan’s Nikkei 225 finished down 1.7%, weighed by Samsung’s earnings worries. India’s BSE Sensex finished down 1.8% and Hong Kong’s Hang Seng closed down 2.5%.

Three key takeaways from last week…

• Last week’s sell-off means that picking winners is going to get harder. Hot takes on last week’s across-the-board decline have ranged from ominous bearishness to dismissive bullishness. However, neither end of the spectrum paints a full picture. The bulls will need to recognize higher inflation is coming, along with higher interest rates, and that does not bode well for equities markets like U.S. stocks. Outgoing Fed chair Janet Yellen echoed this sentiment, saying that stocks are currently overvalued. However, the bears will need to recognize that the U.S. economy’s fundamentals remain solid, and likening the current situation to the lead-up to the crash of 1987 is premature. In any case, what last week does mean is that with tax cuts baked into the cake, and rising inflation and interest rates starting to get priced into equities, picking winning stocks is going to get harder. Investors will need to go back to the inglorious work of fundamental analysis instead of just riding momentum.

• Expect Bitcoin prices to continue to drop before they rebound, if they do at all. Bank of America, Citigroup, and JPMorgan Chase announced they would be halting cryptocurrency purchases on credit, joining Discover and Capital One in their respective bans. Partly a product of retail investors use of credit cards as leveraging tools to amplify Bitcoin returns, and partly a product of regulation stipulating that banks prevent money laundering, the move doesn’t bode well for Bitcoin or its cryptocurrency peers. Losses last week were amplified by rising interest rates and worries of a regulatory crackdown in India. With Bitcoin having shed 50% of its value since peaking in November, prospective Bitcoin owners should expect the bad and the ugly to outweigh the good in the coming weeks and months.

• Trump may end up regretting touting the stock market as a sign of his success as president. Observers have long been warning that his excessive commentary on the market may come back to bite him. Every president eventually encounters a market storm, and markets have tended to do poorly during midterm election years as it is. After the market rocketed to all-time highs, now, interest rates and inflation are on the rise, asset contagion is at a six-year high, and a potential market correction is incoming. While voters still feel good about the economy, and have good reason to feel that way, a more muddled economic picture may not bode well for Trump and the Republicans come November.

Featured image courtesy of Trading and Investment News