The Market Melt-Up

Stock indexes had an amazing start to 2018, so it shouldn’t be a surprise they closed January with consecutive down days.

Before Jan. 30, the S&P 500 had 350 trading days without consecutive daily declines of 0.5% or more each. That’s a record by a wide margin.

Fewer than a handful of such S&P 500 streaks were longer than 150 days, and none exceeded 175 days, according to Bespoke Investment Group.

In the September 14, 2017, edition of Bob’s Journal and again on December 28, 2017, I discussed some of the data that show this bull market is one of the longest on record. The bull market also ranks near the top for extended periods without significant declines.

Instead of starting 2018 with a long overdue decline, the market indexes accelerated.

The S&P 500 had one of its best results for a January ever, and the best since 1987, at least through Jan. 26. It returned 7.30% for the month as of Jan. 26 and still closed with a 5.64% return, despite a tumble in the final days of January. The index had 14 record closing highs during the latest January, which was exceeded only in January 1928 and 1955.

While technology stocks led the indexes higher in 2017, that wasn’t the case at the start of 2018. Consumer discretionary and health care took the lead, each gaining more than 9.8% as of Jan. 26.

The rest of the major U.S. stock market indexes also got off to good starts.

While the S&P 500 was up 6.76%, the Dow Jones Industrial Average returned 7.06% and the Nasdaq 100 gained 8.97%. The mid-cap and small company indexes gained 4.5% or less.

International stocks also started the year well.

The All-Country World Index returned 6.77%. Emerging market equities soared 10.14%.

Many country indexes did better than the United States. Brazil returned 16.59%. Other big gainers included Italy, soaring 12.7%; China, climbing 12.05%; and Russia, rising 11.57%. Most of the major European countries jumped more than 7% for the period. Elsewhere, Japan gained 7.68%.

Part of the excess gains for overseas stocks resulted from a decline in the dollar. The euro gained 3.51% against the dollar and the yen rose 4.02%.

Commodities also got off to a good start in 2018. Oil gained 10.07% and natural gas was up 15.31%. Broad-based commodities gained 3.79% and gold rose 3.83%.

The only major investments not doing well are bonds. Interest rates have increased steadily, despite no additional moves by the Federal Reserve.

Long-term treasuries lost 2.77%, as of Jan. 26. Intermediate treasury securities declined 1.76%, and even 1-3-year treasuries lost 0.25%. Treasury Inflation-Protected Securities (TIPS) lost 0.70%, and the Total Bond Market fell 1.00%.

Is the January 2018 surge the final market melt-up and a signal to sell stocks?

Not if history is a guide. In other years with strong January returns, the market indexes had positive returns for the entire year 68% of the time. They usually were strong, double-digit-percentage returns. However, the minority of years with negative returns tended to have big losses.

Investor psychology is worth paying attention to this time. The economic fundamentals still are very positive. But how will investors react after being lulled into complacency by a long period of low volatility with no meaningful declines? Will they realize declines historically happen with some frequency and are short-term? Or will they panic when they see that first meaningful decline in their portfolio values?

The response will hinge at least partly on how investors measure the decline.

If they look at the percentage of any decline, they’ll probably take it in stride. But they could panic if they focus on the points an index declines. For example, with the Dow now above 26,000, a 2% decline would be 530 points. That would cause some headlines to compare the decline to 1987’s Black Monday, which was more than 500 points, but a 25% drop.

We can’t predict how investors will react, or even when the next meaningful decline will occur. We’re going to hold our current positions for now and focus on the things that really matter to the markets. We won’t try to guess what markets and investors will do next.

The Data

Households still are in good shape, according to the Personal Income and Outlays report. Personal Income increased 0.4%, and consumer spending matched that. Wages and salaries increased 0.5%. A possible negative in the report is that the savings rate declined to 2.4%, its lowest level in 13 years.

Inflation, as measured by the PCE Price Index, still is low. It was 0.2% for the core index for the month and 1.5% over 12 months.

Consumer Confidence, as measured by The Conference Board, increased to 125.4. December’s decline was revised higher to 123.1 from 122.1. The January reading is a little below the 17-year high of 128.6 recorded in November.

Housing continues to help consumers.

House prices increased a healthy 0.7% in November, giving a 6.4% increase over 12 months, according to the S&P CoreLogic Case-Shiller House Price Index. House prices are rising partly because of a shortage of inventory for sale.

Pending sales of existing homes increased 0.5% in December. They’re up the same percentage over 12 months. Compare this to new home sales, which increased 14% over 12 months. The relatively flat pending home sales over the last year generally is attributed to a lack of inventory for sale.

Manufacturing continues to show strength, and the economic data is starting to match the strength in the surveys and anecdotal reports.

Industrial Production increased 2.9% for the month, and last month’s increase was revised higher to 1.7% from 1.3%. After excluding the volatile transportation sector, Industrial Production increased 0.6% for the month and now is up 8.2% for 12 months.

Core capital goods, which is an important measure of business investment, was a mixed picture. It declined 0.3% for the month. But the prior month was revised higher to a positive 0.2% from a negative 0.1%. Also, much of the decline during the two months was focused in electrical and communications equipment. Core capital goods production increased 8.4% over 12 months.

The Dallas Fed Manufacturing Survey is consistent with other manufacturing data. It rose to 33.4 from 29.7. The survey obviously is very positive, though it is more positive than the hard economic data.

The Chicago Purchasing Manager’s Index has been at or near 50-year highs in recent months. That continued with the latest reading of 65.7, down a little from last month’s 67.8. The growth reflected in this index is considered unsustainable.

The PMI Manufacturing Index rose to 55.5 from 55.1. That leaves it just below the three-year high.

The ISM Manufacturing Index declined a little, dipping to 59.1 from 59.7. This index has been stronger than the PMI index and the manufacturing activity data for longer than a year.

Productivity declined in the fourth quarter by 0.1%. Output increased 3.2%, but 3.3% more hours were needed to do it. Unit labor costs rose 2.0%, which included a 1.8% compensation increase and the reduced productivity.

The second estimate of gross domestic product (GDP) showed a small decline to 2.9% from the first estimate of 3.2%. But the details of the report were very strong. The weaknesses were in exports and inventory. Real consumer spending increased a strong 3.8%. The GDP Price Index is showing higher inflation, coming in at an annualized 2.4%.

The rate of wage increases continues to rise. The Employment Cost Index found that wage and benefit costs increased 0.6% in the fourth quarter, down a little from 0.7% in the third quarter. The 12-month change is 2.6%, which is well above the level of less than 2% that prevailed for most of the recovery.

Preliminary employment data looks strong ahead of Friday’s Employment Situation reports. The ADP Employment Report said 234,000 new private sector jobs were created in the last month. In addition, last month’s number was revised down to 242,000 from 250,000. This report has been stronger than the government’s monthly numbers much of the last year.

New unemployment claims declined by 1,000 to leave the weekly number and four-week average near historic lows.

The Markets

Stocks stumbled this week. The S&P 500 declined 0.45% for the week ended with Wednesday’s close. The Dow Jones Industrial Average dropped 0.43%. The Russell 2000 sank 1.64%. The All-Country World Index lost 0.76%. Emerging market equities fell 0.72%.

Long-term treasuries lost 0.25% for the week. Investment-grade bonds fell 0.03%. Treasury Inflation-Protected Securities (TIPS) declined 0.11%. High-yield bonds dropped 0.51%.

The dollar lost 0.13%.

Energy-based commodities fell 1.34% for the week. Broader-based commodities lost 0.91%. Gold declined 1.00%.

Bob’s News & Updates

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