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Weekly Market Update for October 5, 2018

by JM Hanley

The Dow was down on Friday, falling 180 points to close at 26,447. For the week, the Dow was essentially unchanged (SP500 -1.0%) and year-to-date is now up 7.0% (SP500 +7.9%).

The Administration struck a trade deal to replace NAFTA with Canada after months of negotiation. The details are largely immaterial from the market’s perspective. Since a deal with Mexico had been agreed upon earlier, this means that North America will remain a free trade zone. The Administration simultaneously intensified non-economic pressure on China. The state of play on both sides of the Pacific seems to change from one minute to the next, but Washington continues to work for a comprehensive restructuring of their trading relationship.

Payrolls increased a bit more slowly than anticipated last month. A rough hurricane season didn’t help. However, the figures for July and August were revised up substantially. Unemployment fell to 3.7%, its lowest level since December of 1969 (though labor force participation is lower). Wage growth remained stubbornly slow despite further tightening in the labor market. Paychecks increased 2.8% (annualized).

The yield on the 10-year Treasury (an important interest-rate indicator) rose 16 basis points, closing at 3.23%. This marks its highest level since 2011. The jobs report revealed that the labor market remains quite healthy, so the Federal Reserve might raise rates more than anticipated next year.  Higher rates would make the return on Treasuries, along with all other existing fixed-rate securities, less attractive. Lending some credence to this view, Fed Chairman Jerome Powell said interest rates remained low despite several hikes this year. But plenty of factors converged to make this the perfect storm. Deficit spending has increased. The government must issue more debt to pay the bills, so the new supply of Treasuries is growing. The Federal Reserve is also selling the Treasuries it bought during the financial crisis, adding even more supply. When supply goes up and demand doesn’t change, prices fall and yields rise.

The rapid increase in yields dragged down the technology sector and other high-growth equities. Companies that are growing quickly are valued based on the earnings they will produce many years in the future. Investors compare this future stream of earnings with the compounding value of what they can earn in low-risk options, like Treasuries. If the return on Treasuries increases, tech companies’ future earnings look less attractive than before, and valuations fall.

The price of crude oil rose 1% this week to $74 a barrel – up 23% YTD. US crude stockpiles showed a greater-than-expected build – of 8.0m barrels – while product inventories of gasoline (-0.5m bls) and diesel (-1.8m bls) both fell. Oil prices continued climbing early in the week, but reversed course following the inventory report and amidst a falling equity market. There was also chatter that Saudi Arabia and Russia may have secretly agreed upon an in their production rates. Share prices of domestic oil producers followed the commodity this week and provided an offset to the broader equity market weakness.

General Electric replaced its CEO, John Flannery, with Lawrence Culp, the former chief of fellow industrial conglomerate Danaher. The move followed GE’s announcement that its cash flows would weaken due to ongoing struggles in its power business. Flannery’s plans for restructuring GE were appropriately far-reaching, but his execution was slow. Culp’s success at turning around Danaher augurs well. GE’s stock rose 17% this week.

*The information contained in this commentary is not investment advice for any person. It is presented only for informational purposes to assist in explaining factors that may have had an impact in the past or may have an impact in the future on client portfolios or composites. All expressions of opinion reflect the judgment of the firm on this date and are subject to change. Included information has been obtained from sources considered reliable, but we do not guarantee that the foregoing materials are accurate or complete. Clients or prospective clients should contact Ulland Investment Advisors for individualized information prior to deciding to participate in any portfolio or making any investment decision. Ulland Investment Advisors does not provide tax advice. All clients are strongly urged to consult with their tax advisors regarding any potential investment. Past performance does not guarantee future results; there is always a possibility of loss.

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