The Trump rally finally hit the wall. His threefold agenda of reduced regulation, reduced taxes, and increased infrastructure spending smacked up against higher interest rates, increased regulation, and tariffs. First rates: February’s wages were up 2.9% year over year, the best pace since June of 2009, and well above the Fed’s inflation target of 2.0%. The market sold off dramatically fearing the Fed will aggressively hike rates. Secondly, increased regulation: various tech companies are under the threat of increased regulation for not protecting consumer privacy or paying less than their fair share of taxes. Thirdly, tariffs: higher prices could affect the consumption of goods ranging from aircraft to pigs to piping to chemicals to fruit. After a glorious January, the S&P 500 retreated in February and March and ended the 1Q down -0.76%.
Earnings may have to be adjusted downward to reflect new tech regulations constraining the sale of personal information and for lost revenues due to tariffs. Yet, because of the $1.5 trillion in tax cuts and robust global growth, S&P 500 earnings are still expected to increase by double digits. To our thinking, the more important factor is the Fed which has projected seven more rate hikes before the end of 2020. In the era of low fixed returns many investors sought out higher (riskier) returns in stocks. What happens when investors can obtain higher fixed returns? Fleeing the market will depress prices.
Momenta, our biosimilar pharma, received FDA approval for a key drug and is benefitting from an FDA which wants to expedite biosimilar releases; the stock was up +30%. First Energy (FE) gained +11% despite what seemed to be a torrent of bad news. Two of FE’s power generation subsidiaries (FES & FENOC) are declaring bankruptcy. As the parent company, FE will take a loss on some debt, but cash flows from the transmission and distribution subsidiaries are enough to cover the dividend.
The disappointment in the Q was Portola which lost -33%. The company received an FDA request for additional information on a clinical trial for the firm’s first-in-class, blood thinning reversal agent. At this point, it is only a request for information and not a requirement that a new clinical trial be initiated which is what the market fears. Interestingly, even with the info request, the drug still has an FDA “breakthrough therapy designation” reflecting its groundbreaking potential to save lives.
Our only significant trade is the Q was the purchase of shares of a firm which manufactures and sells capacitors. Demand for capacitors is strong as they are used in all electronics. The company made a recent acquisition that complements its existing product line which will boost revenues.
April 1, 2018 Paul F. Rodgers, CFA
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