Market Update First Quarter 2017
Mixed month for markets ends with gains
April was a volatile month for financial markets, but early declines turned to gains at the end. Investors reacted positively to U.S. tax reform proposals and the potential for a pro-European Union (EU) outcome in the French presidential election. The S&P 500 Index was up 7.2% year-to-date through the end of April, while the NASDAQ moved ahead a stunning 12.3%.
Markets were also supported by improving fundamentals. The blended earnings growth rate for S&P 500 companies for the first quarter was 12.5%, according to FactSet. Although just over half of companies have reported earnings so far, this healthy rate is well above expectations and the highest number we’ve seen since the third quarter of 2011, when the economy was in full recovery mode. This level of earnings growth is expected to continue over the next few quarters. And because fundamentals drive market performance in the long run, the earnings number represents encouraging news for future equity results.
Foreign equity markets fared even better. The MSCI EAFE Index rose 2.5% in April, with most of its gains occurring after the first round of the French election. Year to date, the index was up 10% through April. Reports of faster-growing economies around the world also helped markets. Although the MSCI Emerging Markets Index experienced a bit more volatility in April, it finished with a 2.2% gain. The index was up an impressive 13.4% year-to-date through April.
The Bloomberg Barclays Aggregate Bond Index ended the period with a 1.6% gain for year to date. Interest rates dropped slightly during the volatile month. The 10-year Treasury rate started April at 2.35%, declined to 2.18% mid-month, and ended the period at 2.29%.
Economy improves amid signs of slowing growth
Much of the economic news was positive in April, although overall growth appeared to slow. Differences between strong sentiment and weak spending continued to be a concern.
Gross domestic product (GDP) growth for the first quarter of 2017 was estimated at 0.7%, down from 2.5% at year-end. Although this is something to watch, slower growth in the first quarter has been the norm during the current recovery. Since 2010, first-quarter GDP growth has averaged 0.9%, before rebounding to an average of 2.4% for the other three quarters of the year. This pattern suggests that seasonal factors (winter weather has been a key factor recently) are at play and that growth may accelerate for the rest of 2017.
Supporting this notion, consumer sentiment has improved substantially since last year’s election—up to its highest levels since the end of the dot-com boom. Although it has started to stabilize recently, it remains high. Business confidence is also strong. Though the ISM Manufacturing and Non-Manufacturing indices—important indicators of overall business sentiment—decreased slightly in April, they remain at high levels. This signals the likelihood of further expansion. Durable goods orders, which are a proxy for business investment and therefore confidence, also increased in April.
Hard data lags soft numbers
Unfortunately, this optimism hasn’t translated into increased spending. Consumer spending was especially disappointing in April. Retail sales dropped unexpectedly, and the previous month’s gain was revised to a loss. Weather and low gas prices played a part in the decline, but ultimately increases in consumer spending will be critical for faster growth. Consumer prices, personal consumption, and personal spending also came in weaker than expected for the month.
On the business side, hard data also continues to lag sentiment. Manufacturing output missed expectations and declined for the first time in seven months. In addition, results for the previous two months were revised downward. The positive numbers from the last six months indicate that the slowdown may be temporary, but this gauge should be monitored.
The April jobs report showed renewed strength after a weak reading in March, as the headline number of 211,000 new jobs beat expectations. The 4.4% unemployment rate and the underlying data surrounding wage growth were positive as well. A healthy job market is essential for high consumer confidence, so this will be an important indicator going forward.
Housing continues to shine
One of the bright spots in the economic recovery has been the strength of the housing market. The trend continued in April, as housing data came in largely better than expected. Home builder confidence remains near post-recession highs. And, although housing starts declined slightly during the month, the long-term trends are positive.
Existing and new home sales increased more than expected in April. The growth in new home sales was particularly impressive because this measure was expected to decline. Strong demand and increased building permits with low supply bodes well for growth in housing.
Political risks continue to drive markets
Domestically and abroad, political risks appear to be playing a larger part in financial markets. This was certainly the case during April.
In the U.S., the major political news was the Trump administration’s release of its first proposal for comprehensive tax reform. The plan includes a dramatically lower corporate tax rate, a change in the way companies are taxed on earnings in foreign countries, fewer personal income tax brackets—from seven to three—and a lower top rate. Given the broad scope of the proposal and the current political climate, the proposal will likely lead to vigorous debate. Because some of the strength in consumer and business sentiment can be attributed at least in part to the promise of tax reform, the negotiation will be watched closely.
In Europe, the news was also dominated by politics. World stock markets bounced higher following first-round results in the French presidential election—widely seen as a referendum on the future of the EU. Emmanuel Macron, a strong EU proponent, won the presidential election but now faces the challenge of gaining control of France’s parliament in next month’s election.
Meanwhile, North Korea tensions continue to escalate. So far, the U.S. and China appear to be working diplomatically to defuse the crisis. This cooperation has not only served to reduce worry about North Korea but also to ratchet down the level of tension regarding economic issues.
Risks remain, but the future is bright
Despite the very real risks domestically and globally, we think the current outlook for the rest of 2017 looks solid. Multiyear highs in consumer sentiment, as well as the potential tailwinds of looser regulations and tax reform, point toward the possibility of accelerated growth. How much this confidence will translate into increased spending remains to be seen. From a political standpoint, concerns remain, but so far actual results have been much less worrisome than analysts had expected.
As always, the possibility for shocks and instability continues. Therefore, we continue to believe a well-diversified portfolio designed around long-term needs is still the best strategy for meeting personal investing goals.
- Alex Armstrong, CFP®
All information according to Bloomberg, unless stated otherwise.
Disclosure: Certain sections of this commentary contain forward-looking statements that are based on our reasonable expectations, estimates, projections, and assumptions. Forwardlooking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is not indicative of future results. Diversification does not assure a profit or protect against loss in declining markets. All indices are unmanaged and investors cannot invest directly into an index. The Dow Jones Industrial Average is a price-weighted average of 30 actively traded blue-chip stocks. The S&P 500 Index is a broad-based measurement of changes in stock market conditions based on the average performance of 500 widely held common stocks. The Nasdaq Composite Index measures the performance of all issues listed in the Nasdaq Stock Market, except for rights, warrants, units, and convertible debentures. The MSCI EAFE Index is a float-adjusted market capitalization index designed to measure developed market equity performance, excluding the U.S. and Canada. The MSCI Emerging Markets Index is a market capitalization-weighted index composed of companies representative of the market structure of 26 emerging market countries in Europe, Latin America, and the Pacific Basin. It excludes closed markets and those shares in otherwise free markets that are not purchasable by foreigners. The Bloomberg Barclays U.S. Aggregate Bond Index is an unmanaged market value-weighted index representing securities that are SEC-registered, taxable, and dollar-denominated. It covers the U.S. investment-grade fixed-rate bond market, with index components for a combination of the Bloomberg Barclays government and corporate securities, mortgage-backed pass-through securities, and asset-backed securities. The Bloomberg Barclays U.S. Corporate High Yield Index covers the USD-denominated, noninvestment-grade, fixed-rate, taxable corporate bond market. Securities are classified as highyield if the middle rating of Moody’s, Fitch, and S&P is Ba1/BB+/BB+ or below.