Market Update Second Quarter 2017
Global stock markets collectively had their best opening half year in years, but turbulence in the last week of June could be a harbinger of greater volatility. All but four of thirty major indices representing the world’s biggest stock markets by value have risen this year, a first-half performance unmatched since 2009. Looking back 20 years, only four first-half rallies have been as widespread as or better than the current global surge. Two of them preceded sharp market corrections and two others came at the start of long bull markets.
For the year to date, the U.S. stock markets have scored solid gains. As listed above, the Dow and S&P 500 performed in sync, rising 9.4% and 9.3% respectively. The NASDAQ gained an impressive 14.1%. Earnings growth continues to support the U. S. stock market; after strong earnings growth in the first quarter, the second quarter looked good as well. According to FactSet, as of June 30, the S&P 500’s estimated earnings growth rate for the second quarter was 6.6%. This figure is slightly lower than the number anticipated at the end of the first quarter but may be enough to drive stocks higher.
The MSCI EAFE Index, which represents the stocks of developed international markets, gained 13.8%. The MSCI Emerging Markets Index fared better, moving up 18.6%. The renewed earnings growth and a supportive economic environment have driven the strong market performance year-to-date. The current synchronized global economic expansion is the first since the financial crisis, and it should continue to support faster growth.
Results for fixed income markets were mixed. The Federal Reserve (Fed) interest rate increase—though expected—forced market adjustments. The Bloomberg Barclays Aggregate Bond Index declined 0.10% in June, as the rate on the 10-year Treasury rose from 2.21% at the beginning of June to 2.31% by month-end. Longer-term results were better. The index was up 2.3% year-to-date.
Economic data supports growth
First-quarter gross domestic product (GDP) growth was stronger than the initial estimate. The figure was revised upward, to 1.4%, which was double the original 0.7% estimated rate. Positive revisions to consumer consumption numbers were the major drivers of the improved GDP rate. Consumption rose from an initial estimate of 0.3% growth to a robust 1.1% increase.
Second-quarter data was largely positive, with some month-to-month variation. Consumer income and spending rose 0.4% in April, and the figures for March were revised upward. Solid job and wage growth engendered the good results.
Data toward the end of June was less positive. Income growth has been strong, but spending growth has declined to 0.1%. However, this performance was actually better than it looked. The drop was due to lower gas prices—an overall positive—and moderating auto sales, which is a continued adjustment down from very strong previous sales levels. Combined with the decline in inflation, these factors seem to indicate that the decrease in spending may not be a concern yet.
The May jobs report was also weak, with only 138,000 jobs created. This figure was well below expectations, although the unemployment rate fell to its lowest level in 16 years. The slowing pace of job growth might have been due to a lack of qualified job seekers, not a lack of jobs. However, June’s employment numbers came in strong with 220,000 jobs in June with a slight uptick in jobless rate to 4.4%. Despite some weak data, the Fed remains positive about the outlook for the economy. It raised the federal funds rate by 0.25% at its June meeting. The increase was anticipated and largely interpreted as a sign of continued confidence.
Housing rebounds following a weak April
Perhaps the most encouraging data for the most recent quarter came from the housing sector. Some results for May were stronger-than-expected and offset a slight slowdown in April. Existing home sales in May were up 1.1%, though analysts had forecast a decline. New home sales also increased by more than expected for the month. The upticks were notable given the low level of supply on the market—existing housing stock is at its lowest level since 1982 and is expected to remain tight for the foreseeable future.
Healthy demand drove the strength in housing. The S&P/Case-Shiller U.S. National Home Price Index showed that home prices had surpassed pre-recession highs. Sales have continued to increase despite all-time highs in prices. This signals that many consumers are confident enough in the economy to make a long-term investment.
Business and consumer sentiment still strong
The largely positive hard data reported in June was bolstered by continued strength in business and consumer sentiment. Business confidence remained high in May. This was reflected in the surprise increase in the ISM Manufacturing Index, which analysts had expected to remain flat.
Core durable goods orders, which are a proxy for business confidence, increased slightly during May. The ISM Non-Manufacturing Index rose in June to 57.4 as compared to 56.9 in May (anything above 50 is considered a sign of growth). Consumer confidence is still high, despite a small pullback in some surveys in June. The Conference Board Consumer Confidence Survey declined slightly, yet its three-month average is at the highest level since 2001. The high levels of confidence are providing a solid tailwind for continued growth.
Political risks remain
As has been the case for much of the year, politics continue to add uncertainty to the markets. The major domestic concern has been the Republican effort to reform heath care which has been unsuccessful to date. To add to the uncertainty, the fate of wide-ranging tax reform is partially tied to the success of the administration’s health care efforts. Republican lawmakers were looking to use savings from health care reform to offset potential revenue losses from corporate and personal tax cuts. At this point, expectations are low, so the downside risk is probably low as well. There may be some upside potential if Congress is able to move forward.
Internationally, political risks remain. But given the better-than-expected results from recent European elections, these seem less pressing than earlier in the year. Progress has been made in dealing with economic issues. For example, the Italian banking system has started to resolve some of its problems. However, market volatility could still arise from upcoming Italian election results and a worsening of the situation with North Korea.
Strong first half is a good sign for the rest of 2017
Risks remain and there have been signs of slowing growth, but the outlook for the U.S. economy continues to look positive at least for the time being. High levels of confidence combined with increasing income and spending bode well for second-half growth. And, as growth speeds up in the rest of the world, the U.S. should benefit.
Although we are happy with the positive results of the stock markets – particularly in the U.S. since 2009 – we can’t ignore the fact that the S & P 500 now trades at 18-times its 12-month forward earnings and is around its highest level in 13 years. This bull market is the second longest recorded in U.S. history. We know trees don’t grow to the sky, so we will not be surprised to see some kind of pullback in the second half of the year or early in 2018. Given this expectation, if you think you will need cash in the next 12 to 24 months for spending, please let us know, as it may be a good time to create a reserve.”
However, we continue to believe a well-balanced portfolio designed to match objectives and hedge against the inevitability of less positive conditions in the future remains the best means to achieve your financial 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.