Economic Summary
Economic growth in the second quarter of 2017 increased to 2.6%. This was largely due to increased non-residential investment and personal consumption. An increase in inventories took away from growth while the increase in net exports added to the improved growth rate. We expect economic growth to remain stable for the second half of the year.
At the July Federal Open Market Committee (FOMC) meeting, the Fed left the target federal funds rate unchanged at a range of 1.00-1.25%, which was widely anticipated. The two main factors that the Fed considers when it decides how to set interest rates are the unemployment rate and Inflation. Inflation pressures are declining slightly in the U.S. with the Consumer Price Index (CPI) numbers falling to 1.6% year-over-year. Energy prices were up 2.4% last month and food prices rose incrementally by 0.9%. The Fed’s preferred measure of inflation, the Personal Consumption Expenditure (PCE) deflator decreased to 1.4% year over year. The possibility of a Fed rate hike in December remains.
The Fed has outlined its plans to reduce its balance sheet holdings of Treasuries, beginning possibly as soon as September. This should put pressure on interest rates to rise, although international demand for U.S. Treasury securities with relatively higher yields offsets this effect somewhat. If central bankers in the Eurozone economies back off their economic stimulus measures, this will put upward pressure on interest rates globally. We expect Fed chairperson Janet Yellen to give us some indication of her plan for the second half of the year at the Fed’s annual monetary policy symposium August 24-26.
The July employment report surpassed expectations by adding over 209k jobs last month. The unemployment rate declined to 4.3% (its lowest level in 16 years) even with an increase in the participation rate (the percentage of the population that is either working or actively seeking work) to 62.9%. This trend of a healthy and growing labor market continues. Currently there is no increased wage pressure (wages only rose 2.4% on a year-to-year comparison) although as the labor market continues to tighten we expect wage pressure to build.
With companies representing 86% of market capitalization having already reported 2nd quarter earnings, the year-over-year increase in operating earnings per share (EPS) growth is over 20%. Most of these reporting companies have exceeded expectations, with 73% of them surpassing on earnings and 57% greater on revenue. We expect the sectors that should see the strongest growth in earnings to be energy (due to weak year-over-year comparisons), technology, health care and telecom.
Equity Market Summary
The S&P 500 continued its upward climb in July, rising by 2.06% bringing the year to date total return of the Index to 11.59%. Where do we go from here? A correction could be coming, as August and September historically are the year’s weakest months, D.C. fiscal progress has been disappointing, and central banks globally are signaling tighter monetary policy. However, the global backdrop is supportive, with growth balanced between developed and emerging economies, inflation muted, and the weaker dollar bolstering exports and earnings. History suggests the positive market trends will continue through year-end. In all the years when the S&P was up 10% or more through July, that has been the case. We appear to be in a secular bull market with benign inflation and rising earnings. While gains have been impressive and stocks are no longer cheap, they still look inexpensive relative to core fixed income.
All international equity markets (emerging and developed international) continue to outpace domestic U.S. equities. The MSCI Emerging Markets index up +6.0% during July and +25.7% YTD. The MSCI EAFE Index (Developed Int’l) is up +2.9% during July and +17.5% YTD.
LARGE CAP OUTPERFORMS SMALL CAP YTD
| Dow Jones | 13.02% |
| S&P 500 | 11.59% |
| Russell Midcap | 9.57% |
| Russell 2000 | 5.76% |
GROWTH OUTPERFORMING VALUE YTD
| Large Cap | 16.29% vs. 6.29% |
| Mid Cap | 13.26% vs. 6.57% |
| Small Cap | 10.90% vs. 1.17% |
Best Performers: Year to date the Technology sector is still the best performing sector (+22.3%) and was the second best performer during the month of July (+4.3%). The strongest monthly performer in July (+6.36%) was Telecom. The defensive, rate sensitive sector was buoyed by mixed economic data and comments indicating a less hawkish Fed, but the sector is still the second weakest (-5.1%) for the year. Healthcare is still the second strongest performer year to date (+17.0%), but was only up 0.8% during the month of July.
Worst Performers: Energy is still the worst performing sector YTD at -10.4% with oil prices falling steeply over supply glut concerns from consistent growth in U.S. production, but it did bounce 2.5% in the month of July, slightly outperforming the S&P 500 average. Telecom is still the second worst performer at -5.1% given its high dividend payout ratio is a proxy for income generation and the likely upward trajectory of rates.
Fixed Income Summary
The 10-year U.S. Treasury yield ended the month unchanged at 2.3%, and down 15 basis points since the start of the year. Although the Fed has been raising short-term rates and is expected to raise them again before year-end, longer-term rates have come down, causing the curve to flatten, impacted by lower inflation expectations and continued foreign demand for U.S. Treasuries. When rates outside the US are at or closer to zero, money flows into higher yielding Treasuries, which look attractive on a relative basis, keeping longer Treasury rates lower.
Although many recessions have come after a flattening yield curve, only half of flattening yield curves have been followed by recessions.
Fixed income performance: The broadest measure of the U.S. bond market, the Barclays U.S. Aggregate, returned 0.43% during July and 2.71% year to date. Global bonds have had the highest returns, +1.7% during July and +6.2% year to date. High yield is a close second, returning +1.1% during July and 6.1% year to date. Municipal bonds also returned 0.8% in July and 4.4% year to date.
YEAR-TO-DATE INDEX RETURNS (as of 7/31)
| Index | YTD Returns |
| Barclays Global Aggregate | 6.16% |
| Barclays U.S. Aggregate | 2.71% |
| Barclays U.S. High Yield | 6.09% |
| Barclays Municipal Index | 3.57% |