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Market Outlook: June 2017
Consumers plod along. Although the Conference Board’s consumer confidence fell more than expected in May, it remained close to post recession highs. Consumer spending also rose in April, getting the second quarter off on a strong note. However, the pace of spending remains more subdued than robust, with May auto sales slipping after April’s increase.
Economy plods along. The latest Beige Book found activity expanding at a modest-to-moderate pace across most districts in early April through late May, while the Philly Fed State Leading Indexes projected growth to increase in 46 states over the summer. There was some deterioration in breadth—the net share of expanding states fell to 92%, matching its second-lowest level in this expansion. But the overall leading index suggested a modest pickup in real GDP growth over the next 6 months.
Not too shabby manufacturing. Last week’s weakness in the preliminary Markit PMI and Richmond Fed readings (both indicators of manufacturing sector economic health) were overwhelmed by this week’s favorable regional readings in Chicago and Texas, as well as upbeat final Markit and national ISM reports. The Chicago barometer hit a 2½-year high, factory production in Texas reached a 3-year high, the final Markit index was revised up, and May’s manufacturing ISM rose in line with expectations as production and new orders remained robust.
Labor market tightens. The unexpectedly weak nonfarm payroll job gains after the strong ADP report may reflect a growing issue confronting employers: increasing difficulty finding qualified workers. Online help-wanted ads rose in May by the most since December 2012, and the labor demand/supply ratio suggests further tightness. Demographics are a key reason. The 10-year annualized growth rate of the working-age population is its lowest level since the start of the series in the late 1950s. More significantly, the 16-to-64 working-age population grew just 0.5% annually over the past 10 years—the lowest on record. The rising growth rate of younger workers and declining growth rates of older workers explain why productivity growth is weak. Evaporating global barriers for jobs and A.I. (Artificial Intelligence) taking jobs are also things keeping wage inflation subdued.
Housing market tightens. Pending home sales in April fell for the third time in the past 4 months, with sales contracts on a year-over-year basis off the most since June 2014. The National Association of Realtors attributes this weakness to deteriorating affordability conditions, as inadequate supply continues to push existing home prices higher. Its outlook is for these trends to continue for the rest of this year, with existing home sales rising 3.5% this year and the median existing home price rising 5%.
Construction spending disappoints somewhat. April construction spending unexpectedly fell, led by a big drop in public construction spending. On the private side, the decline was modest, with softness in both residential and non-residential categories. Much of the decline in private residential construction was in home improvements, as single- and multi-family private construction spending continued to maintain good momentum, a positive for residential investment this quarter. Further, the upward revisions to March data imply better momentum in construction spending in Q2.
Political Watch. Historically, when an administration gets in trouble, it doubles down on policy. Congressional Republicans now see an expiration date on their control of Congress, and this is forcing them to get their act together or risk coming to midterms with little to show save controversies. Investors should not be caught off guard in coming weeks when Trump releases a large infrastructure package, and the Senate coalesces around a tax reform plan.
Drawdown coming? The last time the S&P 500 fell 10% or more was in August 2015, almost 450 trading days ago. Historically, drawdowns occur every 258 days on average, or once a year. Although equities may appear overdue as measured purely by time, we would note that volatility tends to cluster. In the 1990s, equities were drawdown-free for 7 years. Today, we see fundamentals such as the ongoing global economic expansion as supportive of fewer drawdowns.
Final Analysis. We believe the macro backdrop remains supportive of moderately positive risk asset returns. Both stock and bond markets typically react favorably to a modestly growing, rising rate environment with subdued inflation. We continue to favor equity over fixed income and credit over rates, but we are cautious on broad market beta. We see full US valuations as a potentially limiting factor to forward US returns, which may lead to relative outperformance for both global developed and emerging equities.
Equity Market Summary
May 2017 saw the S&P 500 index move to new highs as it increased just over 2%. This trend gave positive momentum to the S&P 500 Index as it finished nearly 10% higher for the year. Developed foreign markets as measured by the MSCI EAFE index increased by over 4% for the month (and over 7% for the quarter to date) due to improving optimism on global growth, and aided by strength in the euro versus the U.S. dollar. Emerging markets stocks also added to its yearly returns as the MSCI Emerging Markets index returned almost 3% for the month. Oil prices for the month initially rose in anticipation of a meeting between OPEC and Russia, but fell strongly after news of increased U.S. production. The Bloomberg Commodity index declined approximately 1% for the month. With the oil price surge slowing, a rapid increase in inflation seems unlikely. The first quarter 2017 corporate earnings season showed the highest revenue beats since the fourth quarter of 2013, and companies have been able to obtain EPS growth from revenue and not just by cutting costs. May was a very narrow market with Tech up 3.4% and Utilities up 2.2% and every other sector down. With continuing policy challenges of the new administration, there will be at least several quarters before proposed changes by the administration, including tax reform, lead to improvements in corporate profitability.
LARGE CAPS OUTPERFORM SMALLER CAPS YTD:
GROWTH OUTPERFORMING VALUE YTD :
|Large Cap||16.02% vs. 3.88%|
|Mid Cap||12.9% vs. 4.79%|
|Small Cap||9.4% vs. -0.68%|
Best performers: Year to date through the end of March, the Technology sector has the best returns at 22.1% followed by Consumer Discretionary at 13.8%. While both sectors have benefited from reasonable valuations, the growth expectations of Technology and Consumer Discretionary have increased from an improvement in consumer sentiment over the last several months.
Worst performers: Energy (-12.9%) and Telecom (-7.5%) have had the worst negative YTD returns with oil prices declining due to inventory supply/demand imbalances. Telecom with its high dividend payout ratios is suffering by being an income proxy with rising rates. Some of the pullback has to do with higher valuations in these 2 sectors with their strong performance in 2016.
Emerging markets solidly outperformed developed markets as higher growth and gains from currency movements such as the weakening dollar contributed to the 18.4% YTD gain of the MSCI EM (Emerging Markets) compared to a YTD gain of 15.6% by the MSCI EAFE (the more developed market international index).
We continue to think a balanced portfolio including alternatives continues to be appropriate for investors. While we do see some continued upside in equities, we believe returns will be muted with slow but positive economic growth which will limit corporate earnings growth. Valuations on equities have generally moved higher in anticipation of higher growth so prudent to not overreact (and overinvest) in sectors that may have gotten ahead of improving fundamentals. Investors will need to be realistic on returns going forward.
Fixed Income Summary
- The Federal Open Market Committee (FOMC) In a widely anticipated move, the FOMC decided to maintain the target federal funds rate at the current range of 0.75% to 1.00% at its May meeting. While the Committee has noted continued strength in the labor market for some time now, they view the slowing growth in economic activity over the first quarter as a transitory event. Both the unemployment rate and inflation are near their long term projections, and if economic activity can reclaim its path of moderate growth, we expect further interest rate increases at each press conference meeting in 2017 and more to follow in 2018.
- The 10-year US Treasury yield declined by 7 basis points to 2.22% at the end of May. There was a “flight to quality” move related to the release of mixed economic data showing more muted growth.
- Fixed income investment performance edged up during the month of May, as Treasuries rallied. Most domestic asset classes showing a positive return year-to-date, with the Barclays U.S. Agg up 2.38%. Munis were also up 3.94% YTD. U.S. high yield has been the leading domestic asset class in fixed income for the year at 4.79%.
YEAR-TO-DATE INDEX RETURNS (5/31)
|Barclays Global Aggregate||+4.50%|
|Barclays US Aggregate||+2.38%|
|Barclays US Intermediate Government/Credit||+1.91%|
|Barclays US Corporate High Yield||+4.79%|
|Barclays Municipal Bond||+3.94%|
About the Authors
Kristin Bell joined Southeastern Trust in May 2015 as Vice President and Portfolio Manager. Kristin came to STC with more than seventeen years experience in investment related analysis, trading, and portfolio management, including roles at Unum Group, Wachovia Bank, and Fidelity Investments.
Kristin holds a B.A. in Psychology from Wheaton College as well as the Chartered Financial Analyst designation. She has previously served on the board of St. Peter’s Episcopal School and as Treasurer for the Thrasher School PTA Executive Board.
Robert Clark joined STC in November 2012. He has over a decade of experience in wealth management and has held a number of roles within super-regional financial institutions. Robert holds both the Chartered Financial Analyst designation as well as the Certified Financial Planner designation. He obtained his M.B.A. from Wake Forest University, is a graduate of the U.S. Naval Academy and spent five years as a Naval Officer. Robert is a member of the East TN Society of Financial Analysts.
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