Market Update for the Quarter Ending June 30, 2019

Strong June leads to positive quarter for markets
June was a great month for stocks, as all major equity markets saw positive returns. The S&P 500 gained 7.05 percent for the month, the Dow Jones Industrial Average (DJIA) returned 7.31 percent, and the Nasdaq Composite rose by 7.51 percent. Further, June’s gains offset May’s declines, leading to positive quarterly performance of 4.30 percent for the S&P 500, 3.21 percent for the DJIA, and 3.87 percent for the Nasdaq.

This positive performance came despite weakening fundamentals. According to FactSet (as of June 28, 2019), the estimated earnings decline for the S&P 500 in the second quarter is 2.6 percent. This estimate is down from the 0.5 percent decline projected at the start of the quarter. Keep in mind that earnings declined in the first quarter for the first time since 2016. As such, this projected earnings decline for the second quarter in a row is concerning. Analysts project further declines in the third quarter before a return to growth in the fourth quarter. Ultimately, fundamentals drive long-term performance, so this is an area that deserves attention going forward.

Although fundamental support worsened during the month, technical factors were another story. In May, all three major U.S. indices dropped below their respective 200-day moving averages. But they bounced back in June to close the month well above that trend line. This bounce was an important development, as long periods spent below the 200-day moving average could show that investors are becoming less confident in U.S. equities. In turn, this lack of confidence could be a headwind to future performance.

The international story in June was much the same. The MSCI EAFE Index returned 5.93 percent, and the MSCI Emerging Markets Index returned 6.32 percent. Once again, these gains offset losses in May, bringing the MSCI EAFE Index to a 3.68 percent gain for the quarter. The MSCI Emerging Markets Index, which fell further than the developed markets in May, ended the quarter with a 0.74 percent gain.

Technicals for international stocks were supportive during the month. The developed and emerging market indices finished June above their respective 200-day moving averages. These indices had ended May below their trend lines, so this rise was a very positive development, like what we saw in U.S. equity markets.

Even fixed income had a positive June, driven by falling interest rates. The Bloomberg Barclays U.S. Aggregate Bond Index returned 1.26 percent, as the 10-year U.S. Treasury yield went from 2.14 percent at the end of May to 2 percent at the end of June. In fact, rates fell throughout the quarter, as the 10-year yielded 2.49 percent at the start of April. These declining rates led the index to a quarterly gain of 3.08 percent.

High-yield bonds also had a strong month and quarter. The Bloomberg Barclays U.S. Corporate High Yield Index returned 2.28 percent in June and 2.50 percent for the quarter. High-yield spreads ended the quarter unchanged despite a large increase in May, as the rally in June helped drive spreads lower.

Economic growth: Slowing but still growing
The fall in yields was due in large part to rising worries about economic growth. Only 75,000 new jobs were added in May. This result was below expectations of 175,000 and below the 2018 average of 215,000 new jobs per month. This disappointing number suggests that job growth is slowing.

Workers have begun to notice that new jobs are not as plentiful as they have been in years past. We saw this recognition in the declines in both major measures of consumer confidence in June. Positive market returns and a strong jobs market support consumer confidence. A decline in confidence—despite the strong market returns—indicates that workers may be starting to worry. That said, confidence remains at high levels, so this month’s drop is not an immediate concern.

Although confidence may be down, it has not yet hit actual behavior or economic growth. In fact, consumers kept earning and spending. Personal income and personal spending were up by 0.5 percent and 0.4 percent, respectively, in May. Retail sales also grew by a healthy 0.5 percent.

Businesses had a similar quarter, with some spending growth despite mixed confidence indicators. The Institute for Supply Management (ISM) Manufacturing index declined during the quarter. This drop reflects manufacturers’ growing concerns over a prolonged trade war. As you can see in Figure 1, the index is now at its lowest level in more than two years.

Figure 1. ISM Manufacturing Index, 2014–Present

chart

Despite the decline in sentiment, business investment and output continued to show steady growth. May’s industrial production report showed a 0.4 percent gain. This result was better than economist expectations. Core durable goods orders, a proxy for business investment, showed solid 0.3 percent growth in May. These results suggest the sector may be doing better than the sentiment indicates. The ISM Nonmanufacturing index was also positive. It held on to a higher level, suggesting that manufacturing was not a reflection of weakness in the economy as a whole.

The mixed confidence data was disappointing, but business investment continues and should have a positive impact on economic growth.

Fed continues to support economic expansion
Another tailwind came from monetary policy. In a press conference after the Federal Reserve’s June meeting, Chairman Jerome Powell indicated that the Fed would continue to watch for any negative economic impacts from the ongoing trade war. Further, he said the Fed would step in with stimulative measures if necessary.

Powell stopped short of saying that the Fed would cut rates at its next meeting. Still, market participants interpreted his comments as confirming the likelihood of a cut this year. At the start of the quarter, markets priced in a 65 percent chance of one rate cut during the year. Now, at the end of the quarter, the market has priced in a 100 percent chance of a rate cut at the Fed’s July meeting. Further, a second rate cut in either October or December is anticipated.

Inflation remains stuck below the Fed’s stated 2 percent target. But with slowing job growth and the rising concern around trade, a rate cut is certainly possible—and could be another tailwind for stocks.

Political risks remain
Although the economy continued to chug along, politics remained a concern, especially around trade. This impact was clear in May, when a couple of events rattled markets. First, we saw escalations in the China-U.S. trade war. Second, we had the surprise announcement of a blanket 5 percent tariff on all Mexican goods, although they never went into effect. On a more positive note, the G20 meeting at the end of June was drama free. World leaders toned down political rhetoric leading up to and during the meeting. This relative lack of political drama, along with a commitment for further trade negotiations between the U.S. and China, helped calm investor concerns and paved the way for June’s positive performance.

Economic growth poised to continue
All in all, this was a positive quarter for the U.S. economy. Despite concerns over international trade, the economy continues to grow at a solid clip. Consumers continue to show that they are willing and able to spend, and businesses are doing the same. Earnings declined in the first quarter and will likely do so again in the second quarter, but a return to growth by year-end should help support long-term performance.

Lower interest rates should support faster growth going forward, as lowered borrowing costs spur economic activity. We saw a surge in mortgage applications once rates fell in June. If rates remain low, there is a possibility that we could see housing growth return in the second half of the year.

Despite the very real political risks, the U.S. economy continues to grow. Markets have had a great start to 2019. Equities saw positive returns in five of the first six months of the year. These strong returns led all three major indices to double-digit year-to-date returns. There is a good chance that trend will continue. That said, the declines in May show that despite the positive tailwind from a growing economy, market volatility can come at any time. Thus, a well-diversified portfolio that matches your goals and risk tolerance remains the best way forward in a volatile world.

Co-authored by Brad McMillan, managing principal, chief investment officer, and Sam Millette, senior investment research analyst, at Commonwealth Financial Network.

All information according to Bloomberg, unless stated otherwise. 

Disclosure: Certain sections of this commentary contain forward-looking statements based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking 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 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, non-investment-grade, fixed-rate, taxable corporate bond market. Securities are classified as high-yield if the middle rating of Moody’s, Fitch, and S&P is Ba1/BB+/BB+ or below.

Market Update for the Month Ending May 31, 2019

Markets hit turbulence in May

After four months of rising stock markets, we finally saw a decline in May. All three major U.S. markets ended the month down, driven by rising worries about a trade war. The S&P 500 declined by 6.35 percent during the month, the Nasdaq Composite lost 7.79 percent, and the Dow Jones Industrial Average fell by 6.32 percent. Of course, this pullback is a concern. But in the bigger picture, it has taken markets back only to mid-March levels. They are still well above where we started the year, so there is no need to panic yet.

The pullback was due to declining confidence, as fundamentals improved during the month. According to FactSet (as of May 24, 2019), with 97 percent of companies reporting, the first-quarter blended earnings growth rate for the S&P 500 stands at –0.4 percent. If this number comes in as expected, it would be the first quarter of year-over-year earnings declines since the second quarter of 2016. On first glance, this may seem like bad news. But it is much better than the 4 percent drop forecast on March 31, or even the 2.3 percent drop expected at the start of May. Plus, analysts expect earnings growth to be positive for the rest of the year. This growth should help bolster equity performance going forward.

Although fundamentals were supportive during the month, technical factors were another story. All three major U.S. indices ended May below their respective 200-day moving averages. In fact, the S&P 500 and Nasdaq dropped below the trend line on the last day of the month. This drop is a warning signal for U.S. markets. A prolonged dip below the 200-day moving average can indicate deteriorating investor sentiment and serve as a headwind for future performance.

The international story was much the same, as global trade concerns affected markets across the world. The MSCI EAFE Index fell by 4.80 percent during the month, and the MSCI Emerging Markets Index declined by 7.22 percent. Here again, technical factors were not supportive. Both indices spent most of May below their respective trend lines.

This was an especially disappointing month for developed international markets. The MSCI EAFE Index spent April above its 200-day moving average. This marked the first full month above the trend line for the index in more than a year. But the move below the trend line in May indicates that investors are still cautious about international investing.

Fixed income markets had a better month than equities. Here, investors rotated away from riskier asset classes and into investment-grade bonds. Yields fell during the month, with the 10-year Treasury falling from 2.52 percent to 2.22 percent. This drop led the Bloomberg Barclays U.S. Aggregate Bond Index to a gain of 1.78 percent in May, as bond values typically increase when rates drop.

High-yield fixed income had a challenging month. This space is less driven by rate movements and more correlated with equities. In May, risk-averse investors favored higher-quality sectors of the fixed income market. The Bloomberg Barclays U.S. Corporate High-Yield Index declined by 1.19 percent during the month.

Economic data a mixed bag
The economic data released in May was a mixed bag. We saw improvements in consumer sentiment and spending. But we also saw lowered business optimism and investment amid concerns over the ongoing trade wars. Despite the varying results, the economy continued to show growth.

Consumers were the major bright spot during the month. Rising confidence led to increased spending. The University of Michigan consumer confidence survey hit a 15-year high at midmonth before moderating at month’s end. Plus, the Conference Board’s measurement of consumer confidence showed better-than-expected improvement.

Solid employment results helped bolster consumer sentiment. The 236,000 new jobs added in April drove the unemployment rate down to a 50-year low of 3.6 percent. Wage growth also remained healthy, with a 3.2 percent year-over-year increase.

Rising consumer confidence led to better-than-expected spending growth. Personal spending rose by 0.3 percent in April. This increase was supported by 0.5 percent growth in personal income over the same period. To be sure, consumer spending is very important to the economy. As such, it will be important to watch whether improvements in confidence can continue to translate into more spending.

Businesses feel weight of the trade wars
Worries over trade wars with China and Mexico drove much of the negative data released in May. Businesses especially began to feel the effect of these continued trade disputes. The Institute for Supply Management (ISM) Manufacturing and Nonmanufacturing indices both fell during the month. As a result, the ISM composite index of business sentiment dropped to its lowest level since October 2016 (see Figure 1).

Figure 1. ISM Composite Index, May 2010–April 2019

chart

Declines in business sentiment were echoed by decreased business investment. Durable goods orders in April fell by 2.1 percent, which was worse than expected. Revisions to March’s orders also showed weakness. The slide in April was due to a decline in aircraft purchases. Industrial production also disappointed. Lowered utility production and a drop in manufacturing led to an overall decline of 0.5 percent.

Net international trade, which was a surprise tailwind for first-quarter growth, reversed course. The trade deficit widened from $49.4 billion to $50 billion in March. This increase was driven by imports increasing faster than exports. Economists expect that this deficit widened further in April, as the escalating U.S.-China trade war likely slowed export growth.

As mentioned, May’s data had mixed results. But the improvement in consumer sentiment and spending is likely to outweigh the concerns around the business sector. Here, it is important to note that consumer spending makes up more than two-thirds of the economy. Despite the trade-related headwinds in the business sector, improvement in spending should help keep growth going.

Economy withstands rising political risks
As we have seen time and again, political risks can have a direct effect on markets. They generate uncertainty and, therefore, short-term volatility. In fact, political risks drove much of the instability across markets in May. Here, the escalation of the U.S.-China trade war and the surprise announcement of a 5 percent tariff on all Mexican goods were the main culprits.

Developments in May gave rise to a heightened level of worry. Now, markets are priced for more bad news. This pricing sets them up for more declines if the trade situation deteriorates. It also creates an opportunity for a recovery if tensions ratchet down. Of course, there is no telling what will happen with trade developments over the next few months. But the fundamentals suggest growth will continue. This growth should help support markets and provide the foundation for a recovery if the trade tensions do resolve.

Big picture remains positive
Last month’s decline reminds us that although market volatility can create pain in the short term, the big picture in the U.S. remains positive. Consumers continue to be confident and willing to spend. These factors should help boost growth throughout the year. Companies are expected to show improving fundamentals. Finally, even with the declines seen in equities, markets are still positive year-to-date and remain well above December lows.

There are risks out there, especially politically. Nonetheless, the U.S. remains economically resilient and continues to show signs of growth. All in all, May was a bad month for markets. But it is quite possible that it was just that—a bad month—and not the beginning of a larger negative trend.

As always, a well-diversified portfolio and a long-term view toward investing remain the best way to meet financial goals in an unpredictable world.

Co-authored by Brad McMillan, managing principal, chief investment officer, and Sam Millette, fixed income analyst, at Commonwealth Financial Network.

All information according to Bloomberg, unless stated otherwise. 

Disclosure: Certain sections of this commentary contain forward-looking statements based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking 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 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, non-investment-grade, fixed-rate, taxable corporate bond market. Securities are classified as high-yield if the middle rating of Moody’s, Fitch, and S&P is Ba1/BB+/BB+ or below.

Market Update for the Quarter Ending March 31, 2019

Strong March caps great start to the year
For the third month in a row, all three major U.S. equity markets were positive for the month. The Nasdaq Composite led the way with a return of 2.70 percent, and the S&P 500 grew by 1.94 percent. Meanwhile, the Dow Jones Industrial Average (DJIA) came in with a gain of 0.17 percent, held back by Boeing. The three indices finished the quarter in the same order, with gains of 16.81 percent for the Nasdaq, 13.65 percent for the S&P 500, and 11.81 percent for the DJIA.

Despite this strong performance, market fundamentals worsened during the first quarter. According to FactSet, the estimate for first-quarter earnings growth for the S&P 500 stood at 2.9 percent at the end of 2018. As of quarter’s end, this estimated earnings growth had fallen to a loss of 3.9 percent. This weakening of company fundamentals was widespread. In fact, all 11 sectors showed declines in estimates over the course of the quarter.

Fundamentals drive performance over the long term. But over the short term, weakening fundamentals do not necessarily mean that markets will suffer losses. In fact, over the past 20 quarters, this marks the 15th time that market values have increased while earnings estimates have declined. Further, analysts still expect positive earnings growth for the next three quarters and for the year. This growth should continue to support markets.

From a technical perspective, the news was good. All three major U.S. indices spent much of January and parts of February below their respective 200-day moving averages. Still, they ended the quarter above this important technical level. The S&P 500 and Nasdaq fell below their trend lines briefly in March before rebounding into month’s end.

International markets also had a strong month and quarter. The MSCI EAFE Index, which covers developed economies, gained 0.63 percent for the month and 9.98 percent for the quarter. The MSCI Emerging Markets Index was up by 0.86 percent for March and 9.97 percent for the quarter. Technicals here were also positive at quarter-end. Both indices finished the period above their respective trend lines.

Even fixed income markets had a steady start to 2019. The Bloomberg Barclays U.S. Aggregate Bond Index gained 1.92 percent for the month and 2.94 percent for the quarter. Here, yields declined, pushing capital values up. The 10-year U.S. Treasury yield started the quarter at 2.66 percent and finished the period at 2.41 percent.

High-yield bonds, which are typically less influenced by rate movements, also had a positive start to the year. The Bloomberg Barclays U.S. Corporate High Yield Index gained 0.94 percent in March and 7.26 percent for the quarter. The asset class benefited from lower rates and lower-risk spreads, which dropped during the quarter after a large increase at year-end.

Economic growth slows—but continues
The decline in bond yields was due to a slowdown in growth across the economy. Only 20,000 new jobs were added in February, for example, against expectations for 180,000. This low figure may have been payback for a stronger-than-expected January. Or it may be a sign that job growth is slowing. As you can see in Figure 1, employment growth grew at an increasing rate to end 2018 before falling in 2019.

Figure 1. Employment Growth, 2012–2019

Similarly, consumer confidence reversed its recent bounce to trend lower. This decline might also be a sign that the economy is weakening. A strong jobs market is one of the major drivers of consumer confidence. As such, recent weakness here may be a worrying signal.

With weak job growth and a slide in confidence, it was no surprise that consumer spending growth also pulled back. January’s personal spending report showed modest growth of 0.1 percent. But this result was less than the expected 0.3 percent and not enough to offset a decline of 0.6 percent in December. Of course, the government shutdown to start the year has delayed some data. Still, the major measures of consumer spending also disappointed in the first quarter. Retail sales in February fell by 0.2 percent, against expectations for a modest increase.

While consumer confidence had mixed results during the quarter, business confidence showed improvements. The Institute for Supply Management Manufacturing and Nonmanufacturing indices, which measure producer sentiment, showed rebounds following declines in December and January.

Business investment showed growth to start the year. Durable goods orders increased by 0.3 percent in January. This increase followed 1.2-percent growth in December and 1-percent growth in November. Businesses confidence appears to have rebounded from the year-end turbulence. Spending also continues to grow, although below the levels of 2018.

Fed responds to slowdown
At its December meeting, the Federal Reserve (Fed) indicated that two rate hikes in 2019 were likely. But in response to weaker data, the Fed has since made a large turnabout in policy. At its March meeting, the Fed suggested that no further rate hikes are expected this year. Plus, it said it will end its balance sheet runoff activities in 2019. These moves left policy more stimulative than had been anticipated. Market participants have taken this updated guidance to heart. In fact, some have even projected a rate cut in the fourth quarter.

Of course, slower growth is still growth. Although the data is weak, there is reason to hope for a rebound in the second quarter. Some of this weakness may have been seasonal. First quarters have been weak over the past several years, only to rebound. So, the next couple of months will be important.

The risks are subsiding
Although the economic risks remain, they may be receding. To start, we avoided a second government shutdown. This likely played a part in the rebound in business confidence. Further, housing market concerns, although still present, have diminished somewhat. Lower mortgage rates made buying a house more affordable, leading to increases in new and existing home sales. Existing home sales were especially encouraging, with 11.8-percent month-over-month growth in February.

International risks have also receded for the time being—although they could reemerge. The ongoing Brexit negotiations appear to be deadlocked. The United Kingdom is not providing much clarity as it works toward avoiding a no-deal exit from the European Union. On the bright side, the United Kingdom and the European Union extended the deadline for a no-deal Brexit from March 29 to April 12. So, there is still time for a potential trade deal. A slowdown in Chinese growth also has the potential to affect markets. But, once again, this is more of a medium- to long-term concern than a pressing risk.

A new risk on the radar is the inversion of the yield curve, which occurred at month-end. After the Fed announced an easing of monetary policy, yields on long-term government debt were driven down. This move left longer-term interest rates lower than shorter-term ones. When this happens, it is known as a yield curve inversion and typically signals a higher risk of recession. Although this inversion garnered a lot of headlines, the risk is more for 2020—not 2019. It needs to be watched but not worried about just yet.

Strong quarter starts year off right
As we have discussed, risks remain both at home and abroad. But U.S. markets showed their resilience in the first quarter. Economic growth appears to have slowed, but slow growth is still growth. Earnings growth in the first quarter was disappointing. Here, there may be room for upside, given analysts’ positive estimates for the rest of the year.

Conditions are not bad and may well improve as confidence and spending have room to catch up to 2018 levels. Further, lowered interest rates are generally supportive of faster growth. We can see this in the increases in home sales when mortgage rates declined in February.

The real takeaway from the drop at the end of 2018 and the rebound to start this year is that volatility can happen quickly. The past six months highlight the importance of creating well-diversified portfolios that can withstand short-term volatility.

Co-authored by Brad McMillan, managing principal, chief investment officer, and Sam Millette, fixed income analyst, at Commonwealth Financial Network.

All information according to Bloomberg, unless stated otherwise. 

Disclosure: Certain sections of this commentary contain forward-looking statements based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking 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 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, non-investment-grade, fixed-rate, taxable corporate bond market. Securities are classified as high-yield if the middle rating of Moody’s, Fitch, and S&P is Ba1/BB+/BB+ or below.