Market Update for the Month Ending October 31, 2019

More treats than tricks for markets in October
October was another positive month for markets. Diminishing risks helped drive equity markets near all-time highs. The S&P 500 gained 2.17 percent in October and finished the month at a new record high. The Dow Jones Industrial Average grew by 0.59 percent in October, while the Nasdaq Composite led the way with a 3.71 percent return.

These positive results were supported by better-than-expected earnings during the month. According to Bloomberg Intelligence, the anticipated third-quarter earnings decline for the S&P 500 is 2.1 percent, with 60 percent of companies reporting as of October 31. This is up from estimates of a 3.2 percent decline at the end of September. Further, improvements are widespread, with 8 of the 11 sectors performing better than expected. Fundamentals drive long-term market performance, so this improving third-quarter earnings picture is encouraging. Technicals were also supportive for U.S. markets. All three major indices spent the month above their respective 200-day moving averages, despite some early volatility.

Results were also strong internationally, as receding risk of a “no deal” Brexit buoyed markets. The MSCI EAFE Index increased by a strong 3.59 percent during the month. Emerging markets fared even better, as the MSCI Emerging Markets index climbed 4.23 percent. Technical factors were mixed, however. The MSCI EAFE spent the beginning of October below its 200-day moving average before breaking above the trend line for the rest of the month. Emerging markets took longer to break above the trend but managed to finish the month above this important technical level for the first time since July.

Even fixed income had a solid month, as the Federal Reserve (Fed) cut the federal funds rate by 25 basis points at its October meeting. This marks the third straight meeting where the Fed has cut interest rates, as concerns surrounding lackluster job growth and slowing global trade continue to weigh on board members’ minds. Interest rates rose slightly on the long end of the curve. The 10-year Treasury yield started the month at 1.65 percent and ended at 1.69 percent. The Bloomberg Barclays U.S. Aggregate Bond Index increased by 0.30 percent during the month, and the Bloomberg Barclays U.S. Corporate High Yield Index gained 0.28 percent.

Economic data points to slower growth
The positive returns we saw in October came despite recent data releases that painted a picture of slower overall growth. Annualized third-quarter gross domestic product growth came in at 1.9 percent. This result was down from the 2 percent growth seen in the second quarter and the 3.1 percent growth seen in the first quarter. While slowing overall growth is disappointing, economists had forecast a larger drop to 1.6 percent, so there is some reason for optimism here. This result was driven by stronger-than-expected consumer spending, which offset a slowdown in government spending and business investment.

Consumer spending will likely be the major driver of economic growth in the fourth quarter, as business confidence and spending continue to disappoint. Manufacturer confidence has declined sharply throughout the year, hitting a 10-year low in September. We also saw a decline in the nonmanufacturing sector, which accounts for the lion’s share of economic output. After rebounding in August, the Institute for Supply Management (ISM) Nonmanufacturing index fell to 52.6 in September. The ISM composite index, which aggregates the manufacturing and nonmanufacturing indices, has fallen sharply since reaching a high point in September 2018, as uncertainty from trade wars and various political developments have weighed on business-owner confidence.

Figure 1. ISM Composite Index, 2009–Present

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With business confidence declining, it’s no surprise that spending was lackluster as well. Durable goods orders fell by 1.1 percent in September, against expectations for a more moderate decline of 0.7 percent. Industrial production fell 0.4 percent, and manufacturing output fell 0.5 percent. The General Motors strike may be to blame for some of this decline. But the overall trend points toward continued weakness in business confidence and spending for the immediate future.

Consumer confidence rebounds as spending continues
With markets near or at all-time highs and the unemployment rate near a 50-year low, it is not surprising consumer confidence rebounded in October. The University of Michigan consumer sentiment index increased from 93.2 in September to 95.5 in October. Overall, things are going pretty well for consumers, and higher confidence levels should help drive continued spending growth.

In fact, consumer spending increased by 0.2 percent in September, marking the seventh straight month of growth. This result was supported by a 0.3 percent increase in personal income, which has grown in each of the past 12 months. Solid income growth indicates that the personal spending growth we have experienced this year is sustainable.

The housing sector, likewise, has shown positive momentum following a weak start to the year. Existing home sales fell slightly in September. On a year-over-year basis, however, they rose by a healthy 3.9 percent. We have seen year-over-year growth in housing sales for the past 3 months, following 16 straight months of year-over-year declines. The continued growth in housing is encouraging given the effect it can have on other sectors of the economy. And while high consumer confidence and strong balance sheets are certainly factors in this housing turnaround, the Fed deserves some credit too. Mortgage rates have dropped near two-year lows, as the central bank continues to cut rates and support the ongoing economic expansion.

Political risks shift in October
We entered October with concerns about the escalating trade war between the U.S. and China, as well as the risk of a “no-deal” Brexit. Both of these risks receded during the month, however. Plans for a preliminary U.S.-China trade deal are now on the table, and another extension of the Brexit deadline was announced, this time to January 31, 2020. Markets reacted favorably to these receding risks, but new concerns have emerged to take their place.

Domestically, the impeachment inquiry highlights the very real risk impeachment presents to markets. With public hearings set to begin this month, growing uncertainty may cause volatility. Earlier in the month, a surprise withdrawal of U.S. troops from portions of Syria also seized headlines. Markets quickly shrugged off this development, however.

Internationally, new risks have emerged as well. The British elections are now set for mid-December, as the U.K. and the European Union continue to hammer out a Brexit deal. And if trade war tensions ratchet back up or the protests in Hong Kong increase in intensity, we may see additional market volatility.

Short-term risks remain, but fundamentals are solid
Despite politically driven uncertainty, economic fundamentals remain solid in the U.S. While growth appears to be slowing from earlier in the year, slower growth is still growth. Rebounding consumer confidence and continued strong consumer spending indicate the economy is in a better place than the headlines suggest. If business confidence and spending can follow suit, the economy would be poised for accelerated growth.

There are still very real risks out there, however—the ongoing impeachment inquiry in particular. While short-term volatility may be likely given the political risks, the strong fundamentals should continue to support markets. As always, a well-diversified portfolio that matches investors’ goals can provide the best path forward in these uncertain times.

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 Quarter Ending September 30, 2019

Positive month for markets caps off turbulent quarter

U.S. markets had a positive September, which helped offset volatility earlier in the quarter. The S&P 500 returned 1.87 percent in September and 1.70 percent for the quarter. The Dow Jones Industrial Average performed better, with a 2.05 percent monthly gain and quarterly growth of 1.83 percent. The Nasdaq Composite lagged, with a 0.54 percent monthly gain, taking the index to a 0.18 percent gain for the quarter.

These positive results for the month came despite worsening fundamentals. According to Bloomberg Intelligence (as of September 30, 2019), the S&P 500 is expected to show a year-over-year earnings decline of 3.2 percent for the third quarter. This result is down from the 3 percent decline forecast at the end of August. Although the estimates are negative, earnings season will kick off in earnest midmonth. As such, we’ll have a better picture of the actual results next month. Looking forward, analysts expect 3.3 percent growth in the fourth quarter. This growth could likely help support further market gains. From a technical perspective, all three major U.S. indices were supported, spending the entire month above their respective 200-day trend lines.

International stocks had a strong September. But the month’s positive results did not offset volatility seen earlier in the quarter. The MSCI EAFE Index gained a solid 2.87 percent in September but still had a quarterly loss of 1.07 percent. Emerging markets also gained during the month, at 1.94 percent, but showed a drop of 4.11 percent for the quarter. In both developed and emerging markets, rising political concerns and slowing growth figures weighed on investors.

Technicals were mixed for international stocks. The MSCI EAFE Index for developed international markets fell below its trend line at the start of the month. Still, it recovered and spent the rest of the month above trend. Emerging markets were another story. Here, the index spent the majority of the month below the trend line. September marks the second straight month in which technicals for emerging markets have been a headwind.

Finally, fixed income markets had a tough month. Whipsawing interest rates created volatility, despite the Federal Reserve’s move to cut the federal funds rate by 25 basis points at its September meeting. The 10-year Treasury yield started the month at 1.47 percent. It then rose to a midmonth high of 1.90 percent and finished the period at 1.67 percent. This result is down from the 2.03 percent yield seen at the beginning of the quarter.

The Bloomberg Barclays U.S. Aggregate Bond Index declined by 0.53 percent during the month, on higher rates during that time period. But it rose by 2.27 percent during the quarter, as rates went down. High-yield bonds, which are less affected by interest rate changes, had a better month with a gain of 0.36 percent. This move led the high-yield index to a 1.33 percent gain for the quarter.

Headlines hit markets, but not much
In September, there were many headline-grabbing events. For example, the drone attack on Saudi Arabian oil facilities took out an estimated half of Saudi production capacity. It was a major news story that touched on many sensitive geopolitical concerns. Still, there was no sustained impact on U.S. equity markets. Oil prices did spike as high as 20 percent immediately following the attack. But they ended September well below midmonth highs, as the U.S. and Saudi governments committed to tapping reserves and prioritizing repairs at the damaged facilities. Further, oil prices remain well below levels seen a year ago, and markets seemed to shrug off this event.

The continuing U.S.-China trade war and the slow and steady march toward Brexit also made news in September. The escalated trade war hurt markets in August, but neither story had much influence on markets in September. On the trade war front, new negotiations between the U.S. and China are scheduled for October. This announcement helped drive up equity markets at the beginning of the month. Unfortunately, this bump didn’t last long, as the S&P 500 ended the month below post-announcement highs.

Threats of a no-deal Brexit from British Prime Minister Boris Johnson drove international market volatility in August. But in September? The impact of Brexit on international markets was minimal. Here, developments have moved swiftly over the past month. The British Parliament and Johnson are trying to negotiate a trade deal with the European Union before the October 31 deadline. This situation may be a source of future volatility, especially for internationally developed markets.

Economic fundamentals withstand the risks
The political risks continued to draw attention in September. Nonetheless, many economic releases came in better than expected, with consumer spending continuing to play a key role. August’s retail sales figures beat expectations. Here, we saw 0.4 percent growth against expectations for a 0.2 percent increase. This result marks the sixth straight month of retail sales growth. Consumers have been driving the economic expansion for the past two quarters.

Much of this spending growth appears to be sustainable, which is encouraging. Personal income grew by 0.4 percent in August, which marks the eighth straight month of income growth. There is also some evidence that the tight jobs market is leading to faster wage growth. Indeed, August’s employment report showed wages up 0.4 percent on a monthly basis. Wage growth over the trailing three months is currently at its highest annualized rate in 11 years. This growth bodes well for future consumer spending.

Another key area of strength was the housing sector. It showed solid growth for the second straight month. In September, homebuilder confidence increased to an 11-month high. Here, strong homebuyer demand and low mortgage rates boosted sales. In fact, both new and existing home sales grew by more than expected in August. Existing home sales were especially impressive, with August marking the second straight month of year-over-year growth. As illustrated in Figure 1, existing home sales have struggled to show any year-over-year growth over the past two years. So, these back-to-back solid months are very encouraging.

Figure 1. Existing Home Sales, September 2014–August 2019

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Now, let’s move from the consumer to the business side of the economy. Nonmanufacturer confidence saw a solid rebound in August. The service sector accounts for the lion’s share of economic output. So, this result helped calm fears of a slowdown in the service sector and was a very good development. There was even a positive surprise for the manufacturing sector. Manufacturing output rose by a strong 0.5 percent in August, despite a drop in manufacturer confidence during that time.

Beware the risks ahead
Despite the positive fundamentals, risks remain that could have a dramatic effect on markets. Domestically, the beginning of impeachment proceedings at month-end will likely lead to a contentious election cycle. Of course, the direct economic impact from impeachment proceedings is difficult to forecast. But the uncertainty of this situation will likely weigh on consumer and business confidence and spending. Slowing job growth and declining consumer confidence figures are also areas to watch. Both could lead to lowered spending and economic growth.

Abroad, the ongoing U.S.-China trade war and Brexit have the potential to affect markets. As we saw in September, there is no telling what will happen with these politically sensitive issues. Plus, there is no guarantee that markets will react to new developments as expected.

Risks can hit markets at any time. When looking at the sheer number of them, it seems likely that one or more of the recent stories will disrupt markets in the near future. October is known to be a difficult month for markets, which has elevated the concerns.

Even if we do see a pullback, there is still a lot to like about the U.S. economy. These economic strengths should help cushion any market downturn. Consumer spending growth has been healthy this year, and there are few signs of a slowdown in the immediate future. The rebound in service sector confidence and manufacturing output also indicates that the fundamentals may be more resilient than they seem. Again, this strength could help protect against any short-term disruptions.

Ultimately, volatility is possible and may even be likely over the next few months. But the healthy U.S. economic background should help calm fears of a sustained downturn if and when we face market turbulence. As always, a well-diversified portfolio combined with a long-term view toward investing remains the best way forward in an uncertain 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 August 31, 2019

Turbulent month for markets
August was a rough one for stocks, with all three major U.S. indices declining during the month. The Dow Jones Industrial Average (DJIA) fell by 1.32 percent, while the S&P 500 lost 1.58 percent. The Nasdaq Composite suffered the heaviest losses, finishing the month down 2.46 percent. Still, things could have been worse. With periods during the month where markets fell by as much as 4 percent to 6 percent, a bounce back at month-end helped stave off larger declines.

Despite the volatility, fundamentals improved in August. According to Bloomberg Intelligence, S&P 500 earnings grew by 2.2 percent in the second quarter. This result was up from the 0.8 percent estimated growth rate on July 31 and was driven by strong earnings growth in the health care and communication sectors. As we know, fundamentals drive long-term performance. So, the growth in the second quarter is encouraging.

From a technical perspective, all three major U.S. indices finished the month above their respective 200-day moving averages. The S&P 500 and Nasdaq Composite both spent the month above their trend lines. But this was not the case with the DJIA. It fell below its 200-day moving average for two days midmonth. The index recovered, although it came close to breaching its trend line again the following week. A sustained drop below the 200-day moving average could mean a shift in investor sentiment for an index. As such, it was a positive sign that the DJIA was able to recover both times it neared its trend line.

International markets also had a volatile August, as political concerns weighed on investors. The MSCI EAFE Index fell by 2.59 percent. Here, negative developments surrounding Brexit and a slowdown in key eurozone countries caused uncertainty. Emerging markets had an even worse month. The MSCI Emerging Markets Index fell 4.85 percent. Slowing growth figures from China and political uncertainty in South America contributed to the index’s decline. Technicals were also not supportive for international stocks. Both indices spent most of the month below their 200-day moving averages.

On a brighter note, investment-grade fixed income had a strong month. Investors flocked to the relative safety of high-quality bonds, driving prices up and yields down. The 10-year Treasury yield started the month at 1.90 percent and declined to 1.50 percent by month-end. This drop helped the Bloomberg Barclays U.S. Aggregate Bond Index return 2.59 percent for the month. High-yield bonds also had a solid month. The Bloomberg Barclays U.S. Corporate High Yield Index returned 0.40 percent in August.

Political risks take center stage
Political developments dominated the headlines in August. Let’s start with the continued escalation of the U.S.-China trade war. The month started with an announcement from President Trump of a new 10 percent tariff on $300 billion of imports from China. Then, the U.S. labeled China a “currency manipulator.” This move was in response to the yuan-dollar exchange rate climbing above 7 yuan to the dollar for the first time since 2008. China answered by announcing its own tariffs on select U.S. goods and halting all purchases of U.S. agriculture by Chinese companies.

The escalation of the U.S.-China trade war was a big story, but it wasn’t the only one. President Trump continued his attacks on the Federal Reserve (Fed) and Chairman Jerome Powell. The president questioned whether the Fed should be more aggressive in cutting interest rates. Further, markets were rattled when President Trump tweeted that American companies should remove themselves from China. He also asked whether Powell or Chinese President Xi Jinping was a “bigger enemy.” Finally, there were growing Brexit risks to consider. The prospect of Great Britain crashing out of the European Union without a deal hit international markets hard. Of course, this move would affect Europe the most. But markets around the world sagged on fears of what this departure might mean for global growth.

Economy continues to grow
To be sure, political headlines knocked down markets in August. Still, the U.S. economic picture remained positive, driven by continued strength in consumer spending. July’s retail sales figures came in much better than anticipated. Here, we saw 0.7 percent growth against expectations for 0.3 percent. Core sales came in even better, with 0.9 percent monthly growth. After suffering a slowdown at the end of 2018, consumer spending was a major driver for second-quarter growth. As such, these strong results are encouraging for economic growth in the third quarter.

Strong consumer spending in the second quarter led to economic growth that was better than expected. The first estimate of second-quarter gross domestic product growth came in at 2.1 percent on an annualized basis. This result is down from the 3.1 percent pace we saw in the first quarter, but it is higher than consensus estimates for a 1.8 percent growth rate. Personal consumption, which grew at a 1.1 percent annualized rate in the first quarter, jumped to a 4.3 percent growth rate in the second quarter.

Spending was supported by high consumer confidence levels. The Conference Board Consumer Confidence Index fell from 135.8 in July to 135.1 in August. Given market volatility, this result was better than economists expected. Plus, it is a very high level historically. As you can see in Figure 1, consumers were especially optimistic over the current state of the economy. The present situation part of the index hit levels last seen in the boom of the late 1990s.

Figure 1. Consumer Confidence Present Situation Index, 1999–2019

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Another positive sign could be found in consumer sentiment and spending. Strength here was enough to bring back signs of life to the housing market. For the past two years, housing growth has been disappointing. Rising prices and lack of supply in some regions have limited sales. But July’s existing home sales report provided some hope for housing growth. It showed sales increased on a year-over-year basis for the first time since February 2018. Lower rates likely played a part in this increase in sales, as mortgage applications jumped in June when rates fell in May.

Of course, it is too early to say whether housing growth is here to stay. But this increase was a positive development. Housing is an area of the economy that has a large effect on growth, due to the spending related to buying a home. Going forward, we may be poised for further housing growth. Indeed, we saw another spike in mortgage applications in August as rates fell.

Business data a mixed bag
Consumer data was strong for the month, but businesses were not as confident. The Institute for Supply Management (ISM) Manufacturing and Nonmanufacturing indices declined during the month. Here, trade-related uncertainty weighed on business confidence. July’s industrial production report highlighted manufacturers’ worries over trade. Manufacturing output fell by 0.4 percent during the month. This drop led industrial production to a 0.2 percent loss, against expectations for a slight gain. Unless trade tensions diminish and international demand for U.S. goods returns, it may be difficult for manufactures to grow at higher rates.

Confidence and production were down during the month, but durable goods orders were better than expected. This proxy for business investment came in with 2.1 percent month-over-month growth in July. Still, this news wasn’t as positive as it appears. Much of this growth was due to an increase in volatile aircraft orders. Core durable goods orders, which strip out transportation orders, fell by 0.4 percent. This result indicates that the month’s decline in business confidence may have slowed business spending and investment.

Risks remain but fundamentals are solid
As we saw in August, politics and headlines can hurt markets in the short term. But a solid economy can cushion those declines, and there is a lot to like about the U.S. economy. Despite the uncertainty created by volatile trade developments, consumer confidence and spending levels remain high. At more than two-thirds of the economy, consumer spending is the most powerful factor in the economy. It can continue to power the economic expansions here at home. The return to year-over-year growth in existing home sales is just one example of this.

Looking forward, one of the primary areas of concern will be the unresolved nature of the U.S.-China trade war. We will want to keep a close eye on the impact that uncertainty may have on business confidence and spending. Recently, consumers have been able to keep the economy rolling. But there may be a limit to how much they can do, especially if we see a large drop in consumer confidence. So, an acceleration in business spending would be a welcome development.

Abroad, the looming Brexit deadline and slowing growth in the eurozone could lead to volatility. British Prime Minister Boris Johnson’s attempts to shut down Parliament highlight the type of contentious developments we can expect from that process.

Here at home, the 2020 presidential cycle continues. The Democratic field is being narrowed down before the Democratic primary elections. Given the polarized nature of political discourse in this country, these elections may become a source of future volatility.

As we’ve seen many times this year, volatility can strike suddenly and be caused by a variety of factors. Given the risks discussed here, it is likely that we will see further volatility this year. But even if we do, the fact that the fundamentals of the economy remain solid should help serve as a cushion against any stumbles. As always, a well-diversified portfolio and a long-term view toward investing remain 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 July 31, 2019

Positive July for U.S. markets
Markets had a solid start to the third quarter, with all three major U.S. indices showing gains for July. The S&P 500 returned 1.44 percent during the month, the Dow Jones Industrial Average rose by 1.12 percent, and the Nasdaq Composite gained 2.15 percent.

This positive performance was supported by better-than-expected earnings results. According to Bloomberg Intelligence, companies in the S&P 500 have been outperforming analyst estimates for the second quarter. As of July 31, with 60 percent of companies reporting, year-over-year earnings growth sits at 0.8 percent for the quarter. This result is much stronger than the 2.2 percent decline that was forecast at the start of earnings season in mid-July. Ultimately, fundamentals drive long-term market performance, so this positive surprise for the second quarter is encouraging.

Technicals for all three major U.S. indices were supportive during the entire month of July. All three indices stayed well above their respective 200-day moving averages.

Although U.S. markets had a positive July, international markets pulled back. The MSCI EAFE Index declined by 1.27 percent. Here, concerns surrounding a slowdown in global trade worried investors. The story was much the same for emerging markets. The MSCI Emerging Markets Index was down 1.14 percent for the month. Technicals for both developed and emerging markets remained supportive. In fact, July marks the second straight month that both indices finished the month above their respective 200-day moving averages.

Fixed income had a solid month. The Bloomberg Barclays U.S. Aggregate Bond Index returned 0.22 percent in July. Interest rates declined on the short and long ends of the curve during the month, driving this appreciation. The 1-month Treasury started the month at 2.17 percent and fell to 2.01 percent by month-end. The 10-year Treasury, on the other hand, started July at 2.03 percent and finished with a yield of 2.02 percent.

These declines were driven by the Federal Reserve’s (Fed’s) decision to cut the federal funds rate from a high of 2.50 percent to a high of 2.25 percent at its July meeting. This marks the first time the Fed has cut rates since December 2008. At his postmeeting press conference, Fed Chairman Jerome Powell indicated that future rate cuts are possible—but not guaranteed.

High-yield fixed income also had a positive month. The Bloomberg Barclays U.S. Corporate High Yield Index returned 0.56 percent in July. High-yield spreads declined slightly during the month. Still, they remain well above the lows we saw for much of 2018. As the Fed shifts to a more supportive role for risk assets, there is a chance that spreads could continue to decline going forward.

Consumer spending drives economic growth
In general, the economic data released in July came in better than expected. It showed growth picking up in key areas of the economy. Consumer spending data was especially positive, with 0.7 percent growth in June’s core retail sales. This result capped off a strong quarter for consumer spending, which helped calm fears of a slowdown in economic growth.

Strong consumer spending in the second quarter led to economic growth that was better than expected. The first estimate of second-quarter gross domestic product growth came in at 2.1 percent on an annualized basis. This result is down from the 3.1 percent pace we saw in the first quarter, but it is higher than consensus estimates for a 1.8 percent growth rate. Personal consumption, which grew at a 1.1 percent annualized rate in the first quarter, jumped to a 4.3 percent growth rate in the second quarter.

Increasing consumer confidence supported consumer spending during the month. The Conference Board Consumer Confidence Index was especially impressive. It jumped from 124.3 to 135.7 in July. This is the single largest monthly increase in more than seven years. The index now sits near highs last seen in late 2018, as you can see in Figure 1.

Figure 1. Conference Board Consumer Confidence Index, 1999–2019

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A combination of factors was behind this increase in consumer confidence, but one of the primary drivers was the strong June jobs report. There were 224,000 new jobs added in June, against expectations for 160,000. The underlying data was solid as well. Annual wage growth came in at 3.1 percent, and unemployment remained near 50-year lows.

Potential areas of concern remain
Although consumer confidence and spending growth data came in stronger than expected, it was a different story for businesses. The Institute for Supply Management Manufacturing and Nonmanufacturing indices both declined during the month. In fact, the Manufacturing index fell to two-year lows. These drops show slowing global trade is starting to affect business owner confidence. Despite the declines, both indices remain in expansionary territory. Going forward, we are unlikely to see accelerated manufacturing growth in the second half of the year, unless trade picks up notably.

Although business confidence declined during the month, business spending data was a bit more mixed. Durable goods orders rose by 2 percent in June, beating expectations for 0.7 percent growth. This surprising increase was welcome, but it follows a 1.3 percent decline in orders in May. Despite the uptick in June, business investment declined for the quarter. As such, this will be an important area of the economy to watch going forward.

Another key area of the economy to keep an eye on is housing. Existing home sales fell by 1.7 percent in June, against expectations for a more modest decline of 0.4 percent. This marks the 16th straight month of year-over-year declines in existing home sales. There had been some hope for faster sales growth due to declining mortgage rates and a surge of mortgage applications in May. Unfortunately, those hopes failed to materialize in the face of rising prices and lack of supply in some regions.

Shifting policy risks
There were many policy and political updates in July. Here in the U.S., the major story was the Fed’s decision to cut the federal funds rate by 25 basis points at the end of the month. This measure, combined with the early end of the Fed’s balance sheet reduction plan, indicates that the Fed is becoming more supportive of the economy. With lowered interest rates, borrowing costs should decrease for individuals and businesses. In turn, reduced costs should lead to faster growth going forward.

Another key development was the compromise reached by Congress and the White House to pass a budget increasing government spending and suspending the debt ceiling for the next two years. The passage of this bill was a positive outcome for markets as it eliminated a potential source of politically motivated uncertainty for the time being. Further, it prevented another government shutdown as we head toward the 2020 election cycle.

Internationally, the risk of the UK leaving the European Union without a trade deal increased. Theresa May stepped down as leader of the British government. She was replaced by Boris Johnson. A vocal proponent for Brexit, Prime Minister Johnson has stated that he will lead the British exit from the EU by the October 31 deadline, whether there is a trade deal in place or not. Currently, neither side is showing signs of backing down, so this could be an ongoing source of volatility for international markets over the next few months.

Steady economic growth in the face of global slowdown
Risks remain both abroad and at home, but the economic picture is positive. Better-than-expected economic data released during the month shows that American consumers are still willing and able to spend, despite a slowdown in global economic activity. With improving fundamentals, a supportive Fed, and the passage of the budget and debt limit compromise bill, markets could continue on the upward march that we’ve seen for much of the year.

With that being said, there are still potential areas of concern that should be watched. The slowdown in global trade is starting to affect business confidence and could have an even larger effect on markets going forward. Political risks can also pop up at any time. As always, a well-diversified portfolio that pairs an investor’s goals and time horizon is the best path forward in this uncertain 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 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.