July 09, 2017
Monthly Market Summary – June 2017
Much has been said recently by market commentators and investment strategists about the unusual period we are in where most major world economies are experiencing improving economic conditions. These commentators have been referring to this as synchronized global growth. Indeed, there have been a considerable amount of encouraging economic and corporate profit reports around the world. In fact, there has been enough economic improvement that various central bank officials recently made comments suggesting that the era of extraordinary stimulus measures that have been in place since the financial crisis may be starting to end. These central bank comments rattled global equity, bond, and currency markets in the second half of the month. Key indications that the stimulus measures are likely to be reduced came from the U.S, the European Central Bank (ECB), the Bank of England (BOE), and the Bank of Canada (BOC). In a show of confidence in the U.S. economy, the Federal Reserve Open Market Committee (FOMC) continued to execute its plan for a gradual increase in interest rates despite a recent down tick in inflation. The FOMC raised the federal funds rate as expected by 0.25% to a range of 1%-1.25%. The FOMC surprised market participants by announcing an updated plan for shrinking the Federal Reserve’s balance sheet which was increased significantly during the FOMC’s quantitative easing program. The balance sheet reduction plan includes gradually reducing the reinvestment of maturing Treasury and mortgage-backed security holdings. A specific start date for the plan was not given only an indication that the plan would begin this year. ECB president Mario Draghi stated that the ECB sees no need for further interest rate cuts and signaled that it may be time to consider ending the ECB’s quantitative easing program. Officials from the BOE and BOC hinted that they may raise interest rates before year-end.
Market Indices – June 2017
The major U.S. equity index returns we track were mostly positive for the month of June with only the S&P 500 Growth index posting a very small negative return. Stock prices generally trended higher in June with the Dow Jones Industrial Average, S&P 500, NASDAQ, and Russell 2000 index of small capitalization (cap) stocks all setting new record highs. However, importantly, in mid-month there was an abrupt sell-off in the large technology company stocks that had been the top gainers for the year-to-date, such as Alphabet, Facebook, and Apple. The sell-off in the technology stocks continued through month-end resulting in the technology sector posting the lowest return in the large, mid, and small-cap indices. The sell-off probably was due to investors locking in profits and moving into stocks with lower valuations. One of the areas investors rotated into was the financials sector which had been lagging most other sectors for the first five months of the year. The financials sector also had a boost from the results of the Federal Reserve’s capital adequacy review of banks (stress test). Investors were happy to hear that most major banks received approval to return more capital to shareholders and several banks announced dividend increases and share buybacks. The financials sector had the highest return for the month among large and mid-cap stocks. Healthcare was the top performing sector in the small-cap index and had the second highest return in the large and mid-cap indices. The healthcare sector rose due to a surge in biotechnology and pharmaceutical company stock prices after the Trump administration issued an executive order that indicated the administration will not be as tough on drug pricing as expected. Energy was again the poorest performing sector with a negative return in each market cap category. The defensive sectors of consumer staples and utilities also had negative returns for the month. In a noteworthy shift from prior months, the value stock indices outperformed the growth stock indices on the strength of the financials sector and the weakness in technology.
Foreign equity market returns were mixed for June. Emerging markets outperformed developed international markets. The MSCI Emerging Markets (EM) index had a return of 1.0% compared to the return of -0.2% for the MSCI EAFE index of developed international market equities on a U.S. dollar basis. Currency moves had a mixed impact. The U.S. dollar declined against most major developed international currencies which provided a boost to the EAFE index return for U.S. investors. However, the dollar gained against emerging market currencies which caused the EM local currency return to be higher than the U.S. dollar return. Just as in the U.S., value stocks outperformed growth stocks in the EAFE index. However, in the EM index growth outperformed value by a sizeable margin. In contrast to U.S. equity market results, information technology stocks continued to be the performance leaders in both the EAFE and EM index. Energy had the lowest return in both the EAFE and EM indices. Among developed international markets, the Pacific ex Japan region had the best return due to a return of over 5% for New Zealand. Europe was the weakest region for the month despite indices such as the United Kingdom FTSE 100 and Germany DAX hitting record highs early in June boosted by strong capital inflows. Later in the month European equity prices declined in reaction to central bank comments that investors interpreted as signaling the period of record low interest rates and quantitative easing may be starting to end. Japanese equities moved higher on encouraging economic data. For example, the Japanese Ministry of Finance reported that capital spending rose 4.5%, which was more than expected, and first quarter profits increased over 20%. Emerging country results were mixed. Mexico, Taiwan, Turkey, and Greece each posted mid-single digit positive returns which offset negative returns for Russia, Brazil, India, and Chile. China was up 2% in reaction to news such as high growth in exports and imports, stable industrial output, and retail sales growth of over 10%.
The Bloomberg Barclays U.S. Aggregate Bond index had a very small negative return of -0.1% for June as bond yields moved in a tight range during the month. Short-term Treasury bond yields moved up, and prices down, during most of the month in reaction to the FOMC’s decision to raise its federal funds policy rate. Longer-term Treasury bond yields declined early in the month to reach the lowest levels since before the November 2016 election. Yields fell in reaction to some weaker than expected economic reports including the employment and manufacturing reports along with political headlines that created demand for safe haven assets. The benchmark 10-year Treasury bond yield fell to 2.1% during the month but rebounded the last four trading days to reach the high point for the month of 2.31% on June 30. Hawkish comments by ECB President Draghi and technical factors likely contributed to the rebound. For reference, the benchmark 10-year Treasury yield was 2.25% at the end of May and 2.45% at the end of 2016. Corporate bonds outperformed Treasury bonds as improving corporate profits are supporting credit quality.
The Bloomberg Commodity index declined again in June. This was the fourth consecutive month the index has had a negative return. The grains sub-index was the bright spot with a return of over 6% on weather related news. The industrial metals sub-index also had a solid gain of over 3%. Petroleum was the weakest performing sub-index we track as oil prices declined. The price of West Texas Intermediate crude oil dropped to below $43 per barrel during June but rebounded to end the month at $46.04. Oil was $48.32 at the end of May. Both gold and silver declined for the month.
Vogel Consulting, LLC (Vogel) Tactical Recommendations
Most economic data continues to point to stable to improving global economic conditions, which is likely to be generally supportive for corporate earnings. However, with the strong equity markets over recent months, valuations are not cheap. Therefore, we continue to have a neutral view on global equities. Our tactical allocation recommendation remains as an equal weight to the long-term target allocation for U.S., international developed, and emerging markets stocks as well as to U.S. large-cap, mid-cap, and small-cap stocks. We continue to favor equity over bonds so retain our underweight recommendation for fixed income investments. Our underweight recommendation is because the return expectation for bonds is modest due to the low level of yields and the prospects for yields to move higher (and prices lower) if inflation picks-up and the FOMC continues to hike its policy rate as it has suggested. Within fixed income we continue to recommend a focus on short to intermediate term bonds. We also continue to favor non-Treasury bonds for the yield advantage they provide. We continue to favor hedge fund strategies over fixed income for the lower expected volatility portion of portfolios but also recommend an underweight allocation to hedge funds. Since our expectation is for a moderate rate of inflation to continue, we recommend an equal weight to real assets. We would not be surprised if financial markets experience bouts of volatility as more details emerge about any fiscal, monetary, or political policy changes or if there are delays in implementing these actions. Therefore, we continue to recommend using periods of market strength to raise any cash needed to support spending needs over the coming 12-24 months.
The statistical information contained in this commentary has been compiled from publicly available sources and is presented to you for your review and for discussion purposes only. The information contained in this commentary represents the opinion of the author(s) as of its date and is subject to change at any time due to market or economic conditions. These comments do not constitute a recommendation to purchase, sell or hold any security, and should not be construed as investment advice or to predict future performance. Past performance does not guarantee future results.
The statistical information contained in this commentary was derived from sources that Vogel Consulting, LLC believes are reliable, and such information has not been independently verified by Vogel. Russell Investment Group is the source and owner of the trademarks, service marks and copyrights related to the Russell Indexes. Russell® is a trademark of the Russell Investment Group. An index is not managed and is unavailable for direct investment.