June 20, 2017

Monthly Market Summary – May 2017

Global financial markets were resilient in May and absorbed news about political controversies involving the Presidents of the U.S. and Brazil, terrorist attacks in England and Egypt, and the downgrade of China’s sovereign credit rating. Despite a brief, but sharp equity pullback in mid-month, global equity markets moved higher in May.  Several equity indices hit new record highs during the month including the S&P 500 and NASDAQ in the U.S., the DAX 30 in Germany, and the FTSE 100 in the United Kingdom.  The S&P 500 posted seven new highs during May.  Global bond markets were mostly steady.  The primary area of weakness was in the commodity sector where high supply levels continue to pressure prices.

Major equity indices around the world were trending higher early in the month on strong earnings and economic reports. In mid-month, equity prices turned lower after weak retail company earnings reports, higher than expected producer price inflation in the U.S., and a build-up of uncertainty about President Trump’s ability to move his agenda forward in the midst of the turmoil created by the firing of the FBI director and allegations of dealings with Russia.  Market participants were shaken when on May 17, global equity markets fell sharply.  The S&P 500 dropped 1.8%, which was the largest one-day drop in eight months.  Small-capitalization (cap) stocks declined more – the Russell 2000 index fell over 3%.  The declines were not limited to the U.S.  For example, the Europe Stoxx 600 was down 1.5% and the Japan TOPIX was down 1.6%.  However, markets quickly rebounded and two days later the S&P 500 and NASDAQ had each set another record high.  The rebound was ignited by a much stronger than expected earnings report from Walmart, and was propelled by improving global economic news such as strong manufacturing data out of the euro zone and comments in the Federal Open Market Committee (FOMC) meeting minutes stating that the economy is firm enough that the Federal Reserve (Fed) can begin to unwind its balance sheet that was built up by years of quantitative easing.

Market Indices – May 2017

Growth stocks outperformed value stocks around the world again in May due in large part to the strong gains in information technology stocks and the weakness in energy and financials.  The magnitude of the difference between the year-to-date returns for growth stock indices and value stock indices is significant. For example, the S&P 500 Growth index return for the year-to-date through May 31 is 13.8% compared to the S&P 500 Value index return of 2.9%.  This type of wide dispersion is seen in U.S., developed international, and emerging markets stocks, as well as in large-cap, mid-cap, and small-cap stocks.

U.S. equity index results were mixed for May. The broad large and mid-cap indices had positive returns while the small-cap index declined.  The value indices also declined in each market cap category.  Information technology had the highest sector return regardless of market cap category.  Semi-conductor stocks were among the best performing.  Also, certain technology stocks such as Apple, Facebook and Microsoft hit new all-time highs.  Interestingly, utilities had the second highest return in the large-cap and mid-cap categories as investors turned to defensive stocks amidst the turmoil in Washington D.C.  Energy was the poorest performing sector with a negative return in each market cap category.

Foreign equity market returns were positive for May and outperformed U.S. returns. The MSCI EAFE index of developed international market equities and the MSCI Emerging Markets (EM) index had returns for May of 3.7% and 3.0% respectively on a U.S. dollar basis.  Currency moves provided a big boost to the EAFE index return for U.S. investors as the dollar weakened but only a modest boost for the EM return.  On a local currency basis, the EAFE index had a return of 2.1% and the EM index had a return of 2.5%.  As discussed above, growth stocks outperformed value stocks in the EAFE and EM indices.  Among developed international markets, European countries had the best returns on good earnings reports, improving economic data, and less political uncertainty after the French election.  Among emerging economies, Korea had the best return helped by the strength in information technology stocks.  Russia had the lowest return, which was -6%, hurt by falling oil prices.  Brazil was down 5% as the indictment of President Michel Temer on obstruction of justice charges dampened the prospects for needed reforms that Temer favors.  China was up over 5% even though data reports pointed to a slowdown.  Industrial output and retail sales declined.  The China purchasing managers’ index (PMI) manufacturing component declined for the sixth consecutive month and the services component also declined.

All major sectors of the U.S. bond market had a positive return for the month except inflation protected securities (TIPS). TIPS declined slightly on weaker than expected consumer inflation data.  Corporate and municipal bonds advanced on strong demand even though issuance of new bonds was high.  Longer maturity bonds had the highest returns.  The benchmark 10-year Treasury yield was 2.25% at the end of May, just slightly down from 2.29% at the end of the prior month and down from 2.45% at the end of 2016.

The Bloomberg Commodity index had a negative return for May. This was the third consecutive month the index has had a negative return.  The livestock sub-index has been a bright spot and had another strong month with a return of over 5%.  Energy was the weakest performing sector as oil and natural gas prices declined.  The Organization of Petroleum Exporting Countries (OPEC) agreed to extend production limits for nine months at a meeting in May.  However, crude oil prices moved lower as market participants were disappointed OPEC did not make deeper cuts since global inventory levels are staying high with U.S. crude output increasing.  The industrial metals sub-index was also weak on slowing demand from China.  The precious metals sub-index was little changed from the prior month-end despite a mid-month price drop in both gold and silver.

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. Also, many first quarter earnings announcements from U.S. and non-U.S. companies included upbeat outlooks.  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.