Global markets post solid results in July
Financial markets around the globe rose in July. U.S. equity markets reached new highs, as the S&P 500 Index gained 2.06 percent, the Dow Jones Industrial Average rose 2.68 percent, and the Nasdaq Composite surged 3.42 percent. On a technical basis, all three indices remained well above their 200-day moving averages.
Fundamentals improved substantially in July, with earnings growth coming in well above expectations. According to FactSet, 57 percent of S&P 500 companies have reported earnings as of July 28. Nearly three-quarters of them have seen higher-than-expected sales, as well as earnings well above typical levels. Given this strong performance, second-quarter earnings growth is currently at 9.1 percent—well above the 6.5-percent growth expected at the end of June. A number of companies have yet to report, so actual earnings growth could rise even higher.
International markets likewise had a strong start to the third quarter. The MSCI EAFE Index rose 2.88 percent for the month. The MSCI Emerging Markets Index performed even better with a 6.04-percent gain. Both indices benefited from strong economic performance at the country level, as well as from continued central bank stimulus. Diminishing global risks and stabilizing oil prices also helped. The indices were supported by strong technical factors as well, with both remaining above their 200-day moving averages for the period.
Turning to fixed income, July was a solid month. The Bloomberg Barclays Aggregate Bond Index gained 0.43 percent, as rates on the long end of the curve declined slightly with the Federal Reserve’s (Fed) decision to keep short-term rates unchanged. Although the decision was in line with expectations, markets interpreted the Fed’s comments as dovish, which pushed rates down.
Finally, high-yield fixed income also fared well in July, with the Bloomberg Barclays U.S. Corporate High Yield Index rising 1.11 percent. As has been the case for most of the year, spread compression and strong energy sector results drove much of this performance.
Economic growth heats up
The major theme for July was continued global growth. Here in the U.S., we saw the first estimate of second-quarter gross domestic product (GDP) growth, which rose to 2.6 percent annualized, up from 1.4 percent in the first quarter. The improvement was widespread, with gains in personal consumption, business investment, and exports.
Second-quarter growth was also strong overseas, with positive results from the eurozone, the U.K., and China. Capital Economics, an independent macroeconomic research firm, estimated that global growth rose from 3.2 percent in the first quarter to 3.7 percent in the second. Central banks continued stimulative policies, which benefited economies, but there were also signs of faster organic growth, suggesting that a self-sustaining recovery may be underway. We have not seen this kind of synchronized growth since the financial crisis, so it is a very positive sign.
Business sector gains strength
Given the acceleration of growth in the second quarter after a weak first quarter, can we expect the trend to continue, as has been the case in previous years? Recent data suggests that we just might.
Strong business sentiment remains a positive factor. The ISM Manufacturing and Nonmanufacturing indices increased more than expected for the month. The former hit a 34-month high, and the latter is nearing two-year record levels. Both are well into the expansionary zone, at levels that historically have been associated with GDP growth of more than 3 percent.
In addition to high levels of business confidence, we saw better-than-expected business investment figures. Durable goods orders, which are often used as a proxy for business investment, did well. The headline number for June was up 6.5 percent on increased aircraft purchases. The core figure, which excludes volatile aircraft orders, improved by 0.2 percent. There were also significant positive revisions to the May numbers.
Industrial production was up as well, by 0.4 percent, capping the strongest quarterly increase in three years. Growth was widespread, with mining, manufacturing, and utilities output all expanding in the second quarter. Going forward, continued strength from industrial production could help reinforce second-half growth.
Consumer data mixed but still mainly positive
Although business data was strong, consumer data was more mixed, with strong sentiment figures offset by weaker-than-expected hard data.
Consumer confidence remains high, recently ticking back up after a small pullback. Both major consumer sentiment measures—the Conference Board’s and the University of Michigan’s—beat expectations during the month. In fact, the Conference Board measure reached its second-highest level in 16 years.
Confidence has been driven largely by low gas prices, rising housing prices, and, in particular, a healthy job market. The July employment report was positive, with 209,000 jobs created. In addition, the June jobs report was revised upward from 222,000 to 231,000. Beyond the headline, the underlying data was even more positive. Both the workweek and wage growth increased from May, and workers continued to return to the workforce.
Despite these results, consumer confidence has failed to translate into faster spending growth. Retail sales data for June was actually down by 0.2 percent, against expectations for modest growth. Although the level of decrease may be small, the fact that this measure has not accelerated along with confidence and income growth indicates that this important sector of the economy bears monitoring.
Housing showing signs of potential slowdown
Housing numbers have been healthy for some time. A surprising decline in a recent survey, however, indicates that this sector may be in for a slight slowdown. The National Association of Home Builders industry confidence survey dropped to 64 in July, against expectations for a modest increase to 67. The index remains in expansionary territory, however. Plus, the decline can be blamed mainly on higher material costs, rather than lack of demand for housing.
Housing sales data was mixed. Existing home sales decreased slightly, while new home sales increased in line with expectations. The decline in existing home sales was due in large part to low levels of supply. Offsetting that, though, was the fact that both housing starts and permits increased much more than expected during the month. More worrying is an ongoing decline in affordability, as price increases are outpacing wage gains. Going forward, the major theme to watch in the housing sector will be the intersection between high demand and low supply.
Political risks still the primary focus
Despite some areas that bear watching, the real economic and market risks at the moment are political. Of particular concern is whether Congress will raise the debt ceiling before the government runs out of money, which is currently estimated to occur at the end of September. Failure to pass an increase in a timely fashion has the potential to seriously disrupt markets, so we will be watching this closely. The potential for tax reform could have a more positive effect—but first we need to get past the debt ceiling debate.
Internationally, North Korean missile tests are the major concern, though at this point, they remain an outlier. Other international risks have largely receded, though, of course, they could flare up again.
Sunny skies, but watch the clouds
With synchronized global growth and positive economic news, not to mention strong corporate financial performance, the markets may well continue to rise. But we also need to keep an eye on the risks, including high valuation levels and political uncertainty. As always, a well-diversified portfolio that is in line with your desired levels of risk and return remains the best path forward.
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.
Authored by Brad McMillan, senior vice president, chief investment officer, and Sam Millette, fixed income analyst, at Commonwealth Financial Network®.
© 2017 Commonwealth Financial Network®