Markets Ignore Political Drama
While headlines coming out of Washington continue to sow angst for some, the economy has continued to post a modest but positive rate of growth and the stock market has continued its upward trend established since last Fall's election.The pieces of the jigsaw puzzle that make up the overall economy and markets are largely in place to make for a pretty nice picture, resulting in enough confidence to override other concerns.
Let's take a look at how various indices fared for the past quarter.
|Index||2nd Quarter||2017 Year to Date|
|Dow Jones Industrial Average (the Dow)
|S&P 500 Stock Index (the S&P 500)||+ 2.6%||+ 8.2%|
|NASDAQ Composite||+ 3.9%||+ 14.1%|
|Russell 2000 (small companies)||+ 2.1%||+ 4.3%|
|Dow Jones Global Stock Index (non-US)||+ 4.9%||+ 12.6%|
|10-Year Treasury Bonds||+ 1.5%||+ 2.5%|
|Commodities Index (Reuter-Jeffries CRB)||- 1.9%||- 2.2%|
|U.S. Dollar Index (WSJ Index)||- 2.9%||+ 5.6%|
All index values come from the Wall Street Journal. Stock indices do not include dividend return..
All stock indices--as well as the bond index noted above--rose nicely this past quarter.The positive gains for the first half of the year are already on a par with annual gains that would make most investors happy. The Dow gained over 3% and the tech-heavy NASDAQ gained nearly 4%.Technology stocks have been on a roll and have proven to be the sweet spot in the markets.The more diversified S&P 500 index gained a healthy 2.6%.Small companies--as measured by the Russell 2000 index--also gained ground, but again lagged the larger-stock indices.International stocks had a stellar quarter--clearly outpacing U.S. stocks--following on the heels of an excellent first quarter.The year-to-date gain of this diversified index of international stocks is exceeded only by the gain of the NASDAQ index.In spite of a slight increase in short-term rates by the Federal Reserve Bank (the Fed), intermediate-term bonds--represented by 10-year treasury bonds--experienced modest gains.Market observers have explained this discrepancy as a reaction to reduced inflation expectations and skepticism about economic growth and future rate increases.Commodities fell again this past quarter, led by a whopping decline of 9% in the price of crude oil.The U.S. dollar experienced a noteworthy loss this past quarter, adding to its decline in the first quarter.
In June the Fed raised short term interest rates by another .25% to 1.25%.The Fed treads a fine line between the goal of returning to more normal rates yet avoiding slowing the economy's momentum and stifling gains in employment.Currently, short-term interest rates are still quite low by historical standards.
Where we are now
As mentioned earlier, most of the factors that drive the economy and markets remain positive.The rate of growth of the economy for the first quarter was revised upward to 1.4%.This rate is not as high as desired, but many economists see better growth ahead--though likely not as high as President Trump's hoped-for 3.0%.Inflation remains low.
While interest rates have modestly increased, they are still low enough (and the economy still healthy enough) to stimulate borrowing--an important source of bank revenue.Another positive effect of slight increases to short-term interest rates is that it provides a greater profit margin to banks and brokerage firms as the rates paid to depositors lag the increased earnings the financial firms make on their investment of depositor funds.The difference between what is received and what is paid out is the financial firms' profit.The Fed recently conducted stress tests of 34 of the largest banks in America.All banks passed for the first time since the financial debacle of 2008, allowing banks the freedom to engage in increased dividends and stock buybacks.This also provided a boost to stocks in this sector.
Employment has been a bright spot, with the rate of unemployment (4.3%) at the lowest level in 16 years.While there is some debate about the way the index is calculated, it is clear that those who want jobs and are qualified for jobs can usually find work.Gains in employment have not translated to increased consumer spending.Consumers have tightened their purse strings a bit over the past two months.Traditional brick and mortar stores are generally not doing as well as on-line retailers, as consumers increasingly turn to their computers or mobile phones to shop and buy.As evidence, you can now purchase Sears Kenmore products on Amazon.com!If the negative trend in consumer spending continues, it would place a damper on economic growth.
The remarkable 8-year bull market has lifted stocks to all-time highs.The valuation (or "pricey-ness") of the markets remains modestly high, reflecting the expectation for continued economic growth and its positive effects on corporate profits.Despite the ongoing turmoil in the political arena, market volatility has been very low.One measure of volatility--the CBOE Volatility Index--is often referred to as the "fear gauge".Its current reading is the lowest since 1993. Perverse observers think this may be negative, reflecting complacency of market participants.
For now, it appears we can expect a continuation of the slow economic recovery with low inflation.Market levels support that expectation.The Fed has shared their forecast to raise interest rates once more this year and three times in each of the next two years.This reflects their view of steady economic growth.The Fed will also be modestly reducing its balance sheet--swelled by the 2008 rescue of the financial system--by allowing bonds to mature and not renewing them.If pursued at too fast a pace, the result would put upward pressure on interest rates.Regarding the Fed, there is some speculation that when Chairman Yellen's term expires in February 2018, President Trump will be inclined to replace her with his own pick.This is unlikely to be a market factor this calendar year.
It may be hard to imagine, but the chaos in Washington may increase.The recent inability to pass health care legislation may be followed by struggles to find consensus on other issues including tax reform.If ongoing investigations expose the President, certain family members, and key campaign associates to reprimand, distancing by fellow GOP members could follow. This is something that one can't predict but could roil the markets.
The positive underpinnings of stocks--modest economic growth, solid corporate profits, and low inflation--have remained intact and are expected to remain favorable.Inflation and interest rates are likely to remain relatively low.Earnings releases for the past quarter have included mostly positive news, an indicator of good things to come.International economies will likely continue their positive trends as well.The economy has been more predictable than the news coming out of Washington.Political risk remains high, which could affect consumer spending.Consumer spending accounts for 70% of economic activity.
Please feel free to call with any questions or comments.
Craig S. Limoges CFA, CFP