Market Insight - July 2017
The second quarter of 2017 was bookended by a messy House vote on healthcare in April, and a fumbled deferral of the Senate’s healthcare vote in June. Has the smooth path from healthcare reform, through tax reform, through infrastructure investment, to 3-4 percent GDP growth become rocky, uneven, and unreliable? Despite legitimate concerns that stock gains based on that tax reform could dissipate, and an administration battered by infighting and plunging approval ratings, markets found more than adequate inspiration elsewhere.
Large U.S. company stocks, as measured by the Dow, added over 8% for the year-to-date, while the broader market measure of the S&P 500 rose 8.4%. The NASDAQ outperformed other indices, gaining 14%, although the second quarter ended with a nasty selloff, as skittish investors took profits and rotated out of technology. It was the best first half year for the S&P since 2013, and the best first half for the NASDAQ since 2009. Smaller stocks, measured by the Russell 2000, rose 4.29%, while the mid-cap biotechnology index (IBB) added more than 17%. A more hopeful outlook for the Eurozone economies and a slightly weaker dollar helped international investors to outsized gains this year; the MSCI international developed market index gained 12.8% year-to-date, while emerging markets added more than 18%.
While the stock rally was broad-based, with over 70% of the S&P 500 positive, not all sectors participated equally. The telecommunications sector lost 13%, and energy stocks fell 14%, battered as expectations of higher oil prices from OPEC production cuts did not materialize. Oil ended the quarter at $43 per barrel, down more than 20% from its February highs. On the plus side, all thirty-four of the US “too big to fail” banks passed their stress tests in June, and the banking and financial sector surged at quarter end, adding 6% for the year.
The placid and benign stock market of 2017 could be a casualty if there are disappointments here.
In the near-term, markets will be focused on second quarter earnings and revenue. Investors are not only counting on a continuation of strong year-over-year earnings growth to keep up with increasingly elevated stock market valuations, but now expect these earnings to be driven by real, top line gains in sales and revenue, and not simply cost cutting. While consensus projections for earnings growth, first projected at 15.4% in April, have been dialed down to 7.9% for the second quarter, they still set a considerable higher bar than over the past two earnings seasons. The placid and benign stock market of 2017 could be a casualty if there are disappointments here. We have been rebalancing and taking some gains in large cap U.S. and international equities, to maintain a more moderate balance in this well priced market.
The Fed has completed four rate hikes since December 2015, yet rising short term bond yields have not rattled the stock market, nor have they triggered a collapse in bond prices, as inflation expectations remain moderate. While short term rates are up, the yield on the 10-year U.S. Treasury benchmark bond has fallen to 2.38%. flattening the yield curve. Credit markets remain skeptical of the future of tax and infrastructure stimulus, and continue to price in low inflation and more modest growth expectations.