Market Strategy Radar Screen Weekly June 05, 2017

 Taking Care of Business

US Equity Markets Grind Higher Supported by Economics and Corporate Earnings

The markets turned a potential lemon into lemonade when May’s nonfarm payroll number diverged from expectations last week. Stocks stateside moved higher with the Dow Jones Industrials, the S&P 500 and the NASDAQ Composite closing at new record highs in the week just ended.

Friday’s disappointing non-farm payroll number was taken in stride as investors considered the volatility that can occur in economic data as well as positive offsets from a much better than expected ADP employment number released the day before (253k actual vs. 180k expected jobs added in May) as well as the Bureau of Labor Statistic’s headline unemployment rate at 4.3%—its lowest level in 16 years.

In addition, consumer income and spending data released last week were in-line with widely held expectations and supportive of the thought that Q2 GDP growth could come in at around 3% or even slightly better and substantially improved from Q1’s rather anemic 1.2% GDP growth (revised up last week from an earlier estimate of a 0.7% annualized rate).

As Q1 earnings season neared a close with 495 of 499 companies in the S&P 500 having reported as of last week, earnings are up 14.7% on the back of 7.8% revenue growth (see page 4 of this report for details on Q1 earnings season).

With inflation at modest levels trending more “reflationary” rather than at a worrisomely higher rate of inflation, and with wage growth still modest this far beyond the recovery and into the current economic expansion, the US 10-year Treasury yield closed at a low for 2017 of 2.16% last Friday. The drop in yield from around 2.6% (in mid-March of this year) has generated consternation among those who’d been looking for higher yields on the 10- year Treasury. It’s also caused others to speculate that the 10-year could see its yield fall further to below 2% before the current move is over.

From our perspective the equity and bond rally we’ve experienced thus far in H1 are supported by improving economic fundamentals and corporate earnings that have posted their third straight quarter of positive growth.

With expectations for inflation to remain moderate for the foreseeable future and the potential for Q2 reporting season to add a fourth straight quarter of improving corporate earnings and with medium-term note yields offering very modest competition for investors’ attention, we’d expect that stocks could rise further near term though not in a straight line.

The market’s next leg noticeably higher will likely wait until investors get a sense of just how “improved” earnings will be as Q2 reporting season unfolds.

Last week’s rally may have also gotten a boost from expectations that with economic growth continuing at a modest pace the Fed when it meets on June 14th will be less likely to surprise investors with its decision.

From here ‘til then we’d look for the market stateside to likely either pause and ponder its next move or simply grind a bit higher.

Foreign Stocks Have Their Moment in the Sun

Stocks in the international realm so far this year have given most US equity benchmarks a run for their money with the MSCI EAFE (developed markets ex-US and Canada), MSCI Emerging Markets and MSCI Frontier Markets respectively showing double digit gains in the year to date (see page 7 of this report for performance details).

We continue to recommend that investors consider diversifying their equity holdings globally if they have not yet done so. With the US dollar lower than where it started the year, US multinational companies in the S&P 500 will likely find added tailwind for further gains in the quarters ahead.

That said economic recoveries in the international realm along with relatively favorable forward valuations point to opportunity in owning foreign stocks in both emerging and developed markets in most regions of the world.

In the first full week post the Memorial Day holiday, we look for investors to focus on economic data and the few S&P 500 companies that remain to report results.

A third terrorist attack in the UK this year that occurred on Saturday evening will also likely find investors’ attention diverted as they consider the effects of increased geopolitical risk, political events in Washington D.C., a general election in the UK, and likely continued delays to the process of moving the new administration’s agenda along at the pace that impatient investors might want to see.

For now we will recite the mantra that we have maintained for most of the past eight-plus years, “No boom, no bubble, no bust… we’ll take it.” As investors we’d rather see the stock market grind higher supported by moderate economic growth and persistent improvement in corporate revenues and earnings rather than see it fly like an eagle higher only like Icarus to have its wings melt by the heat of the sun.

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