The More Things Change, the More They Stay the Same
By John Stoltzfus,
Chief Investment Strategist
Markets Seek Their Muse
With U.S. stocks at or near record highs corporate earnings and interest rates remain key to market progress
A combination of mixed economic data, an overall good start to Q2 earnings season, historically low market volatility, along with monetary policy by the Federal Reserve that persists more thoughtful and measured than disruptive to the markets has resulted in positive returns for stocks stateside and abroad in the first two weeks of July.
Two weeks into the month as of last Friday the S&P 500, the S&P 400 (mid-caps), the Russell 2000 (small-caps) stood respectively 1.5%, 1.1% and 0.95% higher than where they started the quarter.
In the same period major international equity benchmarks moved higher with MSCI EAFE (Developed Markets ex-US and Canada), MSCI Emerging Markets and MSCI Frontier Markets advancing 1.9%. 3.6% and 0.98%, respectively.
With the dollar down year to date through last Friday against all of the G10 currencies and broadly lower against 19 of 24 emerging market currencies, prospects remain good for US multinationals’ earnings on the visible horizon.
Both US and international stocks have benefited from a moderate process of rate normalization stateside and expectations for rate normalizations abroad to tack similarly when they occur.
Stateside the 10-year Treasury yield (at 2.33% last Friday) stood lower than from where it started the year (at 2.45%) and off from its recent high of just under 2.4% reached in the first week of July.
When Fed Chair Janet Yellen reported to members of congress last week her message reflected the Federal Reserve’s outlook for inflation to rise gradually and for the Fed to remain committed to a policy of interest rate normalization.
June Consumer Price Index data released last Friday (the day after Fed Chair Yellen completed her testimony to the Senate’s Banking committee) showed that US consumer prices had slowed to a 1.6% rate of growth in the 12 months ending June, down from 1.9% in May. The core CPI, which excludes food and energy, was unchanged at 1.7%.
The softening in the non-core number caused some investors and commentators to temper their expectations for further rate hikes this year.
“A combination of accommodative monetary policy along with trends cyclical and secular tied to technology and globalization have in our view created an economic expansion that is prone to deliver sluggish rather than robust growth.”
The CPI figures showed continued weakness in pricing power across a range of goods and services for a fourth straight month. The softness in the latest numbers appeared to be fairly broad and occurring in cyclical segments of the economy including autos, which have felt the impact of a large number of vehicles coming off leases this year as well as the effects of rising prices while wage growth remains stalled.
Fed Funds futures showed investors’ expectations for rate hikes in September and December had declined as of last Friday to 10.1% and 43.4%, respectively, from 16.1% and 51.9% the prior Friday.
We continue to anticipate at least one more rate hike before the end of this year based on our expectations for continued positive (though modest) economic growth.
Volatility in economic data near term can be caused by numerous factors including technicalities in reporting as well as the effects of seasonality. Data often is adjusted in the periods that follow their initial release.
It is our view that the latest CPI number is not indicative of a broad-based longer-term deceleration of economic reflation but rather more likely illustrative of yet another of many “mid-cycle slowdowns” that the economy has experienced over the course of a protracted process of economic recovery that has transitioned into the current economic expansion.
A combination of accommodative monetary policy over the past eight and a half years along with trends cyclical and secular (longer term) tied to technology and globalization have in our view created an economic expansion that is prone to deliver sluggish rather than robust growth.
We suggest that in such an environment investors remain committed to their goals and objectives, right size their expectations, practice patience and avoid being whipsawed by near-term upticks in volatility. Near-term retracements and pullbacks that could develop from catalysts likely to appear from time to time should be used to identify risks and opportunities and for investors to act accordingly.
We continue to believe that near-term risks appear broadly greater in bonds than among stocks as prospects for revenue and earnings growth look favorable driven by economic fundamentals at the same time that the Federal Reserve remains committed to the normalization of interest rates and considers reducing the size of its balance sheet.
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