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July 2017
SUMMARY: The stock market rally continued into the second quarter, but the bond market started to
flash warning signals that years of central bank monetary accommodation may be ending. Despite profittaking in some high-flying tech stocks in late June, NASDAQ finished the first half with a 14.7% return,
well ahead of 2016’s full-year return of less than 9%. Both the Dow and S&P have returned 9.3% so far
this year. Foreign stocks continued to outperform their American counterparts in dollar terms as the
greenback lost ground against rival currencies. The Federal Reserve raised interest rates again in June,
while the European Central Bank hinted that it may soon join the Fed in tightening monetary policy.
Despite some profit-taking in high-tech stocks in June, U.S.
equities had solid positive returns in the second quarter,
boosting their year-to-date 2017 returns well above the
pace they set last year. The tech-heavy NASDAQ continued
to be the U.S. market leader this year, returning 4.2%, including
dividends, in Q2, despite a 0.9% decline last month. Year-todate, the index is up 14.7%, well ahead of its 8.9% return last
year. The Dow Jones Industrial Average returned an even 4%
in the quarter after climbing 1.7% in June, while the S&P 500
gained 3.1% for Q2 after adding another 0.6% last month;
both blue-chip indexes returned 9.3% in the first half. Smallercap stocks, which were the market leaders in 2016 by a wide
margin with 20%+ returns, continued to lag the big-cap indexes,
although they did some catching up last month. The S&P 600
small caps index rose 3.0% in June, pushing it into the green
for the quarter, when it returned 1.7%, and for the year to date,
where it is up 2.8%. The S&P 400 mid-caps are up a respectable
6.0% YTD, after gaining 1.6% last month and 2.0% in Q2.
S&P 500 Sectors
Even after losing 2.7% in June, info tech stocks remained
the best-performing sector in the S&P 500 so far this year.
The sector is up 17.2% YTD following the second quarter’s
4.1% increase. Health care stocks have started to catch up
of late, gaining 4.6% in June and 7.1% in Q2 to boost their
first-half returns to 16.1%, making them the second-best
performing category. Financials were the best performers in
Prepared for GREENFIELD SAVINGS BANK by Wright Investors’ Service
Global Investment Returns
In U.S. Dollars
Q 2 2017
S tocks
B on ds
U.S.
C an ada
M exico
Japan
P acific ex Japan
A u stralia
C h in a
H on g K on g
Europe
F ran ce
G erm an y
Italy
N eth erlan ds
S pain
S w itzerlan d
U .K .
World
W orld ex U .S .
2.9%
0 .6 %
7 .2 %
5.2%
1 .5 %
-1 .9 %
1 0 .6 %
7 .2 %
7.4%
9 .1 %
6 .4 %
8 .9 %
7 .8 %
7 .9 %
9 .0 %
4 .7 %
4.0%
5 .6 %
1.4%
3 .0 %
2 .6 %
-0.8%
1 .5 %
1 .7 %
0 .8 %
N /A
7.0%
8 .3 %
5 .4 %
8 .2 %
5 .8 %
8 .5 %
4 .0 %
3 .0 %
2.6%
3 .5 %
Trailin g 1 2 M on th s
S tocks
B on ds
17.3%
1 1 .7 %
1 2 .0 %
19.2%
1 9 .4 %
1 8 .3 %
3 2 .2 %
2 3 .8 %
21.1%
2 8 .1 %
2 8 .7 %
3 0 .9 %
2 8 .2 %
3 8 .4 %
1 6 .5 %
1 3 .3 %
18.2%
1 9 .5 %
-0.3%
-2 .5 %
4 .1 %
-12.3%
0 .7 %
2 .0 %
-3 .0 %
N /A
0.6%
0 .9 %
-1 .9 %
1 .7 %
-1 .7 %
N /A
-1 .1 %
-2 .1 %
-2.2%
-3 .8 %
S ourc es : M S C I S toc k & B loom berg B arc lays B ond Indexes as of 6/30/2017
June, rising 6.4%, pushing them into the green for the quarter
(+4.2%) and the year (+6.9%). Following Donald Trump’s
election to the presidency last November, financials were the
biggest beneficiaries of the expectations of a lighter regulatory
environment and higher interest rates. More recently, however,
some of the steam has gone out of the sector as the Republicans’
pro-growth legislative agenda has stalled. In June, however, all
34 of the largest American banks received a passing grade in
the Federal Reserve’s stress-tests and approval of their plans
to return billions of dollars to shareholders in the form of fatter
dividends and stock buybacks. The six largest banks alone plan
to distribute nearly $100 billion to their investors over the next
year or so.
Telecommunications and energy stocks remained the worst
performers among the S&P’s 11 sectors, the only two with
negative returns so far this year. Telecoms lost an even 7.0%
in Q2 after declining nearly 3% last month, lowering their firsthalf return to minus 10.7%. Energy stocks are down 12.6% so
far this year after falling 6.4% in the quarter and a slight decline
in June. Despite promises by some OPEC members to reduce
production, the price of oil has yet to find a bottom. U.S. crude
ended the quarter at about $46 a barrel, down more than 14% so
far this year and 9% just in the second quarter, its lowest level
in nearly a year.
Foreign Stocks
Foreign stocks continued to outperform their American
counterparts in 2017, largely due to a weak U.S. dollar. The
MSCI Europe ex U.K. index, which largely covers the euro
zone, gained 8.4% in dollar terms in the second quarter despite
a 0.8% decline in June, boosting its YTD return to 17.5%.
While stocks in the zone have benefitted from the region’s
recent positive economic performance, the drop in the dollar
has been the biggest boost for U.S. investors. The dollar has
declined 8% against the euro so far this year, nearly 7% just in
Q2. The euro closed the first half at $1.14, up from $1.05 at the
end of last year and its highest level against the greenback in
more than a year.
In Asia, Chinese stocks have been the best performers, largely
due to a soaring Hong Kong market. The MSCI China index
has returned nearly 25% so far this year after gaining more than
10% in the second quarter. Chinese stocks got a further boost
in late June after MSCI said it will be adding China A shares to
its emerging market index, which Moody’s Investors Service
said “will pave the way for global capital inflows” into Chinese
equities. The MSCI emerging markets index was up 18.4% in
dollar terms in the first half after climbing 6.3% in Q2. Japanese
stocks returned nearly 10% in the first half, with more than half
of the gain coming in Q2. The dollar has declined nearly 4%
against the yen so far this year.
Bonds
Bonds had positive returns in the second quarter and first half
but started to weaken late in June amid growing signs that
central bank monetary accommodation is slowly receding.
European Central Bank President Mario Draghi merely hinted
that the ECB may be thinking about starting to tighten monetary
policy in the near future, setting off a fairly major global selloff
of sovereign bonds. Here in the U.S., the Fed raised short-term
interest rates by 25 basis points at its June monetary policy
meeting, its third rate increase since last December. Both the
Bloomberg Barclays U.S. Bond Market Aggregate and its global
aggregate fell 0.1% in June. The U.S. index returned 1.4% in
the second quarter and 2.3% in the first half, while the global
aggregate, ex U.S., has returned 3.5% and 6.1%, respectively,
largely due to the weaker dollar. At the same time, the Treasury
yield curve has flattened out to its narrowest levels in several
years, which some analysts believe signals a future recession.
At the end of June, the yield differential between the two-year
and the 10-year U.S. Treasury notes had tightened to 92 basis
points compared to 113 bps at the end of the first quarter. In
commodities, gold dropped 2.3% in June and 0.4% in Q2, but
maintained a nearly 8% positive return for the first half.
U.S. Economy
Following a weak first quarter, the U.S. economy showed
few signs of picking up speed in Q2. First quarter GDP was
revised higher but still came in at a tepid annual growth rate
of just 1.4%. Moving into the second quarter, the Fed’s Beige
Book covering most of April and May said that “a majority
of districts reported that firms expressed positive near-term
outlooks; however, optimism waned somewhat in a few
districts.” The Chicago Fed’s national activity index fell back
into negative territory in May at -0.26%, down from the prior
month’s upwardly revised reading of positive 0.57. Durable
goods orders fell a deeper-than-expected 1.1% in May, the
biggest decline in six months; core capital goods, a crucial
measure of business investment in new equipment, fell 0.2%.
Industrial production was unchanged, also less than expected,
after increasing by 1.1% the prior month; manufacturing,
the biggest component, fell 0.4%. On a positive note, the
Institute for Supply Management’s indexes both rose in June:
the manufacturing index jumped nearly three points to 57.8,
well above forecasts, while its nonmanufacturing index, which
covers most of the economy, rose a half point to 57.4.
The Consumer
Consumer spending indicators have been particularly
weak. Despite a 0.4% gain in personal incomes, consumer
spending rose a modest 0.1% in May after rising by 0.4% in
each of the two previous months. Retail sales fell 0.3%, the
biggest one-month decline since January 2016, mainly due to
cheaper gasoline prices but also weaker auto and restaurant
sales. Indeed, auto industry reports continue to show signs that
the boom in car sales is over. Both GM and Ford both reported
5%+ declines in sales in June while J.D. Power and Associates
said overall industry sales for the first half were down about
2% compared to the same period last year. But not all consumer
indicators were bad. Consumer confidence indexes at the end of
June remained strong. The Conference Board’s index rose more
than a point to 118.9 in June, well above expectations, while the
University of Michigan’s consumer sentiment index ended the
month at 95.1, up about a half-point from the prior month. And
while consumer spending may have fallen, the personal savings
rate rose in May to 5.5%, its highest level in eight months.
Housing
Housing indicators have been uneven, but the overall
trend shows the market losing steam, mainly due to higher
prices. Sales of existing homes rebounded 1.1% in May to an
annual rate of 5.62 million, after falling 2.5% the prior month,
with the median sales price rising 3.2% to $252,800, a record
high. Sales of newly-built homes rose 2.9% to an annual rate
of 610,000, even as the median sales price jumped 11.5% to
$345,800, also a record. But pending home sales, a forward
indicator, fell 0.8% in May, their third monthly drop in a row.
“This third consecutive decline in contract activity implies a
possible topping off in sales,” said Lawrence Yun, the National
Association of Realtors’ chief economist. “Prospective buyers
are being sidelined by both limited choices and home prices
that are climbing too fast.” Housing starts fell 5.5%, their third
straight monthly decrease, while permits were down by nearly
5%. Construction spending was flat, led by a 0.6% decline in
residential spending.
Jobs
While the unemployment rate has fallen to 4.3%, a 16year low, job growth remains weak and uneven. The
economy added just 138,000 jobs in May, nearly 50,000 below
expectations, while the previous two months’ figures were
downwardly revised by 66,000 jobs. Meanwhile, the labor
participation rate fell to 62.7% and the annual growth rate in
average hourly earnings slipped to 2.5%.
Inflation
Inflation, which had been showing signs of holding near the
Fed’s target of 2% annually, has receded the last few months.
Consumer prices fell 0.1% in May while producer prices were
unchanged. The Fed’s preferred inflation measurement, the
personal-consumption expenditures index, fell 0.1%, while the
core index, which excludes food and energy, rose 0.1%, but just
1.4% on a year-to-year basis, well below the Fed’s target.
Investment Outlook
The Fed’s decision at its June meeting to raise interest
rates for the third time since last December – and the bond
market’s subsequent, if belated, reaction to it – might
lead one to believe that the end of central bank monetary
accommodation has arrived. If that’s the case, it might also
be argued that the end of the eight-year bull market in stocks
and bonds may also be in sight. After all, few could argue that
massive amounts of central bank asset purchases – chiefly
government securities – and eight years of zero percent shortterm interest rates haven’t played a huge – if not the main – role
in driving equity and fixed-income prices to where they are
today. The late June rise in long-term bond rates and the profittaking in tech stocks are evidence to some that we have reached
the peak, or are at least getting a lot closer to it than at any point
since the bull runs began. The fact that the ECB may now be
ready to join the Fed in tightening provides further proof that a
correction may be coming.
But the recent economic performance of the major economies
doesn’t necessarily support that belief. As we’ve seen above,
U.S. economic growth remains basically at stall speed, where it
has lived through most of the past eight years of recovery. The
optimism brought on by Donald Trump’s election has, at least
so far, turned out to be a head fake, as the Republican agenda
to lower taxes and reform the regulatory environment has been
mired in politics. The fact that growth in the euro zone has now
surpassed that of the U.S. should give us pause about how strong
the American economy really is. Outside of the unemployment
rate and some manufacturing statistics, U.S. economic growth
doesn’t appear to be much stronger than it was a few years ago.
As a result, the Fed seems more divided now than at any
time in recent years, so further monetary tightening is
hardly a given. It’s true that Minneapolis Fed President Neel
Kashkari, who wanted to keep rates unchanged, was the lone
dissenter at the Fed’s June 13-14 meeting to raise the federal
funds rate. Since then, however, he’s been joined by several
other voting members on the Fed’s monetary policy committee
who have expressed misgivings about that move. Charles Evans,
the head of the Chicago Fed, said the Fed “could wait until the
end of the year” before raising rates again due to weak inflation
reports, while Dallas Fed president Robert Kaplan said, “I’d like
to see now a confirmation in the data that the recent weakness
in March, and to some extent April and May, was transitory,”
before voting for another rate hike. That may have been a dig
at Fed Chair Janet Yellen, who after the June meeting cautioned
that “it’s important not to overreact to a few readings, and data
The U.S. Economy 2015–2018
% C h an ge In
E n d of P eriod R ates
R eal
G DP*
PCE
C ore
D eflator*
P rofits
from
#
O peration s
9 0 -D ay
T-B ills
1 0 -Tear
T-N otes
2015
Q1
Q2
Q3
Q4
2 .0 %
2 .6 %
2 .0 %
0 .9 %
1 .1 %
1 .8 %
1 .4 %
1 .2 %
3 .8 %
0 .2 %
-3 .2 %
-3 .7 %
0 .0 %
0 .0 %
0 .0 %
0 .2 %
1 .9 %
2 .4 %
2 .0 %
2 .3 %
2016
Q1
Q2
Q3
Q4
0 .8 %
1 .4 %
3 .5 %
2 .1 %
2 .1 %
1 .8 %
1 .7 %
1 .3 %
-4 .2 %
-4 .2 %
-2 .7 %
0 .3 %
0 .2 %
0 .3 %
0 .3 %
0 .5 %
1 .8 %
1 .5 %
1 .6 %
2 .4 %
2017
Q1
Q2 e
Q3 e
Q4 e
1 .3 %
3 .0 %
2 .4 %
2 .4 %
1 .8 %
1 .6 %
1 .6 %
1 .8 %
5 .7 %
1 0 .5 %
1 2 .5 %
1 4 .7 %
0 .8 %
1 .0 %
1 .5 %
1 .6 %
2 .4 %
2 .3 %
2 .5 %
2 .7 %
2018
Q1
Q2
Q3
Q4
2 .2 %
2 .4 %
2 .2 %
2 .2 %
1 .8 %
2 .0 %
2 .0 %
2 .0 %
1 5 .6 %
1 4 .8 %
1 5 .9 %
1 4 .3 %
1 .8 %
2 .0 %
2 .2 %
N /A
2 .8 %
2 .9 %
3 .0 %
N /A
e
e
e
e
e : B lo o m b e rg C o n s e n s u s E s tim a te s ; *: A n n u a l R a te s ; # : Y e a r-O ve r-Y e a r C h a n g e in S & P6 0 0 E PS
S o u rc e s : B lo o m b e rg L P, W rig h t In ve s to rs ' S e rvic e
on inflation can be noisy.” The minutes of that meeting also
showed a division among Fed members about when the central
bank should start unwinding its $4.5 trillion bond portfolio, built
up from less than $1 trillion since 2008. “Several” members
wanted to start the process “within a couple of months,” while
“some others” favored “deferring the decision until later in the
year,” the minutes said.
Indeed, the Fed should probably be more worried that the
economy is too weak rather than it’s too strong, as some
members seem to think. While we don’t necessarily subscribe
to it, there has been a growing chorus of analysts warning that
the economy may be at risk of falling into a recession, claiming
that the recent flattening of the yield curve provides historic
evidence of such an eventuality. Yet at the same time, some
members of the Fed seem overly worried that the job market
may be “overheating,” which seems equally far-fetched given
the huge number of underemployed and weak personal earnings
growth. The bottom line is that we’re not out of the woods yet,
so we can expect easy monetary policies – maybe not stimulus,
but accommodation – to be around for a while. That bolsters the
continued case for holding a well-diversified portfolio of highquality financial assets.
July 2017
Copyright © 2017 by Wright Investors’ Service, Inc., 177 West Putnam Ave., Greenwich, CT 06830-5203. All Rights Reserved. Except for quotations
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shown to those of such indexes may be of limited use. Past performance is not indicative of future results.
QIR-2017.06.30