May 2017 Market Commentary

There was no shortage of volatility-inducing economic and geopolitical events in April. The month began with meetings between President Trump and the leader of China with implications for trade and currencies, followed by weak employment growth, missile and bomb strikes in Syria and Afghanistan, and rising risk of war with North Korea. The month ended with critical French elections, strong corporate earnings releases, weak first-quarter GDP growth, the release of a tax reform proposal, and the first 100-days of the new administration behind us.

At the end of it all, investors looked past current events to future growth prospects, allowing domestic and global equity markets to continue their strong start to the year. The following table contains a summary of April’s market performance:

Index April YTD Index April YTD
S&P 500 (Total Return) +1.03% +7.16% All Country World Index (Net) +1.56% +8.57%
MSCI EAFE (Net) +2.54% +9.97% Barclays Aggregate +0.68% +1.51%
MSCI Emerging Markets (Net) +2.19% +13.88% 60/40 Blend* +1.10% +5.76%

* 60% All Country World Index/40% Barclays Aggregate

 

The positive implications of de-escalating trade tensions between the U.S. and China were quickly forgotten following the U.S. missile strikes in Syria and the release of an unexpectedly weak March job creation report. Non-farm employment rose by 98,000, well below the 180,000 that was forecast. U.S. equity markets fell into negative territory and remained there before rallying in the final days of April on French election results and the release of a tax reform proposal.

A debate broke out within the financial media over the different signals being sent by “soft” and “hard” data about prospects for the economy and markets. “Soft” data such as consumer and business confidence and leading economic indicators all remain at post-financial crisis highs, suggesting an acceleration of U.S. growth in the months ahead. “Hard” data, measuring employment, consumption, and production showed signs of weakness. First quarter U.S. GDP grew at an annualized rate of +0.7%, down from +2.1% in the fourth quarter. Digging into its components reveals that consumption (two-thirds of GDP) grew only +0.3% (down from 3.5% in the fourth quarter of 2016) as car and durable good purchases fell sharply. Production fell by 0.3% as businesses acted to reduce their stocks of unsold goods. An unseasonably warm winter also hurt growth by cutting into spending on utilities. And finally, the dollar’s rise in value in response to post-election views about interest rates hurt exports.

For a variety of reasons, investors appear to be treating this weakness as temporary and are looking to leading indicators of future growth. The first-quarter growth is traditionally the slowest growing quarter each year. In 2016, first quarter growth was less than 1%, but 2.1% for the entire year. While consumption grew slowly, the employment cost index was up +0.8% during the quarter, and 2.6% year-over-year, a post-recession high. This led the Fed to predict a recovery in consumption spending, and predict that second-quarter growth will accelerate to over 3%.

Not to be overlooked as a source of the month’s equity rally is strength in earnings growth. With 58% of S&P 500 companies reporting, the earnings growth rate for the S&P 500 is 12.5% for the first quarter. If that number holds as the rest of companies report, it will be the highest year-over-year earnings growth number since 2011. Of companies that have reported, 77% have beat mean earnings-per-share estimates and 68% have beat mean sales estimates.

Bond markets and interest rates continue to trade in a narrow range as they dissect competing views of growth, inflation and central bank policies. The U.S. 10-year Treasury yield, which began the month near 2.4%, fell to 2.2% on April 18th as disappointing economic reports reduced the market’s expectations of Fed rate hike in June. But by the month’s end, the U.S. 10-year Treasury yield was back to 2.3%, leaving the U.S. yield curve essentially unchanged for the month.

Outside of the U.S., developed market equities rallied late in April over the outcome of the second round of voting in the French Presidential election and its implication for European Union stability. European equities were also supported by the announcement that while downside economic risks were diminished, underlying inflation pressures are weaker than the European Central Bank wants to see before reducing its asset purchases. Emerging market stocks continue to outperform developed market equities, due in part to capital inflows from investors attracted to faster earnings growth, strengthening emerging market currencies and a more attractive risk premium than can be earned on U.S. equities.

The actions of global investors over the last six months suggest a willingness to step into equities on the belief in accelerating growth and improving earnings. Economic recovery and earnings growth within the emerging markets and non-U.S. developed markets is at an earlier stage and at more attractive valuations than in the U.S. This environment is supportive of Caprock’s recommendations for emerging market and non-U.S. developed market equities.

This communication is not an offer or solicitation with respect to the purchase or sale of any security and is for informational purposes only. Information contained herein has been derived from sources believed to be reliable, but Caprock makes no representations as to its accuracy or completeness. Investment in securities involves the risk of loss. Past performance is no guarantee of future returns.