July 2017 Market Commentary

U.S. and global equity markets rose sharply in July on further evidence of sustained global growth, strong earnings performance, a weaker dollar, and new language from the Fed regarding its interest rate policy following weak inflation data. Globally, growth stocks, led by technology, outperformed value stocks. The following table contains a summary of July’s market performance:

Index July YTD Index July YTD
S&P 500 (Total Return) +2.06% +11.59% All Country World Index (Net) +2.79% +14.59%
MSCI EAFE (Net) +2.88% +17.09% Barclays Aggregate +0.43% +2.71%
MSCI Emerging Markets (Net) +5.96% +25.49% 60/40 Blend* +1.87% +10.07%

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

The rally in U.S. equity markets began following comments by Janet Yellen altering the Fed’s language describing recent softness in inflation. Inflation, after reaching over 2% earlier this year on strengthening energy prices has fallen to 1.6% year-over-year. Yellen’s comments express deeper concerns over why wages and inflation aren’t being pushed higher by low unemployment, leading the Fed to question its assumptions about “when and how much” inflation will rise. With lower inflation, Yellen suggested the federal funds rate would not have to rise much to get to a neutral policy level. Investors reacted to the likelihood of the Fed slowing the speed and level of its interest rate tightening by pushing the S&P 500 index 2% higher in the week following Yellen’s comments.

U.S. equity prices also received support from stronger than expected earnings growth. After growing nearly 14% in the first quarter, S&P 500 earnings were expected to grow by about 6% in the second quarter. As the quarter has progressed, companies have reported stronger than expected revenue and earnings growth. Analyst estimates of earnings, which are typically reduced as the quarter wears on, have instead been raised to 9%. They would likely be higher but for earlier weakness in oil prices and oil sector earnings. Only the retail sector is expected to deliver less earnings than a year earlier.

Despite strong performance and improving earnings, U.S. equities saw outflows for a sixth straight week. Energy stocks as well as real estate and materials stocks experienced the biggest outflows. The recipients of these outflows were European, emerging markets, and Japanese stocks.

Non-U.S. developed market and emerging market equities have outperformed U.S. equities due in part to investors recognizing these economies growing above their trend rates, faster earnings growth than U.S. companies are enjoying, and dollar weakness. The strong performance of emerging market stocks was driven in large part by the performance of technology stocks. While remaining attractive relative to their own history and against U.S. equities, within emerging markets, growth stocks are now expensive relative to value stocks.

Investor faith in equities is supported by growing optimism in the strength of the global economy. U.S. GDP grew 2.6% in the second quarter, up from 1.4% in the first quarter. Personal consumption and fixed investment contributed most of the growth. Business investment increased 8.2%, the most in two years. Disposable personal income was up 3.5% quarterover-quarter led by a nearly 3% increase in employee compensation.

A variety of statistics continue to point to sustained growth in the rest of the world. Japanese industrial production was up 1.9% in the second quarter and is forecast to climb 2.6% in the third quarter. European Economic Confidence index climbed to 111, beating expectations. European corporate earnings are up 16% year-over-year, 3% above expectations. In China, manufacturing output and new orders rose at the fastest pace since February on strong exports. The recovery in exports allowed the Chinese economy to grow at a 6.9% rate over the first half of the year, stronger than expected.

In other markets, volatility remains near record lows, the dollar lost value during month, the U.S. 10-year Treasury bond yield remained largely unchanged, and oil prices rose during the month. Many analysts suggest low volatility, as measured by the VIX, appears to reflect investors’ faith in a “goldilocks” recovery of steady growth, low interest rates and low inflation. A goldilocks market may also be contributing to the dollar’s decline, reflecting a decrease in demand for dollars as a safe-haven asset. The dollar fell for the fifth straight month, losing 2.6% and is now down over 8.5% this year, to its lowest level in 13 months. Some analysts are forecasting another 5% drop in the dollar’s value over the rest of year, which could contribute 4% or more to S&P 500 earnings in 2018.

With no policy moves by the Fed or other central banks and little change in expected inflation or growth, bond markets were largely flat. The 10-year Treasury yield finished the month about where it started, at 2.3%. Investment grade credit yields and credit spreads over Treasuries were largely unchanged.

The S&P 500 index ended July at 2477, higher than the year end forecasts by 15 out of 16 leading market strategists. The market is higher than forecast in part from current earnings estimates exceeding forecasts of 14 of the 16 strategists. We continue to assign a high probability to continued economic and earnings growth through 2018 as the basis for maintaining a target allocation to U.S. equities. However, we also recognize that the market’s strong performance could raise the possibility of profit taking and a market draw down. As a result, portfolios that are overweight U.S. equities should continue rebalancing to their strategic allocation.


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.