Plum Street Advisors
Q2 2017 Market Commentary – July 6, 2017
So far, it has been a good year to be invested in international stocks. Developed market stocks as measured by the EAFE index returned 6.1% for the quarter, and are now up 13.8% for the year to date period (Total Return, USD, Net). Emerging markets were up 6.3% in the second quarter, and are now up 18.4% for the year to date (Total Return, USD, Net). Not that the 3.1% total return for the quarter and 9.3% total return for the year to date for the S&P 500 was disappointing, but international stocks are proving their worth in diversification, and are still look much less expensive compared to their underlying earnings.
It has been a consistent theme of ours that a significant international allocation still makes good sense. Today’s economy may be global to a certain extent, but enough differences remain in regional economies, currencies, government policies, and home country investor biases that we continue to see significant benefits of international diversification.
Meanwhile, both domestic and global growth continues apace. The US recovery, now in its eighth year, has reached the third-longest recovery in US history (the average recovery since WWII has lasted for 5 years). Only the fiscal-stimulus fueled recovery of the ‘60s and the tech boom of the ‘90s have lasted longer (each lasted nine years). While getting long in the tooth, this recovery feels like it’s on firmer footing, with a more modest pace and more varied drivers than either of those growth spurts. For the full year 2017, analysts are projecting corporate earnings growth of 9.8% and revenue growth of 5.4%, according to Factset.
US GDP growth was slow, as predicted, in the first quarter and came in at 1.4% per the most recent revision. Expectations for the second quarter are more positive, with Moody’s currently predicting US GDP growth of 2.7%. Equally encouraging, global growth has been picking up and Moody’s expects it to reach 2.8% in 2017, up from 2.3% in 2016.
Hard economic indicators continue to be mixed in the US. Vehicle sales fell 3.4% from the first quarter, although they are still high compared to historical levels. Construction spending was flat in the most recent month, but is expected to pick up in the coming months due to low inventory and low mortgage rates. Inflation remains tame. Unemployment is down to 4.3%. Sentiment indicators (the “softer” signals) continue to show historically high confidence in the economy, and overall growth is expected to continue to be solid, if not spectacular, for the rest of 2017.
The rally that started late 2016 was extended in the second quarter of 2017. In the US, growth stocks continued to lead as they had in the first quarter, with the Russell 1000 Growth returning a total of 4.7% compared to the Russell 1000 Value index total return of 1.3%. Large cap outperformed small cap, as the Russell 1000’s 3.1% total return slightly beat the Russell 2000’s 2.5% total return.
Growth stocks such as Apple, Facebook, and Amazon helped the large cap S&P 500 post its strongest first half since 2013. Energy stocks have done the opposite, losing value as oil prices dropped sharply this year.
As mentioned above, international stocks (both developed and emerging) have outperformed US stocks so far this year as signs of growth are picking up internationally, and in the case of emerging markets, as weaker currencies have helped exports.
The Fed raised the Fed Funds rate by another 0.25% in June, the second increase this year, and appears to be on track for the expected three increases in 2017, although the third increase now might not come until December. Additionally, the Fed announced plans to begin to pare down its balance sheet which ballooned due to the bonds bought as part of its quantitative easing programs. The pause in inflation’s rise this quarter is raising questions, however, about how aggressive the Fed can be. The Fed calls the factors that have stalled inflation temporary, but not everyone is as sanguine.
Overall, bonds as measured by the Barclays’ Aggregate Index added 1.5% in the second quarter for a 2.1% return year to date.
The Bloomberg commodity index is off just under 6% for the year to date. Oil has been the most visible and news-making driver, falling from $57 per barrel at the end of 2016 to $46 as of the end of the second quarter. Precious metals have done better, and gold is up for the year as interest in its hedging properties remain strong.
The US markets gained ground during what was largely a “wait and see” quarter. There were no major breakthroughs in terms of fiscal policy from Washington, mixed indicators from an economy that continues to muddle through, and uncertainty whether the Fed can continue its hawkish policy in the face of flattening inflation during the quarter. The markets will be looking for a catalyst in the third and fourth quarters. It may finally be time for the world’s other developed countries to take leadership of the global economy’s expansion, or the US could get a second wind from a tax cut or from a jump in infrastructure spending. For now, the markets seem to see little risk, and are content to continue to focus on the expansion of corporate margins and modest revenue growth to continue the current rally.