Investor Insights: August 2017

By Bobby Moyer, CFA, CFP®, CAIA

Bobby Moyer, CFA, CFP®, CAIA

Bobby Moyer, CFA, CFP®, CAIA Director of Research Senior Portfolio Manager

See our recap of July's key statistics and market commentary to help guide your investment decisions. 

Noteworthy Numbers

 

nine.pngThe S&P 500 has finished positive for the ninth month in a row. This marks the longest monthly winning streak for the index since it was positive for ten straight months ending in September 1995.

five ninet six.pngThe MSCI EM index, a proxy for emerging market stocks, returned 5.96 percent during the month of July. This represents the best monthly return for the asset class since March 2016. The index is up by 25.49 percent for the first seven months of 2017.

one point seven.pngThe most recent reading of the core Consumer Price Index (CPI) came in at 1.7 percent. This measure, which excludes the volatile categories of food and energy, is below the Federal Reserve’s 2 percent target for inflation.

 

Our Take

The second half of 2017 is off to an impressive start, with most major equity markets posting very strong returns. Stock indexes in the U.S., regardless of their market capitalization or status as “value” or “growth,” were positive for the month. The S&P 500 was up 2.06 percent. Markets abroad were similarly positive, with the developed market index, the MSCI EAFE, up nearly three percent and the emerging market index up nearly six percent for the month. Fixed income returns were slightly positive as well as market interest rates finished the month just under where they began.

Providing a monthly update on markets that keep chugging along in this fashion is, on the surface, a little redundant after a while. After all, the same themes discussed in previous newsletters are still the prevailing themes today—the lack of a fresh and market-moving crisis, a general sense of predictability from the Federal Reserve and an overall indifference to the daily political drama in Washington, D.C. These factors, placed against the backdrop of positive economic news at home and abroad, make for strong equity returns and low volatility. Dig past the surface, however, and some interesting insights can be gained about whether markets are justified in their recent performance.

Take stocks in the U.S., for example. The S&P 500 is up 11.59 percent for the first seven months of the year, well ahead of what would be considered average at this point. Much of the gains during July can be attributed to what has so far been a strong earnings season. According to FactSet, as of July 28 investors saw 289 companies of the S&P 500 report earnings, 73 percent of which beat the analyst estimates for sales for the quarter. This exceeds the 53 percent average experienced over the past five years. Another important data point is the expectation for earnings growth over the next twelve months. With a blended earnings growth rate of S&P 500 companies at 9.1 percent, it’s not unreasonable for markets in the U.S. to be trading at their current levels and gradually higher. The S&P 500’s forward 12-month Price to Earnings ratio, which measures where share prices stand relative to corporate earnings, is at 17.7 as of the end of July. This is above the five year average of 15.4, but not alarmingly high. As we enter August, the main event that could upset the apple cart is if inflation data continues to trend lower from where the Fed would like it to be. As we noted last month, the Fed may feel compelled to raise rates again in September regardless of weak inflation—such a move could spook markets. Current consensus in the market places a low probability on a September rate hike.

Equity returns for international developed countries have been strong this year as well. Positive by 17.09 percent for the year through July 31, the MSCI EAFE is on track to outperform the S&P 500 for the first year since 2012. Much of this is driven by strong growth in Europe, which is in the midst of a substantial quantitative easing policy implemented by the European Central Bank. It’s been five years since the president of the European Central Bank, Mario Draghi, said the ECB would do “whatever it takes” to revive the struggling EU economy. Since that time the ECB’s balance sheet has grown by 1.2 trillion euros, and Draghi has given no indication of when the ECB’s quantitative easing program will begin to wind down. The ECB has been behind the Federal Reserve with beginning quantitative easing and coincidently European markets lagged U.S. markets. As the Federal Reserve looks to return to monetary policy normalization, European markets may outperform US markets with the added help from the ECB.  

The other class of international investing—emerging markets—has been enjoying significant tailwinds in 2017 as well. Also having struggled relative to the S&P 500 since 2012, the MSCI EM index is up 25.49 percent for the year through July 31. A number of factors are contributing to this rally—strong earnings growth in several countries, a number of emerging market countries instituting fiscal reform that appeals to outside investors and also the weakening U.S. dollar. With a weakening dollar, not only do U.S. based investors see enhanced investment returns from currency translation, but the weaker dollar is a bullish factor in local terms for many emerging market economies. This is because of the dollar-denominated debt held by many emerging market countries, which effectively shrinks in size when the dollar weakens and thereby reduces the countries’ deficits.

Global equity markets are in a relatively comfortable place at this time. Valuations, while high, are not unreasonable. The prevailing concerns have been thoroughly digested by the markets, so it will likely require something new to panic investors. That said, there is something of an “August Effect” in the markets due to many traders being on vacation, which lowers daily volume in the markets. Lower volume lends itself to higher volatility. With the S&P 500 being up for nine straight months, investors should be prepared for losses in the short term without losing sight of their long term objectives.

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