Investor Insights: July 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 June's key statistics and market commentary to help guide your investment decisions. 

Noteworthy Numbers

The S&P 500 has fieight.pngnished positive eight months in a row. That is the longest streak sincethe eight-month streak that ended in April 2011. The S&P 500 Total Return Index is positive by 9.34 percent through the first half of the year.

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The VIX, a useful measure  for volatility in the stock market, closed below ten on seven separate occasions during May and June. It has only closed below ten on sixteen previous occasions since 1990, the last one being in January 2007.

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The price of one Euro dollars in terms of U.S. dollar rose to $1.1448 late in June.
This is the weakest the USD has been in more than twelve months.

 

Our Take

Markets moved higher during June as the S&P 500 finished 0.62 percent higher than where it started the month. With the final month of the quarter being off-season for corporate earnings, the growth can generally be attributed to a growing sense of comfort among investors about the current state of the U.S. economy. The jobs report, released earlier in the month, may have had some underwhelming numbers, but digging deeper into the report reveals a labor market that looks increasingly healthy across most major sectors of the economy. The Federal Reserve fulfilled expectations on June 14 when it announced a 25 basis point increase in its targeted federal funds interest rate. This came despite the specter of decelerating inflation, also called disinflation, disturbing some observers. Meanwhile, political developments out of the nation’s capital appear to have faded to background noise, at least as far as Wall Street is concerned. It appears as though markets have adopted a “fine with or without you” perspective on the fiscally oriented legislative items that drove market returns half a year ago. Markets chugged along internationally as well, with the MSCI EAFE Index posting slight gains during the month. Emerging markets also gained despite a sell-off in the price of oil, to which many emerging markets have significant economic ties.

The Fed, led by Chairwoman Yellen, deemed it an appropriate time to increase interest rates in June. The central bank’s decision on policy is driven by its dual mandate: low unemployment and targeted inflation growth of two percent annually. The condition of the labor market—the first prong of the mandate—is supportive of increasing interest rates. While the official measure of unemployment, the seasonally adjusted U-3, is at an attractive 4.3%, the real story of the jobs report released in June is the U-6 measure. The U-6 is a broader measure of the unemployment situation and includes groups that the U-3 doesn’t, primarily those who are underemployed, part-time, as well as discouraged workers. The seasonally adjusted U-6 measurement came in at 8.4%, which is the lowest it has been since mid-2007. As employment metrics continue to normalize to pre-recession historical averages, the Fed sees cause for tightening policy by increasing interest rates. However, the second prong of its mandate, inflation, is falling short of the Fed’s stated target of two percent. The Personal Consumption Expenditure (PCE) index, the Fed’s preferred measure of inflation, is showing persistently weak inflation below the 2 percent target. The latest reading prior to the Fed’s June meeting showed that PCE increased only 0.15% in April to year-over-year rate of 1.54%.

There has been much debate about whether the Fed is making a mistake by continuing to tighten policy when its inflation target isn’t being met. One camp, in which many at the Fed seem to reside, puts forth the argument that the recent slowdown in inflation is transitory, possibly even caused by anomalous influences like the sharp decrease in the cost of mobile phone services spurred on by the industry’s fierce competition or the disruptive behavior of Amazon and their model of providing consumers with goods at lower prices. Considering the strength of the labor market, calling weak inflation transitory may make sense. After all, inflation is driven by wages and demand, and lower unemployment should lead to higher wages and increased demand (though wages have been lagging the unemployment rate for years). Another camp points out that the Fed has claimed it is, above all else, “data-dependent,” and to increase interest rates in the face of weak inflation is contradictory to that claim. The reality is likely somewhere in between the two viewpoints. Forward guidance—the Fed’s deliberate signaling of its intentions as a way to guide expectations in the market—is a key component of the Fed’s influence. Yellen would have undoubtedly been reluctant to keep rates where they were after signaling an increase for months. Not only could it have potentially injected volatility into the markets (although this should be outside the concern of the Fed’s mandate), but it would likely have damaged the Fed’s credibility from a forward guidance standpoint. The takeaway from the Fed’s actions in June is that if inflation persists below target the Fed will have an increasingly narrow path to walk as it contemplates additional rate hikes later this year.

Sweeping legislation from Congress, one of the key drivers of inflation expectations earlier this year, seems to have been on hold for the past few months. Political challenges, both the normal sort and the type the new administration has inflicted upon itself, have all but quashed investor expectations for earth-moving infrastructure spending and pro-growth tax cuts. Despite this reality, markets seem indifferent. While Washington D.C. has screeched to a halt due to the latest story on Russia and the intra-party fighting over the healthcare bill, Wall Street has moved on. If some sort of breakthrough is made on tax cuts or infrastructure then markets will probably start reacting again. However, at this point, it seems as though any legislation that does pass will be so watered down as to not have the effect originally expected by investors.

With the second quarter now behind us, investors can look toward the usual quarter-end economic releases during July to update their views on the condition of the U.S. economy. Corporate earnings will begin to be released which should shed some light on whether the strong consumer sentiment readings we’ve seen over the past several months are translating into increased revenue for corporations. Market volatility, as measured by the VIX index, has been at historic lows over the past two months. It has been a relatively quiet summer in the markets so far, and while no particular event on the horizon seems likely to create a crisis, it’s fair to expect that volatility will revert to a level akin to historical norms sooner or later.

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