We started April’s commentary pulling from the old saying “April showers bring May flowers”. Fortunately for investors, there weren’t too many “showers” in April and there were plenty of “flowers” in May. Developed markets were generally positive with Japan’s Nikkei 225 Average leading the way internationally at 3.41% and our NASDAQ Composite up 3.62% domestically. Broad emerging markets, however, suffered with the MSCI Emerging Markets Index down 3.9% for the month. The S&P 500 was up 1.53% and the Dow Jones Industrial Average was relatively flat at 0.08% for the month. There were a number of developments in May and we highlighted those that we felt were top of mind for investors.
Market Update
Going into May, the difference between the S&P 500’s best performer and worst performer is over 167% with the best stock up 92% and the worst down 75% through the end of May. The disparity also filters down to the sector level. The majority of the top performers for the first five months are primarily in the energy sector, benefitting from the rebound in oil. Indeed, oil is up just over 18% and more than 50% above its 2016 low the middle of February as of this writing. However, technology, materials and consumer staple names are also in the top 10% of performers but without the same degree of concentration. This is why active management can play such an important role in an investor’s portfolio and also why we believe it is prudent in all markets. Active management allows one to remain nimble and look for opportunity when the overall market may be overvalued on average. Passive management takes the opposite approach where the investor simply buys the whole index regardless. Last month’s price-to-earnings ratio for the S&P 500 was roughly 19, meaning investors were paying $19 for $1 of corporate earnings. Compared to the historical average of 17, investors who are buying the S&P 500 index aren’t necessarily getting a bargain.
Source: Morningstar Direct
Mixed Economic Messages
The Federal Reserve certainly has its hands full. It has been nearly six months from the first interest rate hike since the Great Recession and the global economy appears to be sputtering. The month of May saw a number of important data releases from the U.S. government concerning the domestic economy. Some indicated a possible slowdown while others still hinted at economic expansion.
Retail sales, a measure of consumer activity, rose over the previous month. This is important because consumer consumption accounts for nearly 66% of U.S. GDP output. The other third of U.S. GDP is made up of investments, net exports and government expenditures. The U.S. consumer benefitted from an extended period of low oil and gas prices which translated more directly into growth in spending on autos and gas stations and indirectly to online retailers. In addition, wages grew at a 2.5% clip last month which is positive for inflation and one of the key metrics the Federal Reserve uses to plan its future interest rate actions.
Despite the positives, the U.S. economy stumbled and created fewer than expected jobs. Markets were expecting growth of nearly 200,000 new jobs but were met with a reading of 160,000. The unemployment rate was left unchanged at 5% as more people left the workforce and offset the overall job creation. It would also be prudent for us to note that, while the rosy consumer activity number mentioned above bodes well for economic growth, personal consumption expenditures (PCE) has remained high over the past few decades and may not necessarily be the driver of future growth it once was. Indeed, over the last 10 years, consumption has grown at an annualized rate of nearly 3.5% and accounted for just over 80% of all GDP growth since the early 2000s. Any slowdown in PCE could drastically reduce U.S. GDP growth, possibly leading to a few stagnant quarters or even a recession. A recession is defined as two consecutive quarters of negative GDP growth.
Overall, we view the U.S. economy as expanding with some promising “green shoots” of activity. That being said, we recognize that there are headwinds to progress and remain cautious. In addition, we still do not believe the Federal Reserve will meet its adjusted targets this year and are skeptical they will raise rates this June, barring considerable and material improvements in the global economy.
Interest Rates
U.S. Treasury bond yields hit fresh 2-month heights near the end of May. It appears investors are adjusting their future interest rate expectations based on the Federal Reserve’s most recent comments regarding their plans for 2016 rate increases. The Federal Reserve went into the year penciling in four rate increases and a target of 1.25-1.50% but have since tempered those forecasts. In fact, the markets were skeptical in early 2016 that the Fed could meet these goals and it turns out they are right so far. Investors, seeing that the Fed’s plan to raise rates is not materializing as fast, are getting out of shorter-term bonds, preferring to stay in longer term bonds and earn a slightly higher yield or leave fixed income altogether. We would note that two-year treasuries generally tend to reflect the market’s expectations of future Fed actions. Shorter term bond yields have been choppy since their lows the middle of February but are broadly up, indicating that there are more investors selling those bonds, driving prices down and yields up in the process.
Gold
Gold regained some of its luster earlier this year when the equity markets were falling precipitously. Now that most equity markets have rebounded, gold appears to have lost some of that sparkle. Despite trading up the last day of May, the precious metal experienced its largest monthly decline since November, down 6%, as the U.S. dollar regained strength and the market adjusted its expectations regarding the path of U.S. interest rates. Gold has historically exhibited an inverse relationship to rising interest rates and a more valuable U.S. dollar. Rising rates typically increase the opportunity cost of holding gold since it is a non-yielding asset and a stronger dollar impacts the precious metal as it is generally priced in U.S. dollars. Figure 1 below shows the year-to-date movement in the U.S. Dollar Index and gold prices. In fact, the correlation between the U.S. Dollar Index and gold prices is -0.81 which indicates a strong inverse relationship between the two. The U.S. Dollar Index is a benchmark that measures the relative value of the U.S. Dollar compared to a basket of securities, including the Euro, the Japanese yen and the British Pound sterling. Figure 2 charts gold prices relative to the yields on the Barclays Capital 1-3 Year Treasury Index which tracks all U.S. Treasury Bonds maturing in one to three years. The correlation between the two comes in at a more moderate -0.44, still showing the negative relationship.
Figure 1:
Source: Morningstar Direct
Figure 2:
Source: Morningstar Direct
Concluding Thoughts
Looking back on the first five months, one wouldn’t be surprised if investors strayed from their target allocation or financial plan. Many areas of the market entered correction or even bear market territory within the first two months. However, most have rebounded and others are flirting with positive territory. We believe the markets will likely remain range-bound for the near term as there is a lot of uncertainty surrounding key areas in the market such as the future path of interest rates, the global economy and oil prices just to name a few. As we highlighted in our commentary above, we maintain that an active approach will give investors the ability to remain flexible in the months ahead and believe that all investors would benefit from working with an advisor to develop a comprehensive financial plan.
Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. Because of their narrow focus, sector investing will be subject to greater volatility than investing more broadly across many sectors and companies. No strategy assures success or protects against loss. Investing involves risk including loss of principal. Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and bonds are subject to availability and change in price. The fast price swings in commodities and currencies will result in significant volatility in an investor’s holdings.
DJIA
The Dow Jones Industrial Average is comprised of 30 stocks that are major factors in their industries and widely held by individuals and institutional investors.
NASDAQ COMPOSITE
The NASDAQ Composite Index measures all NASDAQ domestic and non-U.S. based common stocks listed on The NASDAQ Stock Market. The market value, the last sale price multiplied by total shares outstanding, is calculated throughout the trading day, and is related to the total value of the Index.
S&P 500 INDEX
The Standard & Poor’s 500 Index is a capitalization weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.
The MSCI EM (Emerging Markets) Index is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of the emerging market countries of the Americas, Europe, the Middle East, Africa and Asia. The Nikkei 225 Index is a price-weighted index that is the most widely quoted average of Japanese stocks on the Tokyo Stock Exchange.
Bureau of Labor Statistics, 2016. http://www.bls.gov/cpi/#data
U.S. Dollar Index, 2016. http://www.investing.com/quotes/us-dollar-index-historical-data
CNBC, May 2016. http://www.cnbc.com/2016/05/30/gold-inches-up-but-on-track-for-biggest-monthly-fall-since-nov.html
Wall Street Journal, May 2016. http://blogs.wsj.com/moneybeat/2016/05/24/yield-curve-continues-to-flatten/
Wall Street Journal, May 2016. http://www.wsj.com/articles/u-s-government-bonds-pull-back-1464097636
Wall Street Journal, May 2016. http://www.wsj.com/articles/u-s-retail-sales-in-april-grow-at-best-pace-in-more-than-a-year-1463142745
