Current economic events
In the United States, politics remain the top story, with market risks rising due to the word “impeachment” now being brandished in the fallout from the dismissal of former FBI Director James Comey. While markets have recovered over the past few days, there is some concern animal spirits in the form of consumer and business confidence data, which could be damaged. In our view, the hard data remains supportive, with jobless claims remaining low and industrial production currently rebounding. In our view, the U.S. economy continues in a goldilocks mode, with solid, but not spectacular, growth.
Politics are also front and center outside the United States. Risks from European elections have eased recently and economic data continues to improve. Markets in Brazil sold off due to accusations that President Michel Temer was recorded during a bribery attempt. Risks within Brazil are meaningful, particularly if these accusations derail reform activity, especially with the economy still ensnared in a recession. There is however, little risk of contagion to the rest of the region or other emerging market nations at this time.
Contributed by: Robert L. Haworth, CFA — Senior Investment Strategist
U.S. stocks experienced a roller coaster-like ride last week, with the Dow Jones Industrial Average (DJIA) dropping 373 points on Wednesday before rallying and ending the week fractionally off due to elevated political uncertainty.
- Last week, the DJIA, S&P 500 and Russell 2000 declined between 0.4 percent and 1.1 percent. Seven of the 11 S&P 500 sectors also declined, with the generally defensive-oriented Consumer Staples, Energy, Utilities and Real Estate Investment Trusts (REITs) advancing.
- Year-to-date performance, on balance, remains superb, with the DJIA and S&P 500 up 5.3 percent and 6.4 percent, respectively, and nine of 11 S&P 500 sectors advancing, led by the 16.9 percent gain of the Information Technology sector. Energy and Telecom Services are the two sectors posting losses for the year.
Political uncertainty is on the rise and is dominating near-term sentiment. Political risk is likely to remain a factor impacting equity prices for the foreseeable future.
- Political uncertainty is impacting equity prices, with the mood in Washington being different today than in recent months, evidenced last week by thoughts of impeachment.
- Impeachment is a big and complicated step that would require Republicans to turn on their own party. For Republicans to impeach one of their own would seemingly require a “smoking gun.”
- Impeachment would also require a complete loss of confidence in President Donald Trump’s leadership by Vice President Mike Pence, the Cabinet and Republican members of Congress. At present, this does not seem to be the case.
- A source of future volatility, former FBI Director Comey’s expected testimony before the Senate Intelligence Committee after Memorial Day is likely to spur investor angst while limiting near-term upside to equity prices.
- This week, Trump’s trip to Saudi Arabia, Israel, Italy and the G-7 Summit is shifting focus toward foreign policy.
- Talk about the demise of Trump’s pro-growth agenda as a basis for a meaningful equity market correction seems premature.
The goldilocks-like U.S. macro environment remains intact, providing the basis for continuation of a risk-on bias and equities to grind higher.
- Earnings are increasing. The first quarter earnings season is essentially over, with roughly 95 percent of S&P 500 companies having released results as of May 22. According to Bloomberg, sales and earnings increased in the first quarter 8 percent and 15 percent year over year, respectively. For 2017, consensus is for sales to increase roughly 6 percent and earnings approximately 10 percent over year-ago levels. Stocks typically trend higher during periods of rising earnings.
- The Federal Reserve (Fed) appears to be proceeding deliberately along the path toward rate normalization, supportive of current valuation levels, with no recession or widespread inflation appearing in sight.
- While the equity-friendly Goldilocks-like economic environment remains, it seems most probable that U.S. equities trend generally sideways into midyear as we await political uncertainty to calm while gleaning updated readings on the pace of economic growth and insight into second quarter results.
- Expectations are relatively high for the second quarter following strong first quarter results. According to Bloomberg, second quarter sales and earnings are currently projected to increase nearly 5 percent and 15 percent year-over-year, respectively.
- Elevated valuations (the S&P 500 trades at 21 times and 18.5 times trailing 12-months and 2017 estimates), pro-growth legislative uncertainty, geopolitical tensions and seasonal tendencies for lagging performance during the summer months are among reasons that could limit near-term upside.
- Our price target for the S&P 500 remains 2,475, based on a multiple of 19 times our 2017 earnings estimate of $130, with upside contingent on stronger-than-expected indications of economic growth driving earnings higher, and magnitude and timing of potential legislative fiscal action.
- Absent a looming recession or widespread inflation, we favor growth over defensive sectors. Information Technology, Financials and select areas within Consumer Discretionary remain among our favorites.
- Consumer Staples, Utilities, Telecom Services and REITs are likely to outperform during periods of uncertainty or if the pace of economic growth falls short of expectations.
Contributed by: Terry D. Sandven — Chief Equity Strategist
Fixed income markets
The 10-year Treasury yield fell to its lowest levels in four weeks as rising political risk dampened risk appetite despite stable economic fundamentals. U.S. industrial production in April had its highest monthly increase in over two years and continuing jobless claims maintained a descent to all-time lows. Nevertheless, political developments in the United States and Brazil raised new questions about the timing and extent of reform efforts, which in turn, increases our expectation for volatility across asset classes. However, the fundamental factors driving growth, such as the labor market, consumer and business sentiment continue to remain stable.
The May Federal Open Market Committee (FOMC) meeting minutes are due to be released this week. There will be an update on their growth and inflation forecast, as well as changes in global growth expectations. We expect the forecasts have not changed meaningfully since the previous March meeting and will signal a high likelihood of a June rate hike and another later in 2017. The minutes are not likely to offer much detail around balance sheet reduction efforts, but we anticipate further information will be disclosed later this year, with balance sheet runoff commencing at the end of 2017 or early 2018. A shrinking balance sheet is likely to contribute to further upward pressure on interest rates.
Contributed by: Gregory L. Powell, CFA — Senior Fixed Income Analyst
Oil prices surged above $50 per barrel (West Texas Intermediate crude oil) for the first time in four weeks. Bullish speculators have returned to the market due to lower prices and hopes OPEC and other producers will extend their agreement on production cuts through year-end. A seasonal pick-up in demand, due to the summer driving season in the United States, is hoped to close the gap between supply and demand this year. In the meantime, fundamentals point to caution on oil prices since inventories remain elevated, U.S. production continues to grow and investment, based on oil rig usage, continues to grow.
Contributed by: Robert L. Haworth, CFA — Senior Investment Strategist
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