Beyond Mere Alpha; June 2017

Wednesday, June 7, 2017 - 8:13am

Politics — and mostly U.S. politics —- dominated the headlines in May, but stock prices continued their upward grind into 2017. The S&P 500 gained 1.4% on the month. Bonds rallied as well, with US Treasuries (as reflected in our CY program) returning 0.5%. The “synchronized global recovery” that has been a theme for much of this year continued, with strong soft data and some bright spots in the hard data out of most developed economies.  In the U.S., purchasing managers' indices and sentiment measures hit consistent highs.  That is important because it means at the producer (industrial) level, money is moving in an expansionary mode.  GDP figures confirmed this momentum in both the US and Europe. All eyes were on the OPEC meeting, but Brent crude saw an intra-month high of USD $54.2/barrel, and then settled back down to USD $50/barrel. Crude trades $47.29 as I type this, and appears stuck in the $50 range for the 2017 summer. That will make it tough for the Energy sector stocks themselves to dig out of the big whole they have dug for themselves so far in 2017.

The 1Q17 S&P 500 earnings season wrapped up with robust earnings growth across all sectors. Revenues generally beat analyst estimates and earnings per share surprised even more, with over three-quarters of US companies beating revenue estimates. Earnings growth was seen in almost all sectors, indicating a broad-based higher earnings trend in the US market. The Conference Board's Leading Economic Indicator (LEI) — an indicator that can sometimes successfully predicted the   movement of the US stock market — took another leg up to 126.9, following notable increase in the past two months. The unemployment rate fell in the May labor market release down to 4.4%, particularly good news after the dismal payrolls report for the previous month. 211,000 non-farm jobs were added in April vs. the 185,000 jobs expected.  MAY’s unemployment rate dropped to 4.3%, but there remains a very high number of underemployed Americans.

Mid-month in MAY, as news of investigations into President Donald Trump made headlines, the US stock market saw one of its largest downward moves in the year-to-date. When it was over, the DOW had dropped 1.8%.  However, the move was not enough to deter the US index from rallying 1.4% on the month — after back-to-back gaining sessions to take the market to new highs in the very early days of June.

It seems likely the current quarter’s data will allow a more accurate appraisal of the state of the US economy, following its now almost traditional first-quarter blip. However, with the labor market getting ever tighter, most market participants are already looking to the Fed to raise interest rates at its next meeting in June. I believe we will see a .25 raise at their June meeting.  I do not expect that to have any negative impact on the markets.  As Fed policymakers weigh future moves, they may also be eyeing the more positive signals coming from many other parts of the global economy

On the technical front, the two heaviest sectors by market cap -- financials and technology — continue to carry the broader market thus far in 2017. Financials continue to weaken, although we have not entirely abandoned the sector in our own SMAs. Information Technology remains the strongest sector, and it is the sector where many of our holdings are concentrated as I write this issue.

On the flipside, the consumer staples, materials, and telecom spaces under performed.  However, these three sectors only comprise — together — around 17.0% of the broader market. For comparison, the technology and financial sectors represent around 20.0% and 15.0%, respectively.  So, which sector a stock belongs to really makes a difference!

The sector where we see the most improvement is Utilities.  Now that is a defensive sector, so if Utilities were to continue to strengthen that could be an inclination of a “risk off” mindset for the market heads into the summer.