The Last Quarter and Tomorrow...
- Howard Isaacson
- Jul 12, 2015
- 5 min read
In this note, I would like to update you on major shifts over the past quarter and thoughts regarding potential outcomes in the coming months regarding the stock and bond markets.
Looking back, the Dow opened the year at 17,823 and ended the 1st quarter at 17,776. During the 2nd Q, we hit highs of 18,351 and lows of 17,576, with a final close on June 30th at 17,619.
As the following Year to Date chart shows, the Dow has done a good amount of bouncing, but has not gone anywhere. Yes, we did hit some new all time highs, which was very exciting, but those increased valuations did not hold. (We do want to point your attention to the thin green line in the chart, which is the 200 day moving average. If one were to apply some technical analyst goggles, the line and its crossing of the recent values of the Dow may indicate that a support point has been hit and given the few days subsequent to the crossing have not produced any further “legs down”, this could be construed as a positive sign. See below for more discussion.)
Source: Fidelity
Similar, but much more extreme, bouncing has occurred within the fixed income markets. Please keep in mind that bond prices move in opposite directions from their respective yields.
* The 10 Year Treasury Yield started at 2.17% on January 1st and closed that month with a low of 1.673% (a level not revisited since the “near meltdown” suffered by Europe in 2012), driven by significant US economic weakness, very low US inflation and a global response to Europe’s Quantitative Easing.
* The yield soared over 2% in February and hit a high in March of 2.24%, before ending the 1st Q at 1.868%
* The 2nd Q has been filled with Fed rate hike discussions and related fears, which brought the rate to a high of 2.478 in June, and ended June at 2.418%.
Note: The longer the maturity of the bond, the greater the impact of the changes in market interest rates on the bond price.
Source: http://finance.yahoo.com/echarts?s=%5ETNX+Interactive#{"range":"ytd","allowChartStacking":true}
The following is a “performance map” of the S&P 500 over the past quarter.
* The most consistent moves within industries were driven by the expectation of higher interest rates; thus, money center banks moved higher, utilities lower.
* Weakness in oil and gas pricing, as well as the fear of slowing global economic growth, negatively impacted the basic materials, oil and gas, and energy service sectors.
* Fears of moderation of US consumer spending brought on a pull back in retail and other consumer driven industries.
Current Economic Picture:
The majority of the economic evidence points to moderate and increasing US growth, constrained prices, and moderate slack within production.
Employment continues to improve with unemployment now officially at 5.3%. http://www.bls.gov/ces/
Though wage growth is lackluster at an annual growth rate of 2.8% for those in private industry, the increase is above the current inflation figures and the growth rate appears to be increasing. http://www.bls.gov/ncs/
The number of job openings hit 5.4 million, well exceeding prerecession highs. http://www.bls.gov/jlt/
Even the U-6 Unemployment Measure, the broadest of figures maintained by the Bureau of Labor Statistics, has declined to 10.5%, seasonally adjusted, from 11.2% at year end. http://portalseven.com/employment/unemployment_rate_u6.jsp
Capacity Utilization was at 78.1% in May versus 79.6% at the end of December. Capacity Growth is running at an annual rate of 2.8%. Average utilization from 1972 thru 2014 was 80.1%. http://www.federalreserve.gov/releases/g17/Current/ Thus, there appears to be room for economic growth with higher capacity utilization.
Twelve month change in Producer Price Indexes (PPI) are easiest shown in a chart:
Similar to PPI above, the Consumer Price Index exhibited deflationary tendencies from November 2014 through January 2015, but with the most recent release for May, it appears CPI may have begun to increase, as May’s change was 0.4%.http://data.bls.gov/timeseries/CUSR0000SA0?output_view=pct_1mth
Factset’s research has estimated an earnings decline for 2nd Q 2015 of -4.5%. Seven sectors are projected to haveincreased earnings, lead by healthcare, and three sectors are projected to have reduced earnings. http://www.factset.com/websitefiles/PDFs/earningsinsight/earningsinsight_7.2.15
ThomsonReuters has identified the three with declining earnings as Energy – 62.8%, Consumer Staples -2.9%, and Industrials -1.1%. http://www.investing.com/analysis/forward-estimate-rose-to-$125-this-week;-expect-q2-%E2%80%9915-earnings-growth-257144 Thus, without energy, the average would be a positive 3.9%, using very simple math, presenting a very different picture.
Looking at projected revenues for the 2nd Q 2015, Factset estimates that excluding energy, total revenues would increase for they quarter by 1.7%, but with energy, we likely will see a decline of -4.5%.
Our thoughts at the moment:
Of course, there are thousands of other facts and partial facts and factors that we are monitoring, but our preliminary thoughts and conclusions are the following:
There are several major wildcards out there that can significantly impact our thoughts and projections, including:
1. Greece and its ramifications on the EU, common currency and other EU members (and their constituent “far right parties”.
2. Jihadists affiliated with Al Qaeda and ISIS, and their reign of terror in the Middle East, North Africa and its potential spread.
3. China’s naval infatuation with land reclamation and militarization of islands in the South China Seas.
4. The Federal Reserve’s messages and actions regarding interest rate increases.
There are other factors, but these four are at the forefront of mind, at the time of this writing.
Fixed income in the US has been and will continue to be very volatile in the short term, especially in longer durations. The Fed is faced with potentially raising rates for the first time in nine years. (Wow, how time has flown by….) Though the Fed does not actually raise rates, they set the Federal Funds Target Rate, and this action has tremendous impact on the overall markets. There had been and seems to continue to be a consensus that the Fed may vote to increase the rate at their September meeting marginally, with a second small increase before the end of the year.
Though the likelihood of rates moving higher between now and year end are good, there is still uncertainty regarding the timing and amounts. The Fed has made it clear that their decisions will be data driven. The following could help defer an increase:
+ Economic and market volatility in Europe from Greece
+ The IMF’s request to the Fed not to raise rates this year
+ The continued appreciation of the USD vs the Euro and other currencies, esp. since the Greek vote
+ Continued weakness in sectors of the US economy and in compensation
Similar to earlier in the year, rates can definitely go lower from here if the market begins to sense a delay in the timing of the increase. As we have seen over the last three years, interest rate changes are impossible to predict with any accuracy or consistency.
We will be back in touch with you shortly with another market update…enjoy the weekend!!
Comments