The third quarter began in bullish fashion as the most of the major stock benchmarks jumped by 1.5% or more in the first week of July.  A key catalyst for this quick start was the Department of Labor’s June jobs report that said the U.S. economy added 224,000 net new jobs, 60,000 more jobs than most forecasts predicted.  The headline jobless rated moved 0.1% higher to 3.7% in June, but the employment numbers remain strong across the board and are keeping consumers in good shape. 

Retail sales reported in July for June’s activity were up 0.4%, which exceeded expectations.  This is meaningful as consumer purchases represent two-thirds of our Gross Domestic Product (GDP).  The second quarter delivered 2.1% GDP growth, slightly above the 2.0% expectation.  While this is weakest print in over two years, the decline was mainly a result of a decrease in business investment.  Consumer spending increased 4.3% and government spending jumped 5.0%.

On the last trading day of the month the stock market gave back some of the first week’s strong gains.  Through previous statements and testimony, the Federal Reserve chairman had opened the door to future interest rate cuts.  The economic sluggishness elsewhere around the globe has caused the Fed to rethink their current fed funds rate target.  In the final trading hours of July, the Federal Reserve announced their first interest rate cut in over ten years.  The 25 basis point cut along with post decision comments by Chairman Powell disappointed market expectations causing a one day stock price correction. Now all eyes turn to the employment numbers to be released on August 2^nd.

The recipe for this strong economy includes more people employed, consumers willing and able to spend, and corporations’ ability to earn money and grow profits.  July 15^th marked the beginning of another round of quarterly corporate earnings announcements.  More will be known by mid-August, but the early news looks positive on the corporate earnings front as 77% of those reporting have exceeded expectations.  As is the case each quarter, there are individual companies that exceed expectations and those that fall short.  On the positive side, money center banks had a good quarter, some technology companies like Alphabet, Intel and Twitter exceeded forecasts while Amazon, Caterpillar and some of the smaller airlines disappointed.  Consumer favorites like McDonalds, Costco, Starbucks and Coca-Cola found their way to new 52-week high stock prices on very strong quarterly results.

While background noise can be distracting, it is important to identify and understand the signal in the headlines.  Tariffs are likely here to stay for the foreseeable future, yet the markets continue to react to the latest threats and realities.  Tariffs on Mexican imports appear to be off the table for now.  After the June G20 meeting, China is back to the negotiating table, but they seem content to be very deliberate with their discussions and may wait it out until the next election cycle.  France may be the next tariff target as they plan to institute a new digital tax on certain U.S. technology firms.

Be aware of your total surroundings but remain keenly focused on the U.S. consumer and corporate profits as those tend to be better indicators of long-term economic health.

U.S. stocks have once again found their way to higher highs.  The S&P 500 cracked the 3,000 level and the Dow Jones Industrial saw 27,000 for the first time this month.  The strong economy, low interest rates, benign inflation, corporate earnings growth and an accommodative Fed have set the stage for this remarkable run in the financial markets.  The Dow Jones Industrial Average, NASDAQ Composite, S&P 500 and the gained 1.12%, 2.15%, and 1.44% respectively in July.  International stocks continued to lag the U.S. as the MSCI EFAE and emerging markets indices declined -1.27% and -1.22% respectively.  

Bond performance is exceeding all expectations at this point in the year and looks likely to hold from here.  Low inflation and continued moderate growth should keep interest rates in a tight trading range.  This month interest rates ticked up slightly after a strong rally into mid-year. The 2-Year Treasury note yield rose 14 basis points to end July yielding 1.89%.  With the fed funds rate now pegged at 2.25%, it’s obvious the market is still calling for another future Fed rate cut.  Yields also increased marginally on both 10-year and 30-Year Treasury securities bringing their yield to 2.02% and 2.53% respectively.  

We would encourage investors and advisers alike to concentrate on asset allocation and portfolio rebalancing and less on absolute market levels and emotions.  Yes, it is true the U.S. stock markets are trading near all-time highs and interest rates remain stubbornly low.   This statement was true a year ago and may still be true a year from now, we just don’t know.  Instead of falling victim to the next bearish viewpoint you read or hear, take this opportunity to rebalance your portfolio back to your targeted risk tolerance.  For example, if three years ago it was determined that 60% stocks and 40% bonds was the asset allocation best suited for your situation and asset appreciation now has your portfolio at 66% stocks and 34% bonds – it’s time to rebalance.  Use this strong market as an opportunity to reduce stocks by 6% and add 6% to bonds, thus returning your portfolio to the original 60/40 allocation target. 

Also, it is important to avoid the temptation to “go to cash” when you read the next well-written “end of the world” piece.  Investing is a marathon, not a sprint.  Enjoy the run, breathe, and stay invested at a risk tolerance appropriate for your situation.    

MARKETS BY THE NUMBERS:

To expand on these Market Commentaries or to discuss any of our investment portfolios, please do not hesitate to reach out to us at 775-674-2222

Economists often look to an indicator called the Purchasing Managers’ Index (PMI) as a directional indicator of the economy. The indicator is an indexed summary of surveys completed by corporate purchasing managers as to how they feel about metrics such as new orders, factory output, employment, inventories, delivery times, etc. They usually give answers that imply improving, no change or decline from the previous survey.

PMI’s are published on a monthly basis for most countries and regions around the globe by two primary sources:

• The Institute for Supply Management (ISM)
• The IHS Markit LTD

PMI’s are also broken into two broad sectors

• A manufacturing sector PMI
• A services sector PMI

In general an index reading above 50.0 suggests expansion and a reading below 50.0 indicates contraction. Both economists and investors closely monitor monthly PMI data to analyze economic health and trends in the surveyed region. In fact, many investors use PMI surveys as a leading indicator of the state of consumer demand and GDP. Below are the US IHS Markit Manufacturing and Services PMI as of June 2019:

We can see that while both the manufacturing and services sector PMI’s are still above 50.0 (expansion), they’ve declined substantially in recent months. It appears optimism is being weighed down by persistent uncertainty surrounding tariffs, global trade conditions, tight labor markets and higher input costs. This has investors concerned that the US economy is slowing down as purchasing manager sentiment weakens.

This week an indicator called a “Flash PMI” will be reported for July. This gives an indication of the final PMI based on 85-90% of all surveys being complete. The Gradient Investment team will be watching both Flash and Final PMI’s to see if current trends persist. The health of the economy is one of the key fundamental tenets we monitor in determining our market forecasts. Therefore we’ll be watching PMI data closely to see if any changes to our forecasts need to be made.

To expand on these Market Reflections or to discuss any of our investment portfolios, please do not hesitate to reach out to us at 775-674-2222.

The US stock market, as measured by the S&P 500, continues to set new record highs rising more than 18% to start the first half of the year. The strong start in 2019 has recouped the poor performance of late 2018 as the stock market continues to set new highs. For the last decade, the stock market has consistently marched up, but has displayed some volatility along the way. This volatility (illustrated by the gold circles) can be seen in the chart below from StockCharts.com.

The question we often get: “Is it too late to invest in the stock market after the strong start to the year?” That same question has been asked many times the last decade. Looking at the results it wasn’t too late to invest at any time the past decade.  There will always be corrections in the market, but we feel the market will continue to grind higher over time. None the less, it may not be as smooth as it has been the last decade as volatility has picked up recently.

Some of the factors that give us comfort the stock market can continue to advance are:

• The economy is still growing
• The Federal Reserve has become more accommodating recently
• Valuation is still reasonable

One of the common metrics for judging the strength of US economy is looking at US GDP (Gross Domestic Product) which is expected to grow around 2% for 2019. With economic growth still positive and unemployment near record lows, we feel the backdrop for stocks is still positive.

The Federal Reserve last month signaled a more dovish tone, putting interest rate increases on hold and adding the possibility of interest rate cuts. A lower interest rate environment is generally thought to be a positive for the stock markets.

With the large stock gains of the last decade, one would think the stock market is wildly overvalued, but that is not the case looking at forward P/E multiples. P/E multiple is a valuation metric that looks at the price of a stock (the P) divided by the earnings (the E) of that company. JP Morgan looked at forward P/E multiples of the S&P 500 for the last 25 years shown in the following chart.

The latest P/E multiple on the S&P 500 is 16.7x which is slightly above the 25-year average of 16.2x. While the stock market is not cheap, its valuation is only slightly above its 25-year average, which we believe is reasonable.

In summary, while the US stock market has performed well to start the year, we believe the conditions are in place to for the S&P 500 to continue to increase in value going forward.  Stock market performance may be more volatile than the past decade, but the fundamental drivers are still in place for markets to move higher.

To expand on these Market Reflections or to discuss any of our investment portfolios, please do not hesitate to reach out to us at 775-674-2222.