By Will Hernandez, CFA, CFP®
Equities, as measured by the S&P 500 Index (US large cap stocks), experienced an early drop in April but ended the month at a 1% month gain and a year-to-date 7.2% gain. The overseas developed markets are up 10% year-to-date. Domestic smaller firms (S&P 600) lagged, returning 0.9% year-to-date.
The conservative sector of the market, fixed income markets (Barclay’s Capital Aggregate Bond Index), gained 1.4% year-to-date. Within bonds, the yield curve twisted, meaning that short term interest rates rose and long interest rates remained flat. Also, bonds with a higher correlation to stocks outperformed. The Fed’s interest rate hike in March meant that the pop in short-term rates was expected. For our investors, this translates to your preferred stocks and intermediate bonds performing best. Note that low interest rates will normally adversely affect long-term bonds more than short-term bonds, thus due to the multi-decade drop in rates we remain overweight in short-term bonds to protect client capital.
Markets are responding to accelerating earnings growth. With one-half of the S&P 500 firms reporting so far, earnings increased a healthy 12.5%. Particularly, data throughout the first quarter showed unexpected growth amongst Financials, Tech, and Healthcare firms. Notably, these represent all 3 broad sectors of the market: growth, interest sensitive, and defensive. But, as financials reveal, even upgraded earnings estimates do not guarantee outperformance as, along with Energy, both areas are heavily negative year-to-date. Tech, however, is the top sector within our ETF portfolios. Missing expectations were utilities (which we don’t hold) and Telecom firms, both interest sensitive sectors, but overall the market responded appropriately to increasing earnings estimates.
The US first quarter curse continues, with first quarter economic growth at 0.7%. Housing data, homebuilder sentiment, consumer as well as business confidence - all forward measures of GDP growth - are improving. Now, consumer spending (about 70% of our economy) needs to see an increase to verify that this confidence is justified. US wages and manufacturing growth improved as well, but note that these are viewed as measures of current and backward-looking economic performance. Four of the last 5 year’s first quarters began with a whimper, including this year, thus there is no reason to become worried at this point.
The US economy has improved slowly and consistently for quite a few years. Abroad, however, is where the sentiment and growth estimates improved recently. Developed markets stagnation, particularly, has reversed course. With the massive strengthening of the dollar in 2014 and 2014 in our past, even a slight decrease in the dollar’s value has left other countries in an advantageous position. With the decade long underperformance, a strengthened dollar, even a slower than the 3% forecast global economic growth, has seemingly priced political and other risks. Investing internationally always involves unique risks, as an example is China’s stalled attempt to create a consumer driven market, and forced them to rely, once again, on manufacturing as a fallback. Overall, monetarily, Europe and Japan continue their own versions of quantitative easing, making growth more feasible.
As growth resumes around the world, and the US shakes off its first quarter, we have the opportunity for the first synchronized economic global expansion since the financial crisis a decade ago. Of course, risks always remain in investing. Economic expectations can adjust down on weaker data, political and geopolitical risks remain. More important, an appropriately diversified portfolio matching your goals to your risk tolerance remains the best way to invest for the intermediate and long-term.