July 2016 Monthly Outlook
One of the bigger economic surprises in June was the US job report that showed a gain of just 38,000 new positions in May versus an expected 160,000. Part of the shortfall could be explained by a work stoppage in the telecom industry. But the estimated payroll loss of 35,000 from that labor dispute barely puts a dent in the actual total. Worse, estimated payroll increases for March and April were dialed back notably as well. The payroll gain for March was revised down from 208,000 to 186,000; the change from April was pared back from 160,000 to 123,000. Despite this small employment gain, the unemployment rate, expected to remain steady at 5.0%, ticked down to 4.7% because the low labor-force participation rate also decreased, going from 62.8% to 62.6%. That rate is now down 0.4% over the past two months. The employment report caused the market expectations for the next Federal Reserve interest rate increase to be pushed further back. This also caused long term rates to decrease significantly in June as the 10 year government yield dropped 34 basis points to 1.49%, which is near an all-time low. The core consumer price index remained stable in May and within the Federal Reserve 2% target.
The Conference Board Leading Economic Index® (LEI) for the US decreased 0.2% in May to 123.7. “The US LEI declined in May, primarily due to a sharp increase in initial claims for unemployment insurance. The growth rate of the LEI has moderated over the past year,” said Ataman Ozyildirim, Director of Business Cycles and Growth Research at The Conference Board. “While the LEI suggests the economy will continue growing at a moderate pace in the near term, volatility in financial markets and a moderating outlook in labor markets could pose downside risks to growth.”
Indicators point to the US economy growing slowly (~2% annually) and being in the late stages of a long business up-cycle without major excesses that brought down some prior economic upturns.
Bond and Stock Market Commentary:
The disappointing jobs report caused long term interest rates to drop and the bond index to increase nearly 2%. This drop in interest rates has caused investors to pile into high yield, interest rate sensitive sectors such as real estate and utilities which increased 6% and 7% respectively in June. The increase in these sectors makes further short term growth difficult as the valuations appear stretched – these sectors have increased 21% and 31% in the past 12 months.
The stock market was in a calm, slight upward state in June until the referendum vote by the UK to leave to European Union. The market expected the UK to remain in the EU, so this surprise caused world stock indexes to drop sharply and the US S&P index to drop over 5% in the two trading days following the vote. We do not believe the UK decision to leave the EU will cause any fundamental changes on our client’s investments, and therefore this development is basically noise that investors should ignore. After the two day market drop, the US stock market recovered to the pre-vote results within a week, allowing the S&P index to increase 0.35% for the month and finish the quarter up 2.45%.
With Q2 concluded, corporate earnings season will be in full swing in the next couple of weeks, and it will be important for corporate earnings to slow the decline that has occurred over the past 2 years and provide guidance that earnings will accelerate in the near future. If earnings continue their slow decline it will be very difficult for stocks to continue increasing as valuations are high relative to earnings growth.
No sector looks obviously cheap in this fully valued market, but we're finding better values among beaten-down consumer cyclical and healthcare stocks. In healthcare, we see improved pipeline productivity driving growth at pharmaceutical and biotechnology firms. Despite political rhetoric around drug pricing, we expect pricing power to remain strong as companies deliver innovative new therapies in areas of unmet medical need, such as oncology and immunology. New immuno-oncology drugs are reaching the market in half the time of drugs developed a decade ago thanks to scientific advancements and a more accommodating regulatory environment.