Quarterly Market Commentary – Second Quarter 2017

We’re all familiar with the daytime TV game show The Price Is Right. Many of us remember watching on days we stayed home from school or on rainy summer days when we had to stay inside. It’s safe to assume we all found screaming at the TV over the price of laundry detergent enjoyable. A popular game on the show was Cliff Hangers, in which a yodeling cardboard mountain climber would ascend a cardboard mountain in steps that corresponded to the contestant’s guess about the prices of three small prizes. If the guesses were too far off the mark, the mountain climber eventually fell off a cliff.

With 97 consecutive months of economic expansion (the third-longest expansion since 1900), economists and investors are wondering if the U.S. economy is the cardboard mountain climber. The question on their minds is – how much more room does the economy have before it reaches the cliff?

This type of speculation drives markets, creates opportunities and causes warning signs. The economy continues to put one foot in front of the other and expand, ignoring the naysayers. By many statistical measures, macroeconomic conditions are strong, especially in the labor markets. Job growth remains constant with non-farm payrolls increasing over 550,000 jobs during the quarter, unemployment staying near all-time low levels at 4.4%, and weekly unemployment benefit claims remaining below 300,000 for 123 straight weeks (the longest stretch since 1970). These are all indicators of a healthy workforce.

On the contrary, wages are growing, though not at the pace that the influx of new jobs may seem to imply. Hourly earnings were forecasted to rise only 0.2% during the quarter, though optimism is building that this could accelerate as the market achieves full employment. GDP growth also remains as a hot topic. Most economists are skeptical that a 3% growth rate ­– as promised during President Trump’s campaign – could be achieved. It has been 12 years since our GDP saw a 3%+ growth rate, and so far 2017 is falling below expectations.  

Oil prices declined throughout the quarter, with WTI opening in the low $50s and ending in the mid $40s. Concerns about an excess supply from U.S. producers sent prices 20% lower, followed by eight consecutive days of rising prices. Add in news that OPEC may or may not work to reduce the supply glut, we saw three oil price rallies of over 13% and two declines of over 18% in a span of just over three months. While prices have been anything but consistent, rig counts have steadily increased 24 of the past 25 weeks, according to Baker Hughes.

Another sector of focus has been U.S. financials. During the quarter, all 34 financial institutions (known as the big banks) passed the Federal Reserve’s annual stress test, indicating that sufficient capital was on hand to survive a financial crisis similar to the one in 2008 as well as a more gradual downturn. This marks the third year in a row that all have passed. This, coupled with planned interest rate increases and gradual unwinding of the Fed’s balance sheet, should provide some tailwinds for the sector for the second half of 2017.

Overseas the focus was on elections, particularly in France. The election of Macron over the pro-Frexit Le Pen certainly provided some much needed stabilization in the European Union. After the surprising results of the Brexit vote and U.S. election, this offered some relief for global markets.

Equity Market Review

U.S. equity markets were again led by large cap growth during the second quarter, a continued trend from the first quarter, with returns of 4.7%, and now up 14% year to date. Small cap value continued to be the laggard from a U.S. equity style perspective, returning only 0.7%.  

Of the 11 sectors of the S&P 500, all sectors posted positive returns for the quarter with the exception of energy (-6.4%) and telecom (-7.0%).  Despite SnapChat’s stock plunging 20% during the quarter, the rest of the technology sector posted strong returns, up 4.1%.  In addition to technology, health care (7.1%), industrials (4.7%) and financials (4.2%) were the leading sectors for the quarter.

Non-U.S. equity assets have continued to perform well in 2017. Emerging markets (as measured by the MSCI EM Index) posted returns of 6.2% for the quarter, now up over 18% year to date. International developed markets (as measured by the MSCI EAFE Index) also posted strong returns with 6.1% for the quarter and 13.8% year to date.

Fixed Income Review

Investors continued to see a flattening in the U.S. fixed income yield curve during the second quarter of 2017 as interest rates increased on the short end of the yield curve while rates on the long end of the curve decreased. The yield on the 10-year U.S. Treasury note decreased from 2.4% on March 31 to 2.31% on June 30. Meanwhile, the yield on the three-month note increased from 0.76% to 1.03%.

The Bloomberg Barclays Aggregate Bond Index, a measure of investment grade debt, experienced positive returns during the second quarter with 1.45%. Similarly to equity markets, international fixed income outperformed U.S. fixed income for the quarter. The Citi World Global Bond Index posted returns of 2.89% for the quarter and 4.4% year to date.

Diversification1

As always, diversification is a topic that we stress to retirement plan participants through communication and education meetings. A diversified asset allocation portfolio is meant to smooth out returns over the long term without having huge positive or negative swings. The following chart shows an example of the long-term results of diversification.

1 Source: J.P. Morgan Asset Management’s Guide to the Markets