Schwab Market Perspective: Spinning Our Wheels
- U.S. equity indexes are within the summer’s range. But that doesn’t mean there hasn’t been action over the last three months as we believe a bullish rotation within equities may be taking place.
- The important third quarter earnings season is just gearing up, with expectations having been downgraded over the past couple of months, setting up the likelihood of a good quarter relative to expectations.
- However, some improvement in economic data and higher inflation readings leaves the possibility of tighter monetary policy from the Fed and even other central banks.
Flat, but not boring
U.S. equity indexes have made little headway over the past few months, but flat is relatively impressive given the obstacles of Fed and election uncertainty, some softer economic data, downgrades in earnings, and valuation concerns. But investors remain skeptical as sentiment, according to the Ned Davis Research (NDR) Crowd Sentiment Poll, remains neutral. Fund flows continue to show money flowing out of equity funds and into bond funds. The continued nervousness is understandable given the uncertainty, but we urge investors to stick with their long-term asset allocation and be careful about chasing yield. For income-oriented investors, do note that the percentage of S&P 500 stocks that have dividend yields above the 10-year Treasury yield is now near an all-time high at roughly 60% (NDR). For context, that’s up from below 10% between 1980 and 2000. The message is not to ignore the income that the equity portion of your portfolio may be generating.
We remain cautiously optimistic about stocks despite the recent sideways movement and the very real possibility of some “October surprises.” But remember, a market which is range-bound but more prone to pullbacks can allow earnings to catch up to price movements, helping to ease valuation concerns. Also, while the indexes have been flat, the rotation seen in the various sectors of the market bolsters our constructive view. Over the past three months, the more defensive sectors of utilities, consumer staples and telecommunications have been the worst performers; while the more cyclical sectors such as technology and financials have been the leaders. This indicates equity investors appear more willing to move out the risk spectrum, gaining confidence in the U.S. economic outlook. The outperformance of financials also likely reflects the belief that the Federal Reserve will hike rates later this year.
Economy perking up?
After a temporary soft patch in August, economic data has improved. The next couple of weeks will be data heavy and we’ll be watching closely to gauge likely Fed policy. We did see the closely-watched Institute of Supply Management’s (ISM) Manufacturing Index move back into territory depicting expansion—rising from 49.4 to 51.5. Importantly, the forward-looking new order component jumped from 49.1 to a strong 55.1, indicating improvement in corporate confidence in the future. Additionally, the ISM Non-Manufacturing Index—representing the much larger service side of the economy—jumped from 51.4 to 57.4, the largest single month increase in the history of the index. In addition, the new orders component rose to a robust 60.0.
Source: FactSet, Institute for Supply Management. As of Oct. 10, 2016.
The forward looking initial jobless claims remains near historic lows, while the September jobs report showed that 156,000 jobs were added. While the unemployment rate ticked slightly higher to 5.0%, it was largely due to more people entering the workforce—considered a “good” rise in the unemployment rate.
Source: FactSet, U.S. Dept. of Labor. As of Oct. 10, 2016.
Although we’ve seen some soft housing data lately, we continue to believe that a strong job market, low interest rates, and increasing in household formations will bolster the housing market and increase the already solid level of consumer confidence.
Source: FactSet, Bloomberg. As of Oct. 10, 2016.
None of this stronger data suggests we’re about to see a rapid rise in economic growth though. In fact, the Atlanta Fed’s “GDPNow” projection for third quarter growth is down to 2.2% from 3.6% in early August. But that’s still up from the 1.1% real gross domestic product (GDP) growth average in the first half of the year; while the start to the fourth quarter is showing further improvement so far. The current earnings season—and projections and outlooks—could go a long way toward building on that story. Earnings estimates have steadily declined over the past month and the year-over-year change for the third quarter is expected to be negative according to Bloomberg. But with a typical “beat” level, which we believe is quite possible, earnings could finally break their negative streak.