Waiting on the Fed…
Stock and bond markets were focused on the Federal Reserve Open Market Committee (FOMC) for most of the second quarter. Investors continue to wonder when the first interest rate hike will occur. Consensus estimates believe it will be at the September or October meeting. The head of the International Monetary Fund gave an unprecedented speech early in June pleading for the FOMC to wait to raise rates until 2016 so as not to derail the recovery of European and other global economies that are still emerging from weak economic conditions. It is unclear how the FOMC will respond.
At home, economic conditions continue to improve. U.S. personal incomes gained, while price pressure remained low. Nonfarm payrolls grew more than projected in May, and average hourly earnings growth jumped 0.3%. Most of the increase in income was saved as consumer spending remained flat. The unemployment rate did rise, but this was a result of more Americans entering the workforce – a positive development. Initial and continuing jobless claims continued to decline and are nearing 15-year lows.
The manufacturing sector also continued to improve even as the strengthening dollar resulted in zero export growth. Businesses increased hiring in May, bolstered by new orders. Non-manufacturing sectors slowed but maintained a healthy pace of growth according to the Institute of Supply Management (ISM).
Stocks rose slightly during the quarter. The S&P 500 inched up 0.3% and the MSCI EAFE Index, representing developed international stocks, rose 0.8%. Bonds lost ground as interest rates climbed. The yield on the 10-Year Treasury rose from 1.9% on March 31 to 2.34% on June 30. Rates likely increased as a result of positive economic expectations for the U.S. economy – a trend likely to continue.
We expect an increase in financial market volatility as we get closer to the start of a rising interest rate cycle driven by the “data dependent” policy of the FOMC. The views of market participants can be expected to shift with every surprising economic number.
Despite the volatility, it is still our expectation that the U.S. bull market will remain intact and any correction will be limited.
The odds favor further depreciation of the euro against the dollar as the monetary policies of the Fed and the ECB diverge. The 20%-plus rise in the trade-weighted value of the U.S. dollar over the past year has depressed commodity prices, with energy sector earnings estimates falling almost 37% since the start of 2015. Consumer staple stocks also face an earnings decline as the dollar’s advance hurts the prospects of large multinationals. This impact should be temporary.
America is still a net beneficiary of drastically reduced oil prices, but the pain is immediate and concentrated in places like Texas, Oklahoma, Alaska and North Dakota. The bust has dealt a stiff blow to the earnings of oil producers, while the benefits are diffused across the country and are emerging with a lag. As consumer confidence rises, an uptick in discretionary spending will result, furthering economic growth.
Changes in the markets and economy are interesting to watch and important for tactical decisions we make on your behalf when positioning the portfolio in the short and intermediate term. Far more important for successful outcomes in the long-run is your strategic asset allocation. If it has been a while since you’ve visited with us about your financial goals, please feel free to contact your account administrator. They will find a mutually convenient time to review your account and determine if the current allocation is still appropriate for your circumstances.Some trust products and IRA contributions/balances are not a deposit, not FDIC insured by any federal government agency, not guaranteed by the bank and may go down in value.