The stock market can handle good news and bad news but does not handle uncertainty well. Still, “uncertainty” was the catchphrase for the world stock markets’ performance in the second quarter of 2015. Dispersion among various global central banks, unrest in Russia and the Middle East, the direction and implementation of the Federal Reserve policy, the U.S. economic growth rate and the trend of the commodity prices kept the U.S. equity market entrapped in turmoil. In spite of small quarterly gains and yet another new all-time high achieved by the S&P 500 Index, the market spent the first six months of 2015 going virtually nowhere. The Dow Jones Industrial Average finished the first half of the year essentially flat at 0.03% and the S&P 500 Index barely crept into positive territory with a 1.23% advance. After spending the previous year in the losing camp, small and medium size companies reclaimed their place as the leading performers. The S&P MidCap Index and the Russell 2000 Index of small companies posted 4.19% and 4.75% gains respectively for the first six months of the year, besting their large-cap competition by a respectable margin. The NASDAQ Composite Index grew by almost 6.00% year-to-date by the end of Q2 2015 and finally – albeit briefly – reached a new high, topping the record set 15 years ago during the height of the dotcom tech bubble.
The developed international markets lost some ground in the second quarter as the MSCI EAFE Index declined by 0.37%. Emerging markets, as measured by MSCI EM Index, increased by 0.25% during Q2, with Latin America being the strongest region. The world markets finished the first half of 2015 in line with their U.S. counterparts.
The 10-year Treasury yield rose from 1.92% to 2.35% during the second quarter in light of the unequivocal statement from the Federal Reserve warning that investors should expect rate hikes to begin in 2015. As a result, bond prices declined, and the Barclays U.S. Aggregate Bond Index lost 1.69% for the quarter, ending the first half of the year by dropping 0.11%.
Economic data received in the quarter confirmed that the U.S. economy slowed to a halt in the first quarter yet again, with GDP (Gross Domestic Product) decreasing by 0.2%. As a result, the bears came out in full force with recession and bear market predictions.
However, there were numerous signs throughout the second quarter that the economy was bouncing back as the weather improved.
The U.S. manufacturing sector expanded in June with the ISM Manufacturing Index showing its highest reading in five months. New home sales hit their highest level since 2008 and existing home sales rose to a six-year high. Motor vehicle sales were at nine-year high. Job growth has been strong over the last three months, and while the average monthly gains have slowed in the first half of this year, the pace has remained strong and weekly jobless claims remained steady at historic lows. Consumer confidence improved, reaching the second highest level since January 2007, and as a result, consumers spent more. Data released by the U.S. Bureau of Economic Analysis (BEA) showed that nominal consumer spending rose 0.9% month-to-month in May 2015 – the highest monthly change since August 2009 – led by increased spending for goods, both durable and non-durable.
The Federal Reserve has been trying very hard to prepare investors for a hike in interest rates at some point this year to avoid the disruption of the financial markets through its heightened transparency. While the month of September is widely seen throughout Wall Street as the most likely starting point, the Fed made it unquestionably clear that, unless inflation accelerates unexpectedly in the near term, its move toward a more normal monetary policy stance would be slow and patient.
The first half of 2015 carried a full year’s worth of financial and geopolitical news – the rise and fall of Chinese equities, Greece’s default and its consequences for Europe, as well as the timing and the extent of the Federal Reserve move. Surprisingly enough, not only is the S&P 500 little changed for the year, but market volatility, as measured by the VIX “fear index”, kept at very tame levels through all these stories.
So, what should we expect for the rest of the year? Has the first half of 2015 been the calm before the storm, or will the bulls stay in charge, helping Wall Street shrug off every piece of bad news as the U.S. economic recovery remains a solid driver of growth?
As we’ve stated time and again, we are not in the business of making bold, aggressive predictions. We can however use our knowledge and expertise to dissect all the pieces of available information to anticipate the next move of the market. We acknowledge that the “wall of worry” for investors is high, but cannot deny that it has always been the case.
Whereas the headlines about Russian bombers approaching the U.S. west coast or ISIS militants moving on Bagdad are selling newspapers, it is important to remember that there have always been pockets of unrest in the world – if not in Russia or the Middle East, then perhaps in China, Cuba or North Korea. While we are witnessing the initial knee-jerk reaction to the developments in Greece as we write this letter, we must keep in mind that Greece’s economy is roughly half the size of Argentina’s, and Argentina’s debt default back in the 1990s was not disastrous for the global economy. Therefore, we believe that a Greek default will not implode the E.U. and will not derail the world markets. When the political pundits talk about the “highest ever” U.S. government debt, they purposely discuss it in nominal terms. Yet in real inflation adjusted terms, or as a percent of GDP, it is by far not the highest debt the U.S. has owed. As perpetual bear “experts” warn the public about the all-time highs of the market, one should realize that just because prices are high, it does not mean that they are expensive. Prices for the market follow the same rule as the prices for goods – supply and demand. The supply of stocks has gone down. There are now fewer publicly traded companies than there were 10 years ago and $2.7 trillion in money markets still waiting for the “perfect entry point” keeping demand strong.
Thus, we continue to believe that stocks will manage to grind higher over the next months with some bumps along the way as the possibility of a correction still exists. Yet, albeit unpleasant, this possible correction will most likely push the market out of its narrow “sideway” move of the past six months, as historically those narrow ranges have the tendency to break to the upside.
Dumont & Blake Investment Advisors, LLC
June 30, 2015