Market Update for the Month Ending May 31st, 2015

Presented by Rich Tegge

A weak end to a strong month

U.S. financial markets were strong in May, despite weak economic reports. After rising between 2 percent and 3 percent at mid-month, stocks dropped somewhat at month-end but still managed to register positive returns. All major U.S. equity markets posted gains, with the Dow Jones Industrial Average up 1.35 percent, the S&P 500 Index up 1.29 percent, and the Nasdaq up an even stronger 2.60 percent.

The good performance in May was driven largely by unexpectedly positive corporate earnings news. Although earnings growth of 0.7 percent for the first quarter is nothing to get too excited about, expectations had been for a decline of almost 5 percent. But earnings gained even though revenues declined, down 2.9 percent.

Despite the less-than-stellar overall earning results, however, most companies did well. Much of the decline in estimated earnings had come from energy companies, buffeted by the downturn in oil prices. Per FactSet, if we exclude the energy sector, company earnings growth was actually 8.5 percent instead of 0.7 percent. As more companies reported during May, the better-than-expected results became increasingly clear and investors moved into the market.

Technical factors remained supportive for the U.S. markets. All three major indices finished the month well above their 200-day moving averages, as their weak closes appeared to be due to concerns about Greece and the European Union (EU) rather than U.S. factors. With more required Greek debt payments coming in June, the ability of Greece to pay is doubtful and the potential for risk is very much alive.

Developed international markets performed very similarly to the Dow and S&P 500 for most of May but suffered more severely at month-end. Even though the MSCI EAFE Index was up almost 3 percent in mid-May, it finished the month with a 0.51-percent percent loss. Just as with the U.S. markets, the cause for the decline appeared to be worries around a Greek default. Technical factors remained supportive, however, with the index closing well above its 200-day moving average, suggesting that its fundamentals are still strong. This is also supported by slow improvements in the European economies.

Emerging markets, as reflected in the MSCI Emerging Markets Index, were hit even harder than developed markets, moving from a gain of 1 percent mid-month to a loss of 4.16 percent at month-end. Here, however, the technical picture is weaker, as the index approaches a worrisome level. Continued concerns about an expensive dollar and its effect on emerging markets, combined with worries about Greece, drove markets down.

Fixed income markets also had a weak May, with the Barclays Capital U.S. Aggregate Bond Index reporting a loss of 0.24 percent. U.S. Treasury rates declined slightly, but underperformance in spread-based and credit products hurt market performance as a whole. Weakness in the fixed income universe was across the board, with all indices down for the month, as shown in the chart.

Source: Morningstar^® Direct

Another first-quarter “snowdown” for U.S. economy

The gross domestic product report released at month-end, showing that the U.S. economy had actually shrunk 0.7 percent in the first quarter of 2015 instead of growing slightly, was consistent with last year’s experience. In addition to unseasonable weather throughout the country again—with the Northeast, for example, enduring the worst winter ever recorded—a strike at West Coast ports hit supply chains across the nation. Although these were both considered unusual and temporary factors, their damage was nonetheless significant.

Despite the short-term nature of the disruptions, a spring recovery is proving slower to appear this year than last. Economic reports have been lukewarm, with consumer spending in particular not living up to expectations. In addition, estimates for second-quarter growth, though still positive, are expected to be modest.

The weak indicators notwithstanding, job growth remains strong. A disappointing March jobs report was followed by a gain of 223,000 jobs in April, with the workforce participation rate rising and the unemployment rate down. At 5.4 percent, the unemployment rate has declined to a level consistent with what the Federal Reserve (Fed) has historically considered full employment. Initial unemployment claims, another good sign of the strength of the jobs market, are close to multiyear lows.

Even though job growth has stayed strong, consumer confidence has been mixed, with some surveys showing declines and others gains. Regardless of the survey, however, the significant result has been that consumer spending growth remains slow. At the same time, personal income growth has been strong, indicating that the financial situation of the average consumer is improving despite the short-term caution in spending.

Given the mix of positive fundamentals and consumer caution, slow growth should continue in the second quarter. As the financial positions of consumers improve, however, faster sustainable growth becomes increasingly likely and may show up in the second half of the year.

Central banks and interest rates

No news was good news from the Fed in May. According to the minutes of their last meeting, members of the Federal Open Market Committee generally considered the slow first quarter to be due to temporary factors, signaling that continued growth is likely. At the same time, however, any interest rate increases are now expected to be in the second half of the year, at the earliest.

The combination of Fed confidence in the economy and continued low rates through at least September suggests that interest rates will remain supportive of the economy and stock market for the next couple of months. Also helping will be continued monetary stimulus by the central banks of both Europe and Japan, even as the Fed looks to increase rates.

International risk remains

Although conditions in the U.S. are improving, at the international level risks remain. Europe is the focus for the moment, with June deadlines fast approaching for Greece to repay substantial sums to the International Monetary Fund and the European Central Bank—repayments that it cannot make, as previously noted. Although the most probable outcome is a new deal—with a commitment for the EU to continue its support of the Greek government—time is running out and tempers are running high. Nevertheless, even if Greece were to default, systemic risk is much lower now than in the past, though uncertainty is still rattling markets.

Two longer-term risks also resurfaced in May. The first is that the British government is now committed to a referendum on membership in the EU. The success of the anti-EU parties in Britain in demanding such a referendum should encourage this possibility in other countries. In addition, although the slow European recovery continues, unemployment is at depression levels in many EU countries. Moreover, election results throughout the EU suggest that it is not just the Greeks who are running out of patience with current austerity policies. Expect to see considerably more uncertainty around Europe through the rest of 2015.

The second major risk is China. Growth continues to disappoint, and its government continues to slowly increase stimulus, despite an earlier attempt to eliminate it. Perhaps in response to domestic concerns, China has become much more aggressive with respect to other countries, expanding its installations in what the U.S., for one, considers international waters in the South China Sea. These actions, which have led the U.S. to send air and naval forces into the contested areas, are also leading Japan to consider a more aggressive defensive stance and will very likely continue to be a disruptive influence in Asia and around the world.

Slow growth continues, on a sustainable basis

With the U.S. economy on the mend and the bulk of the financial risk coming from international issues, it seems as if we are moving back to normal. We are not quite there yet, but we are indeed getting closer.

Normal does not mean, however, that risks have gone away. As mentioned previously, Greece and China represent immediate risks, and although the U.S. recovery is expected to continue, that is neither guaranteed nor something that will go on forever. Cautious optimism remains the appropriate outlook for investors. As always, a long-term perspective and diversified portfolio are the best ways to meet your goals.

 All information according to Bloomberg, unless stated otherwise.

 Disclosure: Certain sections of this commentary contain forward-looking statements that are based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is not indicative of future results. Diversification does not assure a profit or protect against loss in declining markets. All indices are unmanaged and investors cannot invest directly into an index. The Dow Jones Industrial Average is a price-weighted average of 30 actively traded blue-chip stocks. The S&P 500 Index is a broad-based measurement of changes in stock market conditions based on the average performance of 500 widely held common stocks. The Nasdaq Composite Index measures the performance of all issues listed in the Nasdaq Stock Market, except for rights, warrants, units, and convertible debentures. The MSCI EAFE Index is a float-adjusted market capitalization index designed to measure developed market equity performance, excluding the U.S. and Canada. The MSCI Emerging Markets Index is a market capitalization-weighted index composed of companies representative of the market structure of 26 emerging market countries in Europe, Latin America, and the Pacific Basin. It excludes closed markets and those shares in otherwise free markets that are not purchasable by foreigners. The Barclays Capital Aggregate Bond Index is an unmanaged market value-weighted index representing securities that are SEC-registered, taxable, and dollar-denominated. It covers the U.S. investment-grade fixed-rate bond market, with index components for a combination of the Barclays Capital government and corporate securities, mortgage-backed pass-through securities, and asset-backed securities.

 Rich Tegge is a financial advisor located at Wealth Strategy Group, 300 S. Front Street Ste C Marquette MI  49855. He offers securities and advisory services as an Investment Adviser Representative of Commonwealth Financial Network^®, Member FINRA/SIPC, a Registered Investment Adviser. He can be reached at 906-228-3696 or at rtegge@wsginvest.com.

Authored by Brad McMillan, senior vice president, chief investment officer, at Commonwealth Financial Network.

© 2015 Commonwealth Financial Network^®