Most markets rise, but . . .
April was a mixed month for U.S. stock markets. The major indices fell at the start of the period, climbed throughout most of the month, and slumped at April's end. When it was all over, the Dow Jones Industrial Average and S&P 500 Index were up 0.62 percent and 0.39 percent, respectively, though the Nasdaq had fallen 1.89 percent.
The mixed results for the indices reflected the declines toward month-end, as all three measures had been up around 2 percent at mid-month. The late downturn appeared to have been driven by concerns about technology companies and by a surprise revenue decline at Apple, in particular.
The positive results for the Dow and S&P 500 owed a great deal to better-than-expected corporate earnings reports for the first quarter released in April. Although expectations had been revised sharply downward, actual earnings surprised to the upside—declining 7.6 percent. Although a decline isn't good, previous estimates had anticipated an 8.7-percent earnings drop for the period.
Once again, the energy sector led the decline, with the largest year-over-year decrease in earnings and sales of any sector. If we remove energy from the equation, earnings declined only 2.4 percent for the same time frame. Still, only three sectors (led by consumer discretionary) showed year-over-year growth, though six of ten sectors beat earnings expectations—a sign that things continue to be better than expected. As of the end of April, 74 percent of companies had beaten expectations for the first quarter of 2016 according to FactSet, which is above the average and another sign of improvement.
For the market as a whole, technical factors stayed strong for the Dow and S&P 500, with both indices remaining well above their 200-day moving averages. The Nasdaq, however, broke below this support level, suggesting potential weakness for smaller and technology companies.
Developed international markets fared better than U.S. markets, with the MSCI EAFE Index up 2.90 percent, although its year-to-date results are still negative and trail U.S. markets. Improvements in the economies of major European countries, along with continued stimulus from the European Central Bank, combined to support appreciation.
Results for the MSCI Emerging Markets Index were in line with U.S. markets, as it gained 0.56 percent, driven largely by China's decision to accelerate stimulus measures following fears of reduced growth in the first quarter.
For the fixed income markets, U.S. interest rates ticked up slightly. The 10-year Treasury rose from 1.79 percent to 1.83 percent in April, leading to a 0.38-percent gain for the Barclays Capital Aggregate Bond Index. But corporate high-yield bonds did best, with the Barclays Capital U.S. Corporate High Yield Index rising 3.92 percent in response to the better-than-forecasted corporate results.
. . . Spring slow to appear for the economy
U.S. economic statistics reported in April were also mixed. Employment continued to grow strongly, with job gains of 215,000 reported for March and signs that discouraged workers were moving back into the workforce. The Labor Force Participation Rate increased to 63 percent, and wage growth ticked up 0.3 percent. Business sentiment also improved, with the ISM Manufacturing Business Survey moving from contraction to expansion for the first time since last October and the ISM Non-Manufacturing Business Survey rising again after several months of declines.
Consumers, however, continued to worry. Confidence surveys and spending growth stagnated, even as retail sales for March, announced in April, were essentially flat. Actual business performance reports for previous months, also released in April, were weak, with factory orders down 1.7 percent in February and durable goods orders for March down as well. Finally, housing starts and new home sales for March came in below expectations.
Economic growth for the first quarter ratified the overall slowdown, with the gross domestic product report showing only 0.5-percent growth, well below the previous quarter's 1.4-percent figure and below analyst forecasts of 0.7 percent. Consumer spending, which constitutes the majority of the economy, continued to rise slowly. Business spending and investment, however, were hit hard by declines in oil and gas investment (driven by ongoing lower oil prices) and in capital spending on manufactured goods (driven in large part by the strong dollar). Fortunately, both headwinds appear to be fading, as seen in Figure 1, though the effects linger.
Figure 1. Trade-Weighted Value of the U.S. Dollar and Spot Oil Price (WTI $/Barrel), 2013–First Quarter 2016
Despite the very real headwinds and negative data points, longer-term trends appear to be positive. With strong job growth and higher personal savings rates, the ability of consumers to grow spending is as strong today as it has been since the financial crisis. Forward-looking indicators consistently show that faster growth over the next couple of quarters is likely. All in all, the weakness appears seasonal, with the economy poised for faster growth. Just as we saw last year, even if winter weather and other short-term factors hurt the results for one quarter, it doesn't mean that the economy has been derailed.
International uncertainty remains
Slower-than-anticipated growth notwithstanding, the U.S. economy has supported improvement in the rest of the world. Europe has returned to growth, though the political environment across the pond continues to deteriorate. The refugee crisis is still boosting anti-European political parties, and the United Kingdom is scheduled for a European Union exit referendum in June. Markets seem to be paying more attention to the economic improvement, which is a positive, but the political risks remain.
The other main area of concern, China, is also showing signs of economic improvement, as well as political risk. Even so, while China's government has dialed up its stimulus and economic growth is picking up, the shift from investment- to consumption-driven growth appears to have slowed. Political risks include rising activity in the South and East China seas and the ongoing anticorruption campaign in China's government.
A new season slowly takes hold
As we move into the second quarter, it is clear that spring is taking longer to arrive for the U.S. economy than anyone had expected. All the same, ongoing improvements in employment and consumer spending should eventually lead to better growth, and the damage from the slowdown in the oil industry and the shock from the strong dollar are passing. Despite a weak first quarter and areas of concern, the trends appear to be favorable for the real economy.
Financial markets reflect both the short-term uncertainty and long-term trends. U.S. market results for April were solid if not spectacular, and company earnings, though down, have been better than expected. Technical indicators are strong for the two most-inclusive indices. And even the risk areas, while worth watching, look solid in the short term.
Overall, our stance remains optimistic but with elements of concern about Europe and China. As always, a diversified portfolio constructed around an investor's own risk tolerance and time frame should help achieve goals, regardless of what happens in the interim.
Authored by Brad McMillan, senior vice president, chief investment officer at Commonwealth Financial Network.
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. The Barclays Capital U.S. Corporate High Yield Index covers the USD-denominated, non-investment-grade, fixed-rate, taxable corporate bond market. Securities are classified as high-yield if the middle rating of Moody's, Fitch, and S&P is Ba1/BB+/BB+ or below.