Market Update

• Stocks open at all-time highs. U.S. equities are modestly higher in early trading and are looking to add to a 1.5% gain from the S&P 500 on Friday after nonfarm payrolls came in well above consensus. The rally was led by materials stocks, while utilities, telecom, and consumer staples lagged, though all three closed up approximately 1%. Overnight, Asian equities were higher across the board, highlighted by a 4% rise in Japan’s Nikkei Indexafter Prime Minister Shinzo Abe’s conservative coalition won a landslide victory in the upper house of  parliament, strengthening hopes for additional stimulus. In afternoon trading, European markets are also higher, led by Germany’s DAX, which is up 1.6%. Amid the risk-on mentality, the yield on the 10-year Note is up a few basis points after finishing last week at 1.36%; COMEX gold and WTI crude oil are both down modestly, with crude hovering just above $45/barrel and gold trading hands at $1,356/oz.

Macro View

• Earnings recession likely to continue for one more quarter. Earnings season kicks off today with Alcoa’s quarterly results after the close and 13 other S&P 500 companies, mostly financials, reporting this week.Thomson-tracked consensus estimates for the second quarter are calling for a year-over-year drop of 4.8% (or 1.3% ex-energy); therefore, breakeven may be as good as it gets, given S&P 500 earnings have only produced more than 5% upside in once quarter over the past five years (Q1 2015). With the S&P 500 at fresh all-time highs this morning and valuations at the high end of the current bull market’s range, market participants will be looking to corporate America to potentially drive the next leg higher. See our recent Weekly Market Commentary for our thoughts on the upcoming earnings season.

• Earnings growth could possibly resume in Q3. As the drags from the oil decline and the strong U.S. dollar abate, S&P 500 earnings growth could possibly resume in the current (third) quarter. Consensus currently stands at +1.7% for the third quarter, while estimates reflect a 10% increase in earnings over the next four quarters. The resilience of estimates since the Brexit vote and corporate America’s manageable exposure to the U.K. suggest to us that earnings expectations may hold up well this season and potentially help stocks maintain recent gains in the short term.

• Valuations slightly below prior highs. The S&P 500 trailing price-to-earnings ratio (PE) stands at 17.7 times, marginally below the 17.9 times level reached at the S&P 500 highs back in the spring of 2015. On a forward four quarters (or next 12 months) PE basis, the S&P 500’s 16.7 is below the 2015 peak at 17.4. We continue to view stock market valuations as fair, given low interest rates, but acknowledge PEs are in the range when many prior bull markets have ended. As we have written many times, bull markets don’t end because of age or high valuations, they need catalysts; usually economic excesses cause recessions, a scenario we do not see in the next 12 months. More on that in our Midyear Outlook 2016 publication due out tomorrow.

• Another weekly gain for equities. The S&P 500 gained 1.3% last week, coming on the heels of adding 3.2% the week before. This was the ninth straight time since 2012 the week following a 3% gain was higher. More impressive was the action under the surface, as the more aggressive areas led for the week. Remember, for much of this year the defensive areas like telecom and utilities have been the leaders, but last week saw small cap, tech, growth, healthcare, and consumer discretionary lead. The question is, can these historically more “risk-on” groups continue to lead? Last week was a nice start.

• New highs on the horizon. The S&P 500 gained 1.5% on Friday to close less than one point away from the all-time closing high set May 21, 2015. We’ve noted before that market breadth has been strong and variousadvance/decline lines have already made new highs, suggesting price will likely follow. So the S&P 500 didn’t close at a new daily all-time high, but it did close at a weekly all-time high for the first time since mid-July. That comes out to 50 weeks without a new high, the longest streak since September 2008.

• More of the same in Japan. The conservative coalition led by Prime Minister Abe’s Liberal Democratic Party (LDP) won a victory over the weekend in Japan’s upper house of parliament. The upper house is less powerful, and therefore less important to the market, than the lower house. Still, the victory for Abe’s coalition suggests further fiscal stimulation. The Japanese yen weakened on this news and the stock market rallied 3.6%.

• Greater leadership clarity in the U.K. The next U.K. Prime Minister is likely to be current Home Secretary Theresa May. May supported the “remain” camp during the referendum campaign but has promised to support the leave mandate, though on an extended time frame. The markets were pleased with this result, with both the pound and the U.K. stock market gaining ground after the announcement.

• Fed, China, central banks dominate the week ahead.With the June jobs report in the rearview mirror, markets will focus on key data coming out of China this week (Q2gross domestic product [GDP], imports and exports, retail sales, and property prices for June) along with nearly a dozen Federal Reserve Bank (Fed) speakers. In addition, the Fed’s Beige Book is due out on Wednesday, July 13 ahead of the July 26-27 FOMC meeting. The Bank of Canada and Bank of England (BOE) meet this week, with the BOE expected to cut rates in response to Brexit. The U.S. data calendar is highlighted by a post-Brexit view on manufacturing (Empire State Manufacturing) and pre-Brexit views on retail sales, inflation, and industrial production.

• Over the last month, the LPL Financial Current Conditions Index (CCI) fell 5 points to 179. The CCI remains near the low end of its range for the current expansion, indicating the economy may still be experiencing below-trend growth. Almost the entire decline was due to an elevated VIX (a measure of market volatility) immediately following the U.K.’s referendum vote to leave the EU (Brexit). Seven of 10 components actually rose, with shipping traffic and retail sales making the largest positive contributions. View the CCI.

Monitoring the Week Ahead

Monday

 

• George (Hawk)
• Mester (Hawk)
• European Area Finance Ministers in Meeting in Brussels

 

Tuesday

• NFIB Small Business Optimism Index (Jun)
• JOLTS (Jun)
• Bullard (Hawk)
• UK: Bank of England’s Carney Speaks on Financial Stability to Parliament

Wednesday

• Beige Book
• Kaplan (Hawk)
• Canada: Bank of Canada Meeting (No Change Expected)
• China: Imports and Exports (Jun)

Thursday

• Initial Claims (7/9)
• UK: Bank of England Meeting (Rate Cut Expected)
• China: GDP (Q2)

Friday

• Retail Sales (Jun)
• CPI (Jun)
• Empire State Mfg. Index (Jul)
• Consumer Sentiment and Inflation Expectations (Jul)

Sunday

• China: Property Prices (Jun)

Click Here for our detailed Weekly Economic Calendar

 

Important Disclosures

Past performance is no guarantee of future results.

The economic forecasts set forth in the presentation may not develop as predicted.

The opinions voiced in this material are for general information only and are not intended to provide or be construed as providing specific investment advice or recommendations for any individual security. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly.

Stock investing involves risk including loss of principal.

Investing in foreign and emerging markets securities involves special additional risks. These risks include, but are not limited to, currency risk, political risk, and risk associated with varying accounting standards. Investing in emerging markets may accentuate these risks.

Treasury inflation-protected securities (TIPS) help eliminate inflation risk to your portfolio, as the principal is adjusted semiannually for inflation based on the Consumer Price Index (CPI)—while providing a real rate of return guaranteed by the U.S. government. However, a few things you need to be aware of is that the CPI might not accurately match the general inflation rate; so the principal balance on TIPS may not keep pace with the actual rate of inflation. The real interest yields on TIPS may rise, especially if there is a sharp spike in interest rates. If so, the rate of return on TIPS could lag behind other types of inflation-protected securities, like floating rate notes and T-bills. TIPs do not pay the inflation-adjusted balance until maturity, and the accrued principal on TIPS could decline, if there is deflation.

Bank loans are loans issued by below investment-grade companies for short-term funding purposes with higher yield than short-term debt and involve risk.

Because of its narrow focus, sector investing will be subject to greater volatility than investing more broadly across many sectors and companies.

Commodity-linked investments may be more volatile and less liquid than the underlying instruments or measures, and their value may be affected by the performance of the overall commodities baskets as well as weather, disease, and regulatory developments.

Government bonds and Treasury bills are guaranteed by the U.S. government as to the timely payment of principal and interest and, if held to maturity, offer a fixed rate of return and fixed principal value. However, the value of fund shares is not guaranteed and will fluctuate.

Investing in foreign and emerging markets debt securities involves special additional risks. These risks include, but are not limited to, currency risk, geopolitical and regulatory risk, and risk associated with varying settlement standards.

High-yield/junk bonds are not investment-grade securities, involve substantial risks, and generally should be part of the diversified portfolio of sophisticated investors.

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Investing in real estate/REITs involves special risks such as potential illiquidity and may not be suitable for all investors. There is no assurance that the investment objectives of this program will be attained.

Currency risk is a form of risk that arises from the change in price of one currency against another. Whenever investors or companies have assets or business operations across national borders, they face currency risk if their positions are not hedged.

Technical Analysis is a methodology for evaluating securities based on statistics generated by market activity, such as past prices, volume and momentum, and is not intended to be used as the sole mechanism for trading decisions. Technical analysts do not attempt to measure a security’s intrinsic value, but instead use charts and other tools to identify patterns and trends. Technical analysis carries inherent risk, chief amongst which is that past performance is not indicative of future results. Technical Analysis should be used in conjunction with Fundamental Analysis within the decision making process and shall include but not be limited to the following considerations: investment thesis, suitability, expected time horizon, and operational factors, such as trading costs are examples.

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