Written by: Salvatore J. Bruno ; Mark Lacuesta, FRM, CAIA, CIPM
Markets In a sharp U-turn, the S&P 500 Index returned 7.05% in June. YTD, this was the second largest monthly return. Both January and June 2019 monthly returns each followed large drawdowns from their prior months. U.S. small caps followed a similar path as large caps, returning 7.07% in June. Global markets continue to lag the U.S. with the MSCI EAFE returning 5.93%. Emerging Markets fared better in June with the MSCI EM Index returning 6.24%. The U.S. yield curve steepened with Short-Term yields dropping more than longer-term yields, resulting in the 2 and 10-year yield spreads widening. The Bloomberg Barclays US Aggregate Bond Index was up 1.26% while the Bloomberg Barclays US Universal (US Aggregate plus High Yield) Index returned 1.41%. The Bloomberg Barclays US Treasury Bond Index returned 0.92% while the Bloomberg Barclays US Corporate Bond Index returned 2.45%. The Bloomberg Barclays US Short-Term Treasury Bond Index returned 0.36% while the Bloomberg Barclays US Long Treasury Bond Index returned 1.34%. Along with the strong equity market and Fed cut expectations, credit outperformed treasuries and long-duration outperforming short-duration. Oil prices reacted to exogenous shocks in June with the mid-month attack of two oil tankers in the Persian Gulf and from a fire at the U.S. East Coast’s largest refinery. Due to supply disruption concerns, WTI spot prices were up 9.07%. In other commodities, Industrial Metals were up 1.82%, Precious Metals up 7.26%, and Softs up 3.02%. Small Cap REITs outperformed Large Cap REITs in June with the Bloomberg Real Estate Investment Trust Small Cap Index returning 4.31% versus 1.54% by the Bloomberg Real Estate Investment Trust Large Cap Index. 6 of the 8 tracked hedge fund strategies performed positively in June. Global Macro was the highest performing strategy in June while Merger Arbitrage was the only negative returning strategy. Distressed strategies were flat. Hedge Funds posted their best first half since 2009.
Economic Data Q1 2019 GDP QoQ growth was re-confirmed at 3.1%. The prior 3 quarterly GDP growth figures were 2.2% for Q4 2018, 3.4% for Q3 2018, and 4.2% for Q2 2018. The June CPI (YoY) report shows soft Headline inflation of 1.8%, down from 2.0% in the prior report. Core CPI remains relatively flat at 2.0% versus 2.1% from the prior report. On a MoM basis, Headline inflation was 0.1% (down from 0.3%) and Core inflation was 0.1% (unchanged from the prior month). Soft inflation below the Fed’s target would fuel further speculation of a rate cut. The most recent PMI and ISM manufacturing measures each disappointed, falling from their prior levels and missing the survey estimates. The PMI was reported at 50.5 from 52.6 in the prior report while the ISM came in at 52.1, down from 52.8. In June, the April Durable Goods report was finalized at -2.1% while the May (Preliminary) figure is at -1.3%. Over the last 12-months, the Durable Goods report was split evenly between Up and Down periods. While the Services PMI came in at the survey estimate of 50.9, the latest report was also below the prior report of 53. Retail Sales have shown more life, up 0.5% versus -0.2% in the prior month. Retail inventories have not changed, holding steady at 0.5% while Wholesale Inventories are up 0.4% compared to 0.8% in the prior month. The most recent housing data shows an improvement in new Mortgage Applications which are up 1.3% versus -3.4% in the prior report. While new home sales are down -7.8% on lower Building Permits growth of 0.3%, existing home sales are up 2.5% and pending home sales are likewise up 1.1%. The Unemployment Rate was unchanged at 3.6%. The May JOLTS Job Opening report was at 7449, dropping below the survey estimate and the prior period. The change in Private Payrolls also underwhelmed, coming in at 90k versus 236k in the prior period and the survey estimate of 174k. Measures of sentiment were divergent, with the Conference Board Consumer Confidence indicator reported at 121.5, missing the survey expectation of 131.0, and falling short of the prior report of 134.1. Alternatively, the University of Michigan Sentiment measure was reported at 98.2, slightly beating the prior report and expectation of 97.9.
Central Bank The U.S. Federal Reserve June meeting resulted in maintaining the upper bound unchanged at 2.50%. Parsing through the Fed minutes, the word “patient” was dropped, and the Fed communicated it would “act as appropriate to sustain the expansion”. Trade war risks have been the key rationale behind a potential Fed cut. The ECB has signaled a willingness to continue providing monetary stimulus through rate-cuts and asset purchases. The BOE has also signaled the possibility of a rate cut should a no-deal Brexit and global trade risks persist.
Sell in May, but Don’t Go Away
The U.S. market rebounded from its May “spring fever” to reach newer highs, topping off at 2954.18 on June 20, to outperform the rest of the world to end the month and the first half of the year. However, we were reminded that both exogenous and endogenous shocks remain an impetus for market moves. The narrative of geo-political risks, tight employment, trade wars, and slowing growth persist as we head into the second half of 2019.With the Iran Nuclear deal showing further signs of fraying, the oil tanker attack in the Persian Gulf highlighted how geo-political risks can have a direct market impact. The risk of supply disruption, further compounded by the PES oil refinery fire, caused a jump in the price of energy.This spike in energy prices may appear in the next headline CPI report as the U.S. continues to challenge the softer than expected inflation that has called into question the Fed’s more recent rate increases. While the Fed’s recent dovish rhetoric has raised the possibility of potential rate cuts in the future, the Fed’s other mandate of full employment remains satisfied. However, wage growth was dealt a blow with the disappointing change in the recent Non-Farm Payrolls report of 75k, down from the previous report of 263k and far from the survey estimate of 175k.Currently, both the recent Manufacturing and Services PMI figures have come below their prior report. While the change in ISM New Orders has been positive, the ISM Prices Paid have risen by a larger margin. As the concern for the trade war persists, the risk of rising input costs may begin to dampen productivity thereby threatening overall economic growth.The final act of the first half of 2019 concluded with the G-20 summit in Japan where Trump and Xi agreed to restart trade talks, and while he was in the neighborhood, Trump and Kim met at the DMZ to shake hands.As markets continue to operate, teasing out the noise from the signal may continue to provide challenges for market participants, challenging the anecdotal advice of “Sell in May and go away”.Related: Are Small Cap REITS Undervalued?