Stocks see springtime flourish, but summer storms possible

Mike Loewengart, Vice President of Investment Strategy

E*TRADE Capital Management

06/01/18
There’s a time-honored adage on Wall Street, “sell in May and go away,” which refers to the notion that the summer months have traditionally not been kind to the equity markets. While there is some truth to this concept if you dig back in time, recent history has proven otherwise. Since 2013, the Dow Jones Industrial Average has lost ground only once in May. Investors adhering to this moldy May mantra would have again missed out on gains this past month: All major US indexes ended in positive territory in May, despite the ebb and flow of tariff talk and geopolitical tensions around the globe. 
US equity performances, June 1, 2018

Source: FactSet Research Systems, June 1, 2018

The price of oil fluctuated during the month. West Texas Intermediate crude climbed above $72 dollars per barrel on May 21, before retreating to near $67 on news that OPEC and Russia had come to an agreement to boost production for the first time since 2016. That did not translate to lower gas prices at the pump, as many Memorial Day travelers were saddled with $3 per gallon prices throughout much of the country. While higher gas prices hurt consumers and may be inflationary, they can also translate into more capital expenditure for oil companies.

This month the Fed was relatively quiet and gave little indication it would stray from the three projected rate increases in store for the year. (For those keeping track, we had one in March, with another increase slated this month, followed by a final increase toward the end of the year.) But that doesn’t mean the month was not without its drama, so let’s break it down, along with what it could mean for the months ahead.

Domestic equities

The S&P 500® Index advanced 2.4% during the month—its best May performance in nearly a decade, although these gains were interspersed with sporadic volatility. Small-cap stocks outperformed large caps amid this month’s strong dollar story, as these domestically focused companies can be insulated from currency and geopolitical volatility overseas.

US equity performance, June 1, 2018

Source: FactSet Research Systems, June 1, 2018

Tech was the sector leader, on the heels of impressive earnings from the five large technology companies known as FAANGs (Facebook, Apple, Amazon, Netflix, Google (Alphabet)). Industrials and energy took silver and bronze amid rising commodity prices. Consumer staples, telecom, and utilities led to the downside—these sectors are typically viewed as safe havens with bond-like yields in the form of consistent dividends. Amid rising rates, investors may have fled these traditionally safer equity plays in favor of the now more generous payouts from lower-risk bonds.

International equities

Political turmoil in Italy took center stage as European markets dragged lower in May. Failure by two populist parties to form a coalition government led to the installation of former IMF official Carlo Cottarelli as Italy’s prime minister. His tenure could be short-lived, however. New elections are likely in the fall, which some fear could lead Italy to abandon the euro—heightening prospects for European market volatility through the end of 2018.

International equity performance

Source: FactSet Research Systems, June 1, 2018

Emerging markets continued the slide started in March amid the resurgent US dollar. Because emerging market bonds are typically denominated in US dollars, a strong US dollar can hurt emerging markets’ ability to service their debt, while also making the commodities that some of these same countries export more expensive for the rest of the world. Geopolitics in Latin America, including upcoming elections in Brazil and Mexico, likely didn’t help matters, as this region fell the most during the month. 

Fixed income

May was a good month for fixed income, as losses from early 2018 were significantly pared back. The bellwether 10-year Treasury yield went on a wild ride, rising from 2.95% to 3.11% in the first half of the month, only to retreat to 2.83%, resulting in gains for most US government bond indexes.

10-year Treasury yield, June 1, 2018

Source: FactSet Research Systems, June 1, 2018

Municipals were the top fixed income performers, continuing a long-standing trend of outperformance over taxable investment-grade bonds. A continued decline in supply within the muni market likely helped returns.

Corporate bonds, including both investment-grade and high-yield, were among the weakest segments. A flight to higher-quality assets, coupled with widening credit spreads, likely hurt corporates relative to US Treasuries. Foreign-denominated debt was also hit hard amid the rising US dollar.

The bottom line

Needless to say, there is a lot going on at home and abroad that could disrupt the markets as we welcome June. That being said, in looking at the big wide world out there, it’s important to keep in mind that relatively speaking, market observers note that our economy is on solid footing: fundamentals are strong, inflation is at the Fed’s preferred pace (for now), and the job market is well-tuned. With this as a baseline, and in taking a long-term view, disruptions in pockets of the market can be seen as opportunities for the committed investor. Some areas we’ll be looking at:

1. The European Union. Yeah, things aren’t great there at the moment. As noted, Italy is facing serious headwinds, and let’s not forget Spain is in a political crisis, too. These geopolitics likely contributed to the flight to safety in other mature markets abroad, including Japan and the UK, which did relatively well on the month. How this trend plays out will be of interest to anyone invested internationally. 

2. Emerging markets (EM). True, Latin America took a beating this month, but veteran investors will tell you that volatility is par for the course in these regions. And over the long term, EM are an important piece of the pie to consider in building a truly diversified portfolio, as one looks for exposure to markets that do not always move in lockstep with the rest of the world, yet offer the potential for upside. The case for EM exposure is still strong amid what many may find to be attractive valuations and yields.

3. The benchmark 10-year Treasury yield. In April and earlier this month investors were spooked by this benchmark’s climb above 3%. While those fears may have been overblown (more on that subject here), toward the end of May the yield pulled back dramatically, now around 2.8%. If the 10-year stays in this sub 3% range, this may help ease fears of a too-hot economy, while aiding further equity market gains. 

While the US economy is chugging along and economic indicators are generally sound, the above and more (let’s not forget Fed action and unpredictable US trade posturing) may keep the markets on edge as we head into the summer months. Keep your eyes wide open and, as always, thank you for reading.

Mike Loewengart

Vice President, Investment Strategy

E*TRADE Capital Management, LLC

 

Additional contributor:

Andrew Cohen, CFA

Director, Investment Strategy

E*TRADE Capital Management, LLC

 

Mike Loewengart is the Vice President of Investment Strategy for E*TRADE Capital Management, LLC. Mike is responsible for the asset allocation and investment vehicle selections used in E*TRADE’s advisory platforms. Prior to joining E*TRADE in 2007, Mike was the Director of Investment Management for a large multinational asset management company, where he oversaw corporate pension plan assets. Early in his career, Mike was a research analyst focusing on investment manager due diligence for the consulting divisions of several high-profile investment firms. Mike holds series 7, 24, and 66 designations, as well as the Chartered Alternative Investment Analyst (CAIA) and Certified Investment Management Analyst (CIMA) designations. He is a graduate of Middlebury College with a degree in economics.

Andrew Cohen is a Director of Investment Strategy for E*TRADE Capital Management, LLC. Prior to joining E*TRADE, Andrew was the Director of Investments and Operations for a large Registered Investment Advisor, where his responsibilities included investment manager research, asset allocation, and portfolio construction. Previously, he was a Senior Research Analyst and Team Leader for a leading wealth management platform. He is a CFA charterholder and a member of both the New York Society of Security Analysts and CFA Institute. He is a graduate of Virginia Tech with a B.S. in Finance.

 


All index data sourced from FactSet Research Systems as of June 1, 2018.