Summer calm in June

Mike Loewengart, Vice President of Investment Strategy

E*TRADE Capital Management

07/03/17

Summertime? Time to sit back and unwind—that’s the philosophy the markets seemed to take in June. That said, below the surface there were some significant pockets of activity that investors are paying attention to as summer heats up.   

First let’s address the Fed: They bumped the federal funds rate by another 0.25% to 1.00–1.25%, as widely expected. The move suggests the committee’s plan for three hikes in 2017 remains in play. Amid soft economic data, though, some market observers left June wondering about the likelihood of this third increase. Fed Chair Janet Yellen didn’t indicate plans had changed in a June 27 speech, but her remark that asset valuations are “somewhat rich” 1 raised some eyebrows because the Fed doesn’t typically speak to asset prices.

While the yield curve continued to flatten in the bond market, the big news in equities was the #techwreck. Tech stocks fell 2.70% during the month and helped send the Chicago Board Options Exchange Volatility Index ® (VIX ®)2, which measures expected U.S. market volatility in the next 30 days, to a six-week high on June 29. But taking a yearly view on tech makes June look like more of a fender bender given the sector’s outperformance thus far in 2017. And the same could be said for the VIX, which remains low by historical standards.

CBOE Volatility Index in June

Source: Chicago Board Options Exchange

Domestic equities

Investors kept the S&P in positive territory in June, though gains were modest. Still, the index continued to hover near record highs. Joining the party were small-cap stocks, as investors sent the Russell 2000 to its best monthly performance of the year.

Domestic equity performances in June

Source: Morningstar Direct

Picking up the tech slack was a positive move from financials following the Fed and aces on the bank stress tests, along with a still-resilient health care sector. With all the political wrangling about the latest version of a replacement for Obamacare, some may be surprised that health care surged in June. The sector went on a tear, perhaps with investors seeking a less cyclical option and one typically resilient to softening economic data.
Best and worst S&P 500 sector performances in June

Source: Morningstar Direct

Technology has sector leadership midway in year-to-date performance (+17.23), though health care (+16.07%) has been gaining. Biotech stocks helped health care’s run at the end of the first half; notably, the Nasdaq Biotech Index3 was up a robust 8.56% in June. This came amid news of what has been deemed a “constructive” 4 executive order forthcoming on drug pricing.
Nasdaq Biotechnology Index year-to-date performance

Source: Yahoo Finance

International equities

Prime Minister Theresa May sent Britain to the polls looking to expand the Conservative majority in Parliament, in part to quell opposition to Brexit. But May’s gamble on an early ballot backfired, resulting in a hung Parliament. On the month, Britain’s Financial Times Stock Exchange 100 Index5 fell 2.44%. 

International equity performances in June

Source: Morningstar Direct

A highlight for Asian equities was index provider MSCI’s announcement that it will add select China stocks to its indexes. The long-awaited decision to allow stocks traded on the mainland, known as A-shares, could represent China’s continued integration into the global capital markets. In Latin America, political turmoil gripped Brazil, with President Michel Temer—the guy brought in to end corruption—formally charged with taking millions in bribes.
Emerging market equity performances by region in June

Source: Morningstar Direct

Fixed income

The yield curve, which plots interest rates for Treasuries against the length of time they have to reach maturity, continued to flatten with Fed action. The 2–10 Treasury spread hit a 10-month low during the month, with the 2-year Treasury rising and the longer-term 10-year falling amid questions about economic growth and inflation. 

2-10 Treasury yield curve spread since December 2015

Source: Morningstar Direct

Long-term Treasuries led as interest rates continued to fall amid resetting growth and inflation expectations. Investment-grade corporates were a top performer as well, with investors searching for high-quality fixed income with reduced interest-rate sensitivity. The weakest area of fixed income, Treasury inflation-protected securities (TIPS), suffered amid the declining outlook for inflation. Short-term treasuries were slightly weaker as the Fed raised rates.
Best and worst fixed income segments in June

Source: Morningstar Direct

High yield has turned in a mid-single digit performance so far in 2017, with economic growth chugging along slowly and default rates low. Long-term Treasuries have been a solid performer this year as well. There has been no shortage in demand for high-quality or safe-haven government bonds, despite the surge in equity markets. Many appear to have no issue with the interest-rate sensitivity associated with long-term government bonds, though that could change quickly if a spike in rates occurs.

The bottom line

This time of year, it’s natural for investors to turn their gaze toward the beach rather than their portfolios. But investors may want to resist the urge to put their portfolios on cruise control, and look to rebalance as necessary.

Based on market performance through the first half, tactical shifts that investors may be eyeing through their beach hats and shades include:

  • Trimming U.S. equities—Some experts are looking to ease up on large-cap U.S. equities, citing high valuations and the appearance of being stretched.    
  • Exploring smalls caps and international—Many investors are overweight in well-known large caps, so adding small caps could help increase diversification. Another strategy could be to seek exposure abroad, as developed and emerging market equities have largely outpaced their U.S. counterparts in 2017, after lagging for much of the past decade.
  • Building diversification with bonds—In a rising rate environment, some look to increase a portfolio’s diversification across bond funds to mitigate interest rate risk. Short-term, tax-advantaged municipal bonds, which have shrugged off some recent headlines, may be an attractive option.

It’s midyear. The markets have been quiet. And vacations beckon. With the lazy days of summer taking hold and Q3 in sight, now may be a good time for investors to take a look at their portfolios to see where they stand relative to their investment goals.

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.

 


1. Condon, Christopher; Matthews, Steve; Smialek, Jeanna. “Yellen Fed Ramps Up Attention Over ‘Somewhat Rich’ Asset Prices,” Bloomberg, 27 Jun. 2017. https://www.bloomberg.com/news/articles/2017-06-27/yellen-fed-ramps-up-attention-over-somewhat-rich-asset-prices

2. The Chicago Board Options Exchange (CBOE) Volatility Index® (VIX®), also called the fear index, is calculated by CBOE and generally measures expected volatility of the U.S. market in the next 30 days. The higher the number, the more bearish the market is in general. The VIX is used to calculate the put/call ratio.

3. The Nasdaq Biotechnology Index contains securities of Nasdaq-listed companies classified according to the Industry Classification Benchmark as either Biotechnology or Pharmaceuticals which also meet other eligibility criteria. The Nasdaq Biotechnology Index is calculated under a modified capitalization-weighted methodology.

4. Popina, Elena; Wang, Lu; Darie, Tatiana. “Bulls Are Going All-In on the Biotech Rally,” Bloomberg, 21 Jun. 2017. https://www.bloomberg.com/news/articles/2017-06-21/bulls-all-in-on-biotech-rally-as-stocks-surge-options-explode

5. The Financial Times Stock Exchange Index, or FTSE 100 Index, is a capitalization-weighted index of the 100 most highly capitalized companies traded on the London Stock Exchange. The equities use an investibility weighting in the index calculation.