Commentaries

PMC Weekly Review - June 26, 2015

A Macro View – Mid-Year State of the Markets

It is difficult to believe that the mid-year point of 2015 is already upon us, but the slew of decisions being handed down from the Supreme Court, as well as next week’s Independence Day holiday, confirm it is so. We thought it might be an appropriate time to provide a condensed review of the economic and market environment for the first half of the year, and determine if there are any noteworthy trends worth keeping an eye on for the remainder of the year.

From an overall economic perspective, the first six months of the year have produced mixed results. To be sure, the U.S. economy remains in an uptrend, notwithstanding the contraction in real Gross Domestic Product (GDP) of -0.2% in the first quarter. Economists are quick to point out that the negative growth was due largely to temporary factors – such as the adverse impacts of last year’s decline in energy prices, as well as the slowing in exports due to the surge in the dollar – and that more recent data suggest that there is no fear of a recession. The employment situation has been more volatile in the first half of 2015 than it was in the second half of 2014, but job growth does remain robust. Through May, employers had added an average of 217,000 jobs per month, and many economists believe that job growth could accelerate to near 300,000 per month into 2016. Under that scenario, economists say that the economy would approach full employment by 2017. At the same time the unemployment rate remains relatively low at 5.5%. With the tightening in the labor market, wage growth is now also beginning to ramp up. Now in its sixth consecutive year of expansion, the U.S. economy shows few signs of letting up.

An area that is sure to attract a great deal of attention throughout the second half of the year is the Federal Open Market Committee’s (FOMC) monetary policy. After its most recent meeting at the end of June, the FOMC left unchanged its interest rate and balance sheet guidance, but the median expectation of committee members is that the Fed funds rate will rise to 0.625% by the end of the year. Such a move would imply two interest rate hikes, with most analysts expecting the Fed funds rate “liftoff” will begin in September, and that the commencement of a reduction in the Fed’s balance sheet will begin several months thereafter.

Against this backdrop, there has been upward pressure on yields of fixed-income securities. The 10-year U.S. Treasury has seen its yield climb from 2.17% as of December 31st to its current level of about 2.48%. Such has been the case across the entire yield curve spectrum, with the curve shifting higher in relatively parallel fashion as the market anticipates the end of FOMC accommodation. As yields have climbed, total returns for fixed-income securities have ebbed. As we near the end of the month, the Barclays U.S. Aggregate Bond Index has generated a total return of -0.38% year-to-date, it’s worst six-month period of performance since the first half of 2013. Global fixed-income securities fared worse during the first half, in part due to the strong rise in the dollar.

Despite the sub-par performance of fixed-income markets, equity markets have been able to trend higher, with most major indexes now in their seventh consecutive year of gains. After a poor start to the year, stocks rebounded sharply in February, and have moved steadily higher since then. The S&P 500 has delivered a year-to-date gain of +3.1%, but underlying sector performance has been varied. Health care and consumer discretionary have been the best performing sectors, with year-to-date gains of +11.9% and +8.3%, respectively. Interest rate-sensitive Utilities and Energy were the poorest performers, posting -10.5% and -3.8% losses, respectively. Small caps have finally begin to outpace large caps, but growth continues to outperform value. In a reversal of recent trends, international stocks have far outpaced domestic issues. The MSCI EAFE index has gained +9.7% year-to-date. Valuations, while no longer extremely attractive, remain in-line with long-term averages.

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