Summer Markets Roll

By Ketu Desai

The equity markets had a positive May; however, they remain range-bound and sideways. The S&P since hitting 2872 on January 26, has had a tough time sustaining a rally above 2750. The market rallied most of May but was unable to break 2750. Underneath the surface, only three of the eleven S&P sectors are positive YTD, tech, consumer discretionary, and energy. Energy has benefited from a strong move in oil prices, however, still lags the 11 percent move in WTI. Interestingly financials (generally benefit from rising rates) and yield-oriented sectors (generally suffer with rising rates) such as REITs and utilities have struggled this year. Small caps have outperformed large caps behind concerns about foreign economies, a trade war, and a stronger dollar driving investors to domestically-oriented small caps.

While we remain range-bound, many non-domestic markets have struggled. The global synchronized growth thesis is in jeopardy. Data out of Europe has not turned around in the second quarter like it has domestically. Atlanta Fed GDPNow is forecasting 4.7 percent growth in the second quarter for the United States, while growth appears to be stuck around 2 percent in Europe.

The Citi Economic Surprise Index has turned negative in Europe, indicating data is missing forecasts. Earnings growth in the most recent quarter will top 20 percent domestically, compared to 6.5 percent in Europe.

Performance in many emerging markets has also been disappointing. Turkey and Argentina appear to be in crisis. Bad loans on bank balance sheets and rising yields plague investors in India. Recent Chinese data has showed weaker retail sales and investment growth.

The longest stretch of growth in Japan in 28 years ended in the first quarter. Despite these concerns, the market remains supported by a strong earnings outlook across the globe, in the US earnings will likely grow near 20 percent this year, in Europe they will grow 9-11 percent, and around 15 percent in emerging markets. The earnings outlook has prevented significant declines and supported the bottom end of the range, the bulls will likely need a few more positives to break 2750.

The interconnectedness of various markets and its impact on monetary policy was on display in May. As foreign economies have struggled, and the US has shown strength, the dollar has rallied in recent weeks. Many investors until recently favored emerging markets fixed income due to the pick-up in yield, a weaker dollar, and global growth. As emerging markets showed stress, many of those fixed income investors came back to the United States, moving the US 10YR from approximately 3.10 percent back down to 2.82 percent. With the 10YR yield falling, and the Fed raising rates on the short end of the curve, the 2s/10s spread is the narrowest it has been in over 10-years. With the yield curve flattening, the dollar rallying, inflation steady around 2 percent, does the Fed slow down tightening? It seems nearly certain that the Fed will hike rates for the second time this year in June. However, the futures market indicates that we are now likely to only see 2 – 3 hikes this year, compared to 3 - 4 just a few weeks ago.

The ECB's quantitative easing program expires in September, with weaker economic numbers, do policymakers now discuss keeping the program going for longer? The expectation for rate hikes by the ECB has been pushed back later into 2019. It will be interesting to see if the both the Fed and ECB hold-off on tightening, it will have a significant impact across financial markets, and we may finally move out of this trading range.

Looking forward, the Fed will likely raise rates in June, trade negotiations will continue, and the results of bank stress tests will likely drive the sector.


Ketu Desai is the Principal of i-squared Wealth Management Inc. ( ), an investment management firm based in New Jersey.