June’s Improved Optimism on Trade Helps Buoy Risk Assets Despite Mixed Economic Signals
Fed appears poised to cut rates for first time since 2008.
The second quarter is done and dusted, but market participants and futures markets appear to have received confirmation during the second week of July that the interest rate cut they were looking for in June may be imminent.
In prepared testimony for the House Financial Services Committee for Wednesday July 10, Federal Reserve Chairman Jerome Powell said that many Federal Open Market Committee members at its meeting in June saw that the case for a more accommodative monetary policy had strengthened.
Since then, based on income data and other developments, “it appears that uncertainties around trade tensions and concerns about the strength of the global economy continue to weigh on the U.S. economic outlook,” he said, in the prepared testimony.1 The news helped briefly send the S&P 500 past 3,000 for the first time in its history.
The Fed Chairman’s testimony followed what was a strong report on U.S. employment, which kicked off July’s monthly economic releases following the Independence Day Holiday. Until the July 10 testimony, the labor market’s showing in June appeared to have clouded the picture as to how aggressively the Federal Reserve would cut short-term interest rates at its upcoming two-day meeting in July.
Payrolls Exceed Forecasts
Despite signs of weaker global growth and slowing activity in the manufacturing sector, U.S. employers added 224,000 jobs to payrolls in June, according to the Labor Department’s most recent report.2
That was well above expectations following May’s addition of 72,000 jobs. Average hourly earnings rose 3.1% compared to a year ago. The unemployment rate ticked up slightly to 3.7% from 3.6% in May, still near historical lows. Job creation was notable in professional and business services, health care, and transportation and warehousing. Manufacturing employment rose in June after four months of little change. Yet, job growth in the industry has averaged 8,000 per month, compared to an average of 22,000 in 2008.
As noted above, investors and futures markets were already positioning for a rate cut from the Fed when it said in June that it was watching the ongoing trade dispute between the U.S. and China for signs of any impact on the domestic economy and signaled it would consider cutting interest rates if the economy weakened.
That was just the tonic that stocks needed to close out the quarter strongly after prices fell in May amid escalating trade tensions. Equities were further boosted in late June with news that trade talks were getting back on track following a meeting at the G20 summit in Osaka, Japan between President Trump and Chinese leader Xi Jinping.
U.S. stocks and Treasury securities closed out the second quarter on extremely high notes heading into the June jobs report. The S&P 500 had its best first-half performance since 1997, gaining 17.35% year-to-date through June 28. The Dow Jones Industrial Average recorded its best monthly gain (up 6.89% in June) since 1938, according to S&P Dow Jones Indices.3
For the first time since 2016, the yield on the benchmark U.S. 10-year Treasury note slid below 2.00% on a few occasions during June. The 10-year note’s yield has declined by about 68 basis points since the beginning of the year and closed out the second quarter at a yield of 2.006%.
U.S. stocks were able to retain their resiliency in June despite the bond market’s pessimism about the outlook for the global economy and signs that manufacturing, both domestically and abroad, is cooling rapidly. June manufacturing data showed activity in the U.S. hitting its weakest pace of expansion since October 2016. That was coupled with a report of a 30-country composite of global manufacturing activity showing activity falling to its lowest level since October 2012. (Please see Global Manufacturing Downturn Worsens, Recent Data Show, posted July 2 on BCJ Insights for more details.)
In addition, business spending has been mixed, though a factor influenced somewhat by a significant decline in transportation spending, namely commercial aircraft. Overall orders for durable goods, or manufactured items meant to last at least three years, fell 1.3% in May from the previous month, the Commerce Department reported in late June.4
The civilian aircraft and parts component of the report fell 28.2%, while new orders for defense aviation fell 15.3%. Excluding transportation, orders grew in May at a pace of 0.3%. New orders for capital goods, excluding aircraft, a gauge of business investment spending, rose by 0.4%.
Economic Growth Expected to Slow
Initial readings for second quarter gross domestic product (GDP) for the U.S. economy are slated for the final Friday in July. After posting GDP growth of 3.1% in the first quarter, the pace of economic growth is expected to slow in the upcoming quarter. Economists polled by MarketWatch expect 2.4% growth in the second quarter, though other forecasts suggest that the initial readings could be below 2.0%.5 As of early July, the Atlanta Federal Reserve’s GDPNow model estimate is for 1.3% real (inflation-adjusted) growth (the model is updated as data is released and is considered a “running” estimate based on available data).
Data from Germany suggests that the eurozone’s largest economy will register tepid growth in the second quarter. Total industrial output rose 0.3% in May compared to the previous month, however construction output declined 2.4%. After adjusting for calendar effects, total output fell 3.7% compared to a year ago, according to this report.6
In the United Kingdom, meanwhile, expectations are growing that the economy contracted in the second quarter for the first time since 2012. June survey data showed a dip in services and contraction in manufacturing and construction. IHS Markit said the June reading of its all sector PMI for the U.K. point to a 0.1% contraction of GDP.7
While trade representatives from the U.S. and China are back at the negotiating table, it may be worth keeping an eye out for how trade disputes elsewhere impact the global economy in the second half of the year. Japan has placed trade restrictions on South Korea, including on key chemicals used by South Korea’s top chipmakers for production. The U.S. has also threatened to impose tariffs against the European Union for trade restrictions related to subsidies for airplane manufacturer Airbus SE.
Real Estate: Other Factors Besides Low Mortgage Rates May Be Needed for Sales Growth
Despite mortgage rates at two-year lows and the employment market still strong, the housing market continues to show some signs of weakness. Amid what is considered to be the busiest time of the year, new home sales fell 7.8% in May compared to the previous month. Figures from the Census Bureau did show a year-to-date increase of 4.0% compared to a year ago.8
Commenting on the report, the National Association of Home Builders (NAHB) said that sales growth in the $200,000-$300,000 price range indicates middle-class demand is being supported by low mortgage rates and solid employment. The NAHB said it expects June figures to rebound based on these conditions.9
Builder confidence among its members remained solid in June, though not as strong as it was in May, amid sound demand for single-family homes. The NAHB said its members do continue to report rising development and construction costs, as well as trade-related issues. Builders have experienced some respite this year from the surge in lumber prices during 2018, though lumber prices again picked up in June.10
Conditions appear to have loosened up in the existing-home market. Sales in May increased for the first time in two months. Sales were up 2.5% compared to April, yet still down 1.1% from a year ago, according to the National Association of Realtors (NAR). The current sales pace does show that consumers are eager to take advantage of lower mortgage rates which have helped increase purchasing power.11
Yet, whether it’s on the new or existing side of the housing market, it’s becoming clear that low mortgage rates may not be enough to revive sales because affordability and availability issues still remain. The NAR’s recent release shows that the median existing-home price in May was up 4.8% to $277,700, the 87th straight month for price gains. In addition, while inventory is up 2.7% from a year ago, unsold inventory at a 4.3-month supply at the current sales pace, remains near historic lows, and thus, impacting prices.
The prospect that lower mortgage rates would help boost sales and earnings has also been a factor in the strong gains this year experienced by publicly traded homebuilders. The S&P Homebuilders Select Industry Index has risen by 28.16% since the start of the year through the second quarter, far outpacing the broader S&P 500’s 17.35% gain and the much broader S&P 1500, which is up 18.37%. Homebuilding stocks are even outpacing the S&P 500 Information Technology sector, which has gained 26.12% in price terms.
Whether or not the sector’s rally continues into the second half of the year, it’s worth noting that sales and earnings momentum could face pressure given that this year’s peak selling season has come and gone.
Markets: June’s Performance Helps Equities Eke Out Quarterly Gains
The strong performance for U.S. stocks in the second quarter doesn’t paint the full picture of the ups and downs during the past three months. Performance was strong in April, volatile in May and positive again in June. As briefly mentioned earlier, the S&P 500 had its best first-half performance since 1997, while the Dow Jones Industrial Average (DJIA) put in its best monthly gain since 1938.
On a quarterly basis, price returns look a bit less supernatural. The S&P 500 posted a 3.79% gain, while the DJIA rose 2.59%. The Nasdaq Composite recorded a quarterly gain of 3.58%. The technology heavy index is the best performer year-to-date out of the major U.S. indexes, with a gain of 20.66%.
Stocks closed out the quarter on a strong note despite continued fears of slowing global growth, uncertainty over trade and a significant drop in sovereign bond yields – another signal of concerns for global economic output. Notwithstanding the most recent employment report for June, payroll growth in May was weak and survey data from the manufacturing sector also weighed on some sectors of the market during the second quarter.
The energy, materials and industrials sectors, fell significantly during May as prices for commodities, including copper and oil, declined. Those sectors were able to rebound smartly in June. Materials (up 11.48% in June) and energy (up 9.07% last month) led the S&P 500’s 11 sectors in terms of performance. The materials sector rose on support from a weaker dollar and a rally in gold prices ─ the precious metal hit to six-year highs in June. (Please see Market, Macro Forces Support Recent Gold Rally, posted June 27 on BCJ Insights for more details.)
Optimism of a thaw in the trade dispute between the U.S. and China also helped lift the materials sector, as well as information technology (up 9.05% in June). Lagging the leaders were those sectors within the S&P 500 viewed as defensive and less sensitive to the economic cycle, such as utilities (up 3.09%) and real estate (up 1.26%), according to data from Dow Jones Indices.
Shares of small-capitalization stocks, generally viewed as a haven from overseas turmoil, had a strong June with the Russell 2000 posting price gains of 6.90%. Even as it trailed the broader indexes tracking larger-cap stocks (up only 1.74% in the second quarter), the small-cap benchmark has had a strong year, posting gains of 16.17% year-to-date through the second quarter.
Overseas, the STOXX Europe 600 Index rose 2.97% in the second quarter (in U.S. dollar terms). With the negative interest rate environment (the German 10-year bund was yielding about -0.33% at the end of the quarter), sectors such as banks and real estate haven’t fared well in recent weeks.
While manufacturing data has been weak in most of the eurozone’s major economies (with France an exception), the services component of purchasing managers activity showed strong expansion in June. The index was up 6.57% in June, helped along by suggestions from the European Central Bank that it would further loosen monetary policy if weak economic data persisted.
In Asia, the macro themes that helped drive positive performance for stocks in the U.S. and Europe, namely optimism over trade talks, the potential for U.S. rate cuts and a weaker dollar, also led to gains in June for equity markets in China and Korea.
The S&P China BMI (Broad Market Index) rose 6.97% this past month, though it fell 4.62% for the second quarter. Amid mixed economic data and some fallout from the trade dispute with the U.S., the Chinese government continues to support domestic growth, while the central bank injected more than $100 billion into the money markets in June to aid liquidity in the banking sector. Stocks in Korea, as tracked by the S&P Korea BMI also fell during the second quarter (down 2.24%), but posted strong gains in June (up 7.69%), helped by strong demand for technology stocks.
Commodities: Higher Oil, Gold Prices Lead Physical Assets
Commodity prices were volatile during the second quarter, but a weaker U.S. dollar and heightened tensions between the U.S. and Iran helped lift gold prices to six-year highs in June, while oil prices also rose.
Brent crude prices were up 3.19% in June, despite concerns over global growth. Adding to the tensions between the U.S. and Iran and geopolitical risks in the oil market were tanker attacks in the Strait of Hormuz and the Gulf of Oman. Expectations that OPEC would agree to extend its production cuts also helped Brent to rise in June. (The group’s members agreed July 1 to extend its current production deal through March 2020.)
While Brent crude fell 2.69% during the second quarter, the global oil benchmark is still up 23.70% year-to-date through June. Here in the states, West Texas Intermediate prices were up 9.29% in June, boosted during this past month by strong exports, declining inventories, and a major refinery outage on the East Coast. Similar to Brent, WTI prices fell in the second quarter (down 2.78%) but have rallied strongly this year, gaining 29.04%.
A broader look at commodities show that the S&P GSCI was up 4.4% in June and 13.3% year to date. The index tracks agricultural, energy and metals contracts. The Dow Jones Commodity Index gained 3.1% in June and 6.9% through June, a reflection of its lower energy weighting. S&P Dow Jones Indices said the recovery in petroleum prices and impressive gold rally were the main drivers of the broad commodities indexes’ recent performance.12
1-Board of Governors of the Federal Reserve System. (2019, July 10.) Semiannual Monetary Policy Report to the Congress. Retrieved from: https://www.federalreserve.gov/newsevents/testimony/powell20190710a.htm
2-Bureau of Labor Statistics. (2019, July 5). The Employment Situation — June 2019 [Press Release]. Retrieved from: https://www.bls.gov/news.release/pdf/empsit.pdf
3-Silverblatt, H. (2019, July 2). Market Attributes: U.S. Equities June 2019. S&P Dow Jones Indices Market Attributes®. Retrieved from: https://us.spindices.com/documents/commentary/market-attributes-us-equities-201906.pdf?force_download=true
4-U.S. Department of Commerce. (2019, June 26). Monthly Advance Report On Manufacturers’ Shipments, Inventories And Orders May 2019 [Press Release]. Retrieved from: https://www.census.gov/manufacturing/m3/adv/pdf/durgd.pdf
5-Bartash, J. (2019, June 27). First-quarter GDP left at 3.1% as stronger business investment offsets weaker consumer spending. MarketWatch. Retrieved from: https://www.marketwatch.com/story/first-quarter-gdp-left-at-31-as-stronger-business-investment-offsets-weaker-consumer-spending-2019-06-27
6-Dow Jones. (2019, July 9). German Industrial Production Edged Higher in May. Published on Hellenic Shipping News Worldwide. Retrieved from: https://www.hellenicshippingnews.com/german-industrial-production-edged-higher-in-may/
7-IHS Markit. (2019, July 3). IHS Markit/ CIPS UK Services PMI® [Press Release]. Retrieved from: https://www.markiteconomics.com/Public/Home/PressRelease/03e2ca7232564acf8d8867ca7bc1dbd3
8-U.S. Census Bureau. (2019, June 25). Monthly New Residential Sales, May 2019 [Press Release]. Retrieved from: https://www.census.gov/construction/nrs/pdf/newressales.pdf
9-The National Association of Home Builders. (2019, June 25). New Home Sales Decline In May [Press Release]. Retrieved from: https://www.nahb.org/news-and-publications/press-releases/2019/06/new-home-sales-decline-in-may.aspx
10-The National Association of Home Builders. (2019, June 17). Builder Confidence Solid in June Amidst Growing Economic Uncertainty [Press Release]. Retrieved from: https://www.nahb.org/news-and-publications/press-releases/2019/06/builder-confidence-solid-in-june.aspx
11-The National Association of Realtors. (2019, June 21). Existing-Home Sales Ascend 2.5% in May [Press Release]. Retrieved from: https://www.nar.realtor/newsroom/existing-home-sales-ascend-2-5-in-may
12-Boal, F. (2019, July 2). Commodities Performance Highlights – June 2019. S&P Dow Jones Indices, Indexology Blog. Retrieved from: https://www.indexologyblog.com/2019/07/02/commodities-performance-highlights-june-2019/
Sources for Market Data:
Dow Jones Industrial Average:
U.S. 10-year Treasury Note:
S&P Homebuilders Select Industry Index:
Other S&P Indexes:
STOXX Europe 600 Index USD:
West Texas Intermediate:
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