Strong month for U.S. markets
After a volatile October, U.S. stock markets turned in a very strong November, with almost all indices showing strong gains. The Dow Jones Industrial Average was up 2.86 percent for the month, while the S&P 500 Index showed a slightly smaller gain of 2.69 percent. The Nasdaq was the champion again, gaining 3.47 percent.
The best-performing stocks were those of large companies, with smaller firms achieving much smaller gains or even losses in the case of the smallest stocks. Although the U.S. markets in general did well, turmoil in the rest of the world continued to raise investors' focus on risk, which made smaller companies less attractive.
The gains for most markets were driven by strong fundamentals. Per FactSet, as of November's end, with 99 percent of companies reporting in the S&P 500, more than three-quarters had beaten estimated earnings and almost three-fifths had announced higher revenues than expected. The earnings growth rate for the third quarter came in at 8 percent, much higher than the 4.4 percent expected at the end of the quarter, due to positive earnings surprises. Gains in the market were supported by growth in actual earnings.
Markets have also been well supported technically. All major indices are well above their 200-day moving average trend lines, often a sign of continued strength. Seasonal factors are also supportive, with the end of the year historically a strong time for the markets.
U.S. fixed income also did well, with the Barclays Capital Aggregate Bond Index up 0.70 percent for November. Performance was driven by a decrease in rates, as the U.S. Treasury 10-year bond yield dropped from 2.36 percent at the start of November to 2.18 percent at month-end. Low yields in Europe and Japan, resulting from economic weakness, acted as an anchor on U.S. rates.
International markets did not fare as well. The MSCI EAFE Index, which covers developed countries outside the U.S., gained 1.36 percent, but it wasn't enough to make up for its loss in October. The MSCI Emerging Markets Index, on the other hand, declined 1.12 percent for the month, erasing its October gains. Technically, both indices are trading below their respective 200-day moving averages, suggesting potential further weakness ahead.
U.S. economy strong but exhibiting signs of slowing
The U.S. economy continued to improve. Economic growth for the third quarter was revised up in November to 3.9 percent from an already strong level of 3.5 percent, driven by higher-than-expected consumer spending and business investment. Consumers in particular have benefited from lower gasoline prices.
Employment numbers continued to show substantial growth. November marked another month of more than 200,000 job gains—214,000 to be exact, plus a revision upward of an additional 31,000 jobs for previous months. The Employment Cost Index, a better proxy for wage growth than the more commonly reported numbers, grew at very high levels for the second month in a row, and the level of voluntary quits rose to a six-year high. Business confidence remained high across the board. Additional supporting factors for continued growth include low oil and gas prices, which should help support consumer spending.
Coming after the October end of the Federal Reserve's bond-buying program, November's results were subject to concern and uncertainty, but they showed continued growth nonetheless. One potential area of concern was reports of slowing toward month-end. Although still high, consumer and business confidence surveys reported pullbacks, and employment figures also showed declines, though remaining at healthy levels.
Much of this can probably be attributed to weakness elsewhere in the world, rather than in the U.S., as export markets weakened. The question going forward will be whether the U.S. can continue to grow in the face of economic weakness around the globe.
Rest of world continues to weaken
Japan, for example, announced an unexpected return to recession last month and followed that with an announcement of a greatly expanded quantitative easing program designed to create inflation and reduce the value of the yen. This program is an expansion of previous programs, which have not succeeded in accelerating growth, and suggests a real chance that the Japanese economy will continue to grow slowly, at best.
Similarly, Europe, while not actually moving back into recession yet, has shown very slow growth levels. It remains quite possible that the continental economy will start to contract, as even German growth has declined and major economies such as France and Italy face the need to cut spending. Given these factors, Europe is approaching a decision about a quantitative easing program of its own.
Other countries with economic worries include Russia, which is suffering from low oil prices, as well as sanctions because of its actions in Ukraine, and China, which continues to report growth but at the cost of continued central bank-financed stimulus. In both cases, the likelihood is for slower rather than faster growth.
U.S. recovery moves forward despite headwinds
Further limiting the damage will be the positive effects of a stronger dollar. Among the largest of these is to make imports, especially oil, cheaper in dollar terms. Because prices are already down and U.S. oil production continues to grow (see chart), lower oil prices may be with us for a while. This could potentially boost growth enough that it offsets the losses from reduced exports.
The consequences of these factors will be to hurt U.S. exports, either through lower sales or a stronger dollar, and both are already happening. Exports are, however, a relatively small part of the economy, so any damage should be limited.
The Steep Decline in Oil Prices Means More Money in the Pockets of U.S. Consumers
For example, lower oil prices should put additional money in the pockets of American shoppers, with some estimates showing that a $0.10-per-gallon decline in the price of gas could drive another $120 per year, per consumer, in spending. With prices at current levels, that is material.
Positive trends should persist through year-end
Despite the many concerns in the rest of the world and the very real risks to the U.S. economy and markets, the signs at this point are positive. Trends for financial markets, employment, and economic growth are all positive. Moreover, even the risk factors—primarily the strong dollar and weakness elsewhere in the world—have offsetting advantages for the U.S. Still, the positive conditions have led to U.S. markets being richly priced and open to the possibility of a correction, as we saw in October.
Because of this, a diversified portfolio remains the best solution for most investors, with regular rebalancing to harvest gains from fully priced areas and to invest in areas that are more attractively priced. Despite the risks elsewhere in the world and current pricing levels here in the U.S., the long-term perspective remains the best one to adopt in an uncertain world.
Authored by Brad McMillan, Senior vice president, chief investment officer at Commonwealth Financial Network.
All information according to Bloomberg, unless stated otherwise.
Disclosure: Certain sections of this commentary contain forward-looking statements that are based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is not indicative of future results. Diversification does not assure a profit or protect against loss in declining markets. All indices are unmanaged and investors cannot invest directly into an index. The Dow Jones Industrial Average is a price-weighted average of 30 actively traded blue-chip stocks. The S&P 500 Index is a broad-based measurement of changes in stock market conditions based on the average performance of 500 widely held common stocks. The Nasdaq Composite Index measures the performance of all issues listed in the Nasdaq Stock Market, except for rights, warrants, units, and convertible debentures. The Barclays Capital Aggregate Bond Index is an unmanaged market value-weighted index representing securities that are SEC-registered, taxable, and dollar-denominated. It covers the U.S. investment-grade fixed-rate bond market, with index components for a combination of the Barclays Capital government and corporate securities, mortgage-backed pass-through securities, and asset-backed securities. The MSCI EAFE Index is a float-adjusted market capitalization index designed to measure developed market equity performance, excluding the U.S. and Canada. The MSCI Emerging Markets Index is a market capitalization-weighted index composed of companies representative of the market structure of 26 emerging market countries in Europe, Latin America, and the Pacific Basin. It excludes closed markets and those shares in otherwise free markets that are not purchasable by foreigners.