Another great month for stock markets
February was another strong month for financial markets, as sustained consumer and business confidence fueled the rally in equities. The three major U.S. indices posted impressive gains, with the S&P 500 Index up 3.97 percent, the Nasdaq up 3.91 percent, and the Dow Jones Industrial Average leading the way with a return of 5.17 percent. Additionally, the three indices set multiple all-time highs during the month, a performance we have not seen for decades.
The rally was bolstered by better fundamentals and improving sentiment. As of February 24, with 92 percent of S&P 500 companies having reported, the blended earnings growth rate for the fourth quarter of 2016 was 4.9 percent, increasing from the 3.1 percent forecasted at the end of last year. This is the second straight quarter of year-over-year corporate earnings growth, and expectations seem only to be rising.
Consumer and business sentiment continue to improve, which has historically supported market performance. From a technical perspective, the news is also good, with the major U.S. indices remaining comfortably above their respective 200-day moving averages throughout February.
International equity markets also did well last month. The MSCI EAFE Index was up 1.43 percent on better economic news across Europe, though gains were somewhat held back by increased political risks, notably the upcoming French presidential election. The MSCI Emerging Markets Index rose a solid 3.07 percent in February, spurred by improvements in commodity markets and continued uptrends in economies around the globe. Technically, both indices stayed above their 200-day moving averages throughout the month.
To round out the good news, fixed income markets had a strong month, driven in large part by decreases in interest rates across the yield curve. The 10-year Treasury rate ended February at 2.36 percent, down from 2.48 percent at the beginning of the month, on lowered expectations for U.S. fiscal stimulus. This led to a healthy 0.67-percent uptick for the Bloomberg Barclays Aggregate Bond Index.
High-yield corporate fixed income also had a solid month, as expectations for the domestic economy continued to improve. The Bloomberg Barclays U.S. Corporate High Yield Index returned 1.46 percent in February, driven largely by spreads declining to levels not seen in the asset class since 2014.
Consumers ready, willing, and able to spend
After signs of a slowdown in January, economic indicators rebounded and now point toward the possibility of faster growth ahead. Hiring continued strong, jumping to 227,000 jobs created in January, substantially more than the 180,000 expected. The labor-force participation rate also grew, and wages rose during the period.
Additionally, consumer confidence signaled that faster growth is likely, with both measures of consumer confidence hovering near multiyear highs. The Conference Board metric reached levels not seen since 2001, as illustrated in Figure 1.
Figure 1. Conference Board: Consumer Confidence, 2001−2017
The impact of the healthy job market and increased consumer confidence has begun trickling down through the economy, with consumer spending and retail sales both beating expectations last month. Moreover, high levels of consumer confidence, coupled with improvements in job and wage growth, should support even higher levels of consumer spending going forward.
Business confidence and housing market strong as well
Business and manufacturing sentiment was also strong in February, as the ISM Manufacturing and Non-Manufacturing indices remained in solid expansionary territory. Additionally, durable goods orders posted strong growth in January, rebounding from December's disappointing decline. Although much of the growth in durable goods was due to increased aircraft orders, it is encouraging to see a rebound to faster growth levels in this data point. Manufacturing sentiment, in particular, continues to improve as the dollar stabilizes and economies around the world strengthen.
Housing was also on the upswing, as growth levels increased over the past month. Existing and new home sales rose, with the former reaching levels last seen at the beginning of 2007. Housing starts were also up in February, indicating that faster growth in the housing sector is a distinct possibility. Finally, homebuilder sentiment was down slightly in February, though it remains in healthy expansionary territory. Housing is a key economic indicator—it both generates additional spending growth and represents a vote of confidence in the future.
Even the Federal Reserve remains optimistic
Comments from Federal Open Market Committee (FOMC) members have been increasingly positive about the economy recently. With the continued growth in employment, and inflation rising to target levels, expectations for a rate hike announcement after the March 14−15 FOMC meeting have risen to roughly an 80-percent probability. An increase would signal confidence in continued economic improvement, though it could lead to some volatility in the financial markets. Rate increases when rates are low, however, have historically ended up being positive for markets.
Data could still change before the next FOMC meeting, but the most important data point to be released between now and then is the March 10 jobs report. If the report shows healthy job gains and increasing wage growth, the odds of a rate hike happening at the next FOMC meeting would increase.
With a solid U.S. economy, international risks are on the rise
After an extended period of market risks concentrated in the U.S., international risk seems likely to play a growing role in future market volatility. Elections in Europe—in particular, parliamentary elections in the Netherlands in March and the French presidential election in April—have the potential to shake global financial markets. Because of the rise of nationalist parties, as well as the talk of abandoning the euro and even exiting the European Union, many observers have compared these elections with the U.K.'s Brexit referendum.
In Asia, concerns about the relationship between the U.S. and China persist. The yuan, whose value is set by China's central bank, is still near multiyear lows against the dollar, driving both trade tensions with the U.S. and capital flight by China's citizens. Moreover, tensions surrounding China's development of islands in the South China Sea continue to rise, as the U.S. has announced plans to increase the frequency of naval patrols in the region and China keeps building new military facilities on the contested territory.
Worth noting is that the risks, even at the international level, are much more political than economic. Economies around the world are starting to grow, and we are seeing the first synchronized global growth cycle since the 2008 crisis. As such, although the political risks are worth monitoring, the fundamentals have been strong enough to put us in a better position to ride out such risks than we have been in years.
Recovery still picking up speed
With markets setting records, it is natural to be optimistic about the future yet concerned about whether the good times will last. In the short run, prospects look good; however, even if the risks lead to a pullback, the solid economic conditions should limit any downside. The U.S. economy and financial markets are the largest and most stable in the world, and they should continue to allow for long-term growth as fundamentals improve. Although the possibility of short-term volatility is present, a well-diversified portfolio with a time horizon matching client goals remains the best way to achieve financial goals going forward.
Despite the very real risks, the U.S. economy continues to recover and may even be accelerating. The improving economic fundamentals released in February strongly suggest that January's slowdown was fleeting. In fact, the high levels of consumer and business confidence seem to be having a positive impact on spending, which could very well lead to faster growth in 2017.
Co-authored by Brad McMillan, senior vice president, chief investment officer, and Sam Millette, investment research associate, at Commonwealth Financial Network®.
All information according to Bloomberg, unless stated otherwise.
Disclosure: Certain sections of this commentary contain forward-looking statements 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 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 Dow Jones Industrial Average is a price-weighted average of 30 actively traded blue-chip stocks. 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. The Bloomberg Barclays 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 Bloomberg Barclays government and corporate securities, mortgage-backed pass-through securities, and asset-backed securities. The Bloomberg Barclays U.S. Corporate High Yield Index covers the USD-denominated, non-investment-grade, fixed-rate, taxable corporate bond market. Securities are classified as high-yield if the middle rating of Moody's, Fitch, and S&P is Ba1/BB+/BB+ or below.