OREANDA-NEWS. June 21, 2017. U.S. equities returned to their winning ways last week after a one week hiatus. Although the gain was fractional, it nevertheless reflected the resiliency of this rally, especially considering the absence of market moving economic news, a Federal Reserve rate hike and the ongoing distractions of Washington. The S&P 500 gained less than 0.1 percent, but the index ended the week at 2344, just a touch below its record high of 2440, which it reached on Tuesday.
Industrial stocks led the way higher, along with utilities, but otherwise had little company. Conversely, the selloff in technology stocks that began on June 9 continued last week. Materials were also notably weaker. Consumer staples were weaker as well following the news that Amazon was buying Whole Foods, threatening to disrupt the retail grocery business. Financials, which had been an early beneficiary of the rotation away from technology, were flat on the week.

One of the primary supports for stocks has been the outlook for earnings. Bloomberg points out that full-year earnings estimates, which would normally have been lowered by roughly 4 percent by now, half way through the year, have been raised fractionally. But Factset attributes much of the expected year-over-year gains to anticipated strength in energy shares, themselves dependent upon the price of oil. But crude is already trading below estimates imbedded in those forecasts, suggesting that predictions for the sector might have to be lowered.

The Fed Raises Rates, but Investors Remain Skeptical

The Federal Reserve raised the overnight rate again last week, as expected. And it left in place its expectation of an additional rate hike before year-end. However, investors remain skeptical. The disconnect seems to be centered around the inverse relationship between low unemployment and inflation, as represented by the Philips Curve. The Fed has been somewhat dismissive of the recently soft consumer inflation data, believing that weakness in the core data is, in part, attributable to certain one-off occurrences, such as pricing competition in cell phone data plans. The Fed did, however, lower its 2017 projection for core Personal Consumption Expenditures (PCE) to 1.7 percent, down from its 1.9 percent projection in March.

The Fed seems to have faith that sooner or later labor market strength will show up in higher wages. Beyond this year, the Fed expects to raise rates another three times next year and again in 2019, bringing the overnight rate close to its long-term projected rate of 3 percent. But so far, wages have barely budged, and investors are questioning whether they ever will. Average hourly earnings in the June employment report grew by just 2.5 percent year-over-year, the weakest pace since March, 2016 when the unemployment rate was 5 percent. It is currently 4.3 percent.

Credit Concerns Remain Glaringly Absent

Bond yields are manifesting skepticism as well. The ten-year Treasury note is currently trading at 2.15 percent, reflecting a steady erosion in investor enthusiasm for the reflation trade from its peak in March, when the ten-year note yielded 2.63 percent. During that time the yield curve has flattened appreciably, as the yield on the two-year note is relatively unchanged. The spread between the two and ten-year notes has fallen to 83 basis points from 125. Lower quality segments of the bond market are not signaling a deterioration in the credit environment, however.

The yield on the Bank of America Merrill Lynch High Yield Master II index has fallen commensurately to the decline in the ten-year note since March, as has its spread over Treasuries. That doesn’t mean there is much value there. In fact, we think the opposite. But it does imply that credit concerns are glaringly absent. The dollar has also fallen since March. The DXY index is down to 97 from 102. Slower growth for longer once again seems to be the operative theme.

Stocks in the Eurozone are stronger as this week gets underway. Parliamentary elections in France have strengthened the hand of newly elected president Macron, raising the chances of success in his efforts to overhaul the economy. The EuroStoxx 50 index is higher by 1 percent in mid-day trading on Monday. And in Brussels today, Brexit talks begin. Following the recent poor election showing of the ruling Conservative party, under what terms the breakup will be accomplished remain unclear.