Stocks End 1H 2018 With A Dud

Stocks End A Weak First Half

The stock market had a good Friday until the hour before the close where it gave back almost all the day’s gains. The S&P 500 was up only 8 basis points to close out the quarter. The headlines mid-day stated that Nike was pushing the entire market up, but that was clearly wrong as the stock was up 11.1%, but most of the gains disappeared at the end of the session. Specifically, the S&P 500 was at 2,738 at 3:00 PM and closed at 2,718. We’ve seen some odd moves this week which are likely explained by managers closing their books for the quarter.

This was a weak first half for the S&P 500 as it only went up 1.67%. The past week took away gains as the index fell 1.33%. This quarter was mired by fears of a trade war. The CNN Fear & Greed index is at 34 which is fear. It hasn’t risen in the past few days because most of the rallies have reversed lower.

Even though this has been a first half to forget in terms of past performance, it was a great period when you compare it to other countries. The Russell 2000 was up 7% while the MSCI developed international markets index fell 4.7% and the emerging markets index fell 8%. It’s possible that the recent weakness occurred because investors rebalanced their portfolio out of America and into other countries. The Shanghai Composite, which has had a terrible year, was up 2.17% on Friday.

Let’s review some quick stats in terms of market performance for the first half.  4 sectors were up in the first half: consumer discretionary was up 10.8%, tech was up 10.2%, energy was up 5.3%, and healthcare was up 1%. 7 sectors were down. The worst sectors were consumer staples which were down 9.9% and telecom which was down 10.8%. The best industries were internet retail which was up 48.2%, department stores which were up 33.1%, application software which was up 29.7%, and footwear which was up 27.4%. The worst industries were tires and rubber which was down 27.9%, tobacco which was down 22.2%, home furnishing which was down 18.3%, and the homebuilders which were down 17.7%.

Latest Treasury Action

The 10 year yield rose 2.36 basis points after a week where it declined sharply as stocks fell. Since we’re looking at the first half’s performance, the 10 year yield started the year at 2.41% and ended the first half at 2.86%. I expect it to stay very close to where it’s at now for the rest of the year. The 2 year yield increased 1.81 basis points. It has been below this cycle’s peak, which was 2.59%, for 6 weeks now. I expect it to break that peak at some point soon. However, I also think the trade tensions could push the Fed to only hike rates one more time this year which would hurt the 2 year yield. The current chances of at most one hike are 54.6%; if that happens, the 2 year yield will fall. The latest difference between the two bond yields is 33 basis points. The media is constantly talking about the curve which is worrying investors.

Bearishness Is Palpable

One interesting point I read on Twitter was 95% of people are discussing if the economy is headed for a recession and 5% are discussing if GDP growth will be 3.5% or 3.7%. The point being that few people are even noticing the amazing performance when it is right in front of them. The prevailing wisdom is that the economy will fall into a recession soon, so it makes sense to cash out profits. Judging by the current worries, I think people who are selling now are trying to preempt the inversion. It doesn’t make sense to do that because the inversion is usually about a year before the next recession. This has led investors to sell the goods news which has been reported this quarter.

Personal Income & Outlays

The most important report of each month is the personal income and outlays because it includes the core PCE growth which determines Fed policy. The year over year core PCE was up 2%. Usually, this report comes in exactly as expected because it is so late. However, the May report beat estimates for 1.9% and last month’s result which showed 1.8% growth. This was a relatively huge beat because it means inflation is now at the Fed’s target instead of below the target. The core PCE has been above 2% very rarely in this expansion.

There’s two things to keep in mind with this acceleration in inflation. Firstly, the Fed is going to have symmetrical policy which means it won’t be too hawkish when core PCE is above the 2% goal. Secondly, a big reason core PCE is so high is because of easy comparisons. 2017 May core PCE fell 0.1% to 1.48%. The recent acceleration in the past few months has occurred as the comparisons have gotten easier. I expect core PCE to continue to move higher until the 2017 low is reached in August. The August 2017 core PCE was 1.3%. There are three more core PCE reports for the market to worry about, before core PCE comes back down to earth.

Finishing up the inflation portion of the report, the core PCE was up 0.2% month over month which met expectations and was the same as last month. Headline PCE was up 0.2% month over month, which was also the same as last month and met expectations. Year over year headline PCE was up 2.3% which beat estimates for 2.2% and was above last month’s report which had 2% price growth. With the month over month reports meeting estimates and the year over year reports beating estimates, you can see the comparisons playing a big role in the results. I’m not afraid of heightened inflation after seeing this report. Technically, inflation barely even met the target as it was 1.95%.