While many investors had been expecting a summer swoon, instead the markets delivered some summer sizzle. U.S. stocks posted their best month in July since March. The Dow gained 2.9% and the S&P 500 Index neared a record high, gaining 3.6%. Technology earnings propelled the NASDAQ Composite, which had been trailing most of the year, to a 6.7% return during the month, with strong earnings coming in from as Apple, Google, Facebook, and Amazon.
The market got off to a shaky start to the month as investors were still trying to digest UK’s Brexit referendum vote and the specter of corporate earnings season loomed on the horizon. But a strong jobs report, low mortgage rate infused housing numbers, and better retail sales helped flip investor appetites to risk-on. The Russell 2000 Index of small cap stocks gained 6% in July.
The economic data was not all rosy during the month. Second-quarter GDP came in at 1.2%, which was half the expectation of 2.6%, marking the third consecutive quarter that economic growth lingered around 1%. This tepid pace of economic growth makes it almost certain that the Federal Reserve will not hike interest rates this September and raises the likelihood that there may be no rate increase this year at all.
Strong corporate earnings results have also fueled the market to near record highs. Despite the slow growth economy, most corporate earnings reports have been coming in ahead of consensus expectations. FactSet reports that 68% of S&P 500 companies reporting to date have beaten analyst expectations. And while second quarter earnings remain in negative territory at -3.7% overall, the consensus predicts a return to positive earnings growth by the fourth quarter.
Such an earnings recovery will require the reversal of many headwinds including a strong dollar, low long-term interest rates, and weak energy prices. Oil prices did not have a good July, ending up at a 3-month low. Renewed drilling efforts spurred by higher prices have investors concerned about oversupply.
As the market approaches record high levels, there is a healthy amount of skepticism among investors. Ironically, this skepticism could help to support future stock gains. While valuations for income producing assets like bonds and dividend-paying stocks remain at a premium levels in the current yield-seeking environment, investors have many beaten down growth names to rotate into.
Outside the U.S., international markets also rallied in July with the MSCI EAFE Index gaining 5% and Emerging Markets up 4.7%. Post-Brexit, eurozone financial and political conditions have stabilized thanks to a fast-tracked appointment of a new British PM. Global corporate earnings expectations are also on the rise as global economic data shows sign of improvement. Nine out of ten global sectors have seen a rise in earnings estimates in recent months. This also bodes well for market returns going into the end of the year.
The recent rotation into risk-on asset classes such as small caps, technology, and non-US securities is a perfect example of why it is important to stay nimble and diversified. Earlier in the year, large cap stocks, in particular those paying dividends, and fixed income were the only game in town. But now as their valuations have run up to premium levels and investor confidence and risk appetite has increased, this latest market rotation has favored well-diversified, nimble investors.
Going into the end of the year, many headwinds and geopolitical concerns remain, especially given the uncertainties by U.S. presidential election. Investors should remain focused on their long-term goals and remain well diversified to help dampen volatility and find pockets of strength in the slow-growth market environment.
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