Markets do well but...
April was a good month for stock markets, as major indices climbed throughout most of the period, despite a pullback toward month-end. For the month as a whole, the Dow Jones Industrial Average was up 0.45 percent, and the S&P 500 Index gained 0.96 percent. The Nasdaq also did well, returning 0.83 percent. But the respectable results for all three indices were actually down from mid-month gains of around 2 percent for the Dow and S&P 500 and almost 4 percent for the Nasdaq. These declines were primarily driven by concerns about China and the rising risks of a Greek exit from the eurozone.
The positive returns for April owed a great deal to better-than-expected corporate earnings. At the end of March, earnings expectations had been revised downward, with a decline of 4.7 percent predicted for the quarter; however, as of April 30, actual earnings for reporting companies had declined only 0.4 percent. Though a decline is not good, the results were better than expected and they bolstered market results.
Much of the decline in earnings was due to the energy sector, which had the largest year-over-year decrease in both earnings and sales among the sectors. Eight of ten sectors, however, actually reported increases in earnings growth due to upside surprises during the month, indicating that conditions are better than they appear for a broad range of companies. Technical factors also showed strength during the month, and all three indices remained well above worry levels, despite the market pullback at April's end.
Developed international markets performed more strongly than U.S. markets, with the MSCI EAFE Index up 4.08 percent, bringing the year-to-date results above U.S. levels. The decision by the European Central Bank to launch a stimulus program in March encouraged investors, who were further heartened when signs of growth also appeared in European economies.
The MSCI Emerging Markets Index was up by even more than the EAFE—7.51 percent—driven largely by the Chinese government's decision to implement stimulus measures, such as a reduction in required bank reserves, spurred by a slowing of China's economy.
The resumption in growth expectations, and the renewed willingness by investors to take risks, hurt the bond market. U.S. interest rates ticked up, with the 10-year U.S. Treasury rate increasing from 1.87 percent to 2.05 percent during April, driving down the Barclays Capital Aggregate Bond Index by 0.36 percent for the month. Longer-duration fixed income securities performed worst, but corporate high-yield bonds did well, as reflected by the Barclays Capital U.S. Corporate High Yield Index, which gained 1.21 percent.
...Spring slow to appear
Economic statistics continued to show weakness in April. The past winter—the coldest ever in the Northeast—certainly affected the economy, but other factors also slowed growth. The strong U.S. dollar hit exports and manufacturing, and a labor dispute at West Coast ports disrupted supply chains around the country. First-quarter 2015 gross domestic product (GDP) growth announced at April's end was only 0.2 percent, well below expectations, and job growth dropped to 126,000 for March, also well below expectations.
Another significant negative factor was a reduction in both business investment and government spending. Oil and gas drilling, in particular, dropped by almost one-quarter in response to lower oil prices, and state and local spending dropped. Both of these factors appear to be short term in nature—the reduction in drilling may run for one more quarter, and government spending typically rebounds in the second quarter—but the damage done was real.
Despite these very real headwinds and negative data points, longer-term trends remained positive. The weak monthly jobs report didn't change the fact that annual job creation is higher than at any point in the 2000s. Nor did it change the fact that job openings moved to new highs and initial jobless claims moved to new lows as a proportion of the labor force. Though some measures of consumer confidence were down, others were up, and retail spending and savings increased. Low oil prices reduced business investment, but they will eventually stimulate consumer spending, and even now are helping consumers save. Further, as oil prices stabilize, oil investment activity, as seen through active rig counts, will presumably recover as well (see chart).
Overall, the weakness again appears to be seasonal, with the economy poised for continued growth as the job market grows and businesses gain confidence. Just as we saw last year, even if winter weather and other short-term factors hurt results in one quarter, it doesn't necessarily mean that the economy has been derailed.
International uncertainty remains
Slower-than-expected growth notwithstanding, the improving U.S. economy has supported growth in the rest of the world, with even Europe starting to turn around. But, despite its nascent economic recovery, Europe remains a concern because of the Greek situation. The confrontation between the Syriza government and the Europeans has only gotten more divisive, and the chance of a Greek exit from the eurozone increased during April. A deal does remain probable, but the gap between the two sides is substantial and positions are hardening. The consequences of such an exit remain unpredictable, but even contemplating such an event adds significant risk to the global financial picture.
The second area of concern is China, where signs of a significant slowdown continue to appear. Although the Chinese government is deliberately attempting to slow growth—aiming to change from investment-driven to consumption-driven growth—there are signs that the government is worried about the extent of the slowdown. It has implemented stimulus measures to accelerate the growth rate, and further and more radical stimulus measures are rumored. This is not an immediate problem, but it remains a concern.
Spring slowly takes hold
As we move into the second quarter, it seems clear that spring is taking longer to appear for the U.S. economy than anyone had expected—or wanted. All the same, continued improvements in employment and consumer spending should eventually lead to better growth, while the damage from the slowdown in the oil industry and the shock from the strong dollar will pass. Despite a weak first quarter, and though worries remain, the trends appear favorable for the real economy.
Financial markets reflect both this short-term uncertainty and the long-term trends. U.S. market results for April were solid if not spectacular. Company earnings, though down, are doing much better than expected, and technical indicators remain strong. Even the risk areas, while worth watching, are solid.
Overall, our stance remains optimistic, though we hold concerns about Europe and China. As always, a diversified portfolio constructed around an investor's own risk tolerance and time frame should help achieve goals, regardless of what happens in the interim.
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 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 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 Barclays Capital 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.