Markets moved upward in May, building on April’s gains. Investors ignored mixed economic data and rate hike concerns as all benchmarks closed in the green. A spike in bond yields had depressed sentiment for the early half of the month.
However, yields declined later, helping to push up gains. GDP numbers underwent a substantial decline while the labor market exhibited strength. At the same time, the FOMC and the Fed Chair remained optimistic about the prospects of a rate hike before the end of the year.
May’s Performance
For the month, the S&P 500, the Dow and the Nasdaq gained 1.1%, 0.9% and 2.6%, respectively. Economic data was mixed, giving no clear indication on the timing of a rate hike. While industrial production, producer price index and consumer sentiment declined, the nonfarm payroll report turned out to be encouraging.
Meanwhile, Fed minutes showed officials looked past a June rate hike amid slow economic growth. Additionally, Chicago Fed President Charles Evans recommended that the Fed should hold back from hiking interest rates until 2016. However, Fed Chairwoman Janet Yellen said the central bank may raise interest rates this year as she believes soft economic data will not have a lasting effect on the economy.
A drop in global bond yields also helped benchmarks settle in the green. European Central Bank President Mario Draghi’s commitment to continue its asset purchasing program to stimulate the Eurozone’s economy helped stocks recover while bond yields declined. Separately, the Nasdaq ended in the green helped by gains in biotech stocks.
Dismal GDP Data
According to the second estimate by the Bureau of Economic Analysis, the first quarter output of goods and services decreased at an annual rate of 0.7%. This was less than the consensus estimate of a decrease by 0.8%. The first quarter GDP decline was in contrast to the fourth quarter’s growth in real GDP by 2.2%. Growth was hampered by harsh winter weather, cheaper oil prices, a stronger dollar and disruptions in Western Coast ports.
Meanwhile, real personal consumption expenditures, which account for almost two-third of the U.S. economy, increased 1.8% in the first quarter. This was significantly less than the 4.4% increase in the fourth quarter. However, federal government spending expanded at 0.1%, which compared favorably to a 7.3% fall in the fourth quarter.
Unemployment Slips
The unemployment rate went down to a seven-year low figure of 5.4% in April from 5.5% in March. The unemployment rate came in line with the consensus estimate. The U-6 unemployment rate also slipped to 10.8% in April from 10.9% in March.
The U.S. economy created a total of 223,000 jobs in April, short of the consensus estimate of 225,000. However, it was significantly higher than March’s revised job number of 85,000. March’s figure was revised down from previously reported 126,000.
In contrast, private sector job additions were weaker than expected. A total of 169,000 private jobs were added in April, reported Automatic Data Processing, Inc. (ADP). This was less than the 175,000 job additions in March, as well as market expectations. Economists were eyeing an addition of 205,000 jobs.
Mixed Domestic Data
Economic data was mixed in nature. To start with, the ISM Manufacturing Index for April was flat month on month at 51.5%. Construction spending declined while the U.S. trade deficit in March rose to its highest level in nearly six and a half years.
Retail sales numbers came in flat. PPI, core PPI and industrial production all experienced declines. Orders for durable goods also decreased. However, core capital-goods orders gained.
The housing sector enjoyed significant gains. Housing starts surged while construction on new homes climbed at the fastest pace in April since late 2007. The pace of permits for single-family homes also hit the fastest rate since early 2008. New home sales and pending home sales both increased.
Among other positives, US auto sales numbers improved. Factory orders enjoyed their biggest rise in eight months. Data on economic activity in the non-manufacturing sector in April turned out to be better-than-expected. The leading economic index and consumer confidence index both moved upward.
Spike in Yields
An increase in bond yields remained a cause for concern through the month. By the first week of May, the yield on the benchmark U.S. 10-year note touched its highest level for 2015. An increase in European yields may be one factor responsible for the 10-year Treasury yield touching 2.24%.
The situation reversed during the second half of the month. At the end of the second week, U.S. 10-year Treasury note yields declined. This followed a fall in yields of 10-year German government bonds. European Central Bank President Mario Draghi’s commitment to continue its asset purchasing program to stimulate the Eurozone’s economy helped stocks recover and bond yields decline.
Crisis in Greece
At the very beginning of May, the IMF decided to trim its aid to Greece unless the country accepts its debt obligations. At the beginning of the second week, Eurozone finance ministers welcomed Greece’s progress in negotiating with its creditors for a cash-for-reform deal. However, they believe more needs to done to bridge the differences in order to make a comprehensive bailout agreement.
Ultimately, the euro strengthened after Greece was able to pay its debt of about 750 million euros to the IMF. At the start of the third week, Greece’s two-year sovereign bond yields moved north following investor concerns that the country may not be able to repay its debt to the IMF next month. A leaked IMF memo admitted that Greece has less chance of making its debt payment, scheduled on Jun 5.
Last week, IMF Managing Director Christine Lagarde said a lot needs to be done between Greece and its lenders before agreeing on a cash-for-reforms deal. Greece needs to pay 300 million euros to the IMF on Jun 5.
Eurogroup members and Greek officials had started preparing a draft to avoid defaulting on the debt payment that Greece is supposed to make within the stipulated time frame. However, a Eurogroup official said that “We are still working toward an agreement” and that no consensus was reached.
China Increases Stimulus
The People’s Bank of China trimmed its benchmark lending and deposit rates for the third time in six months. China’s central bank stepped up its monetary measures to provide stimulus to China’s slow economic growth.
The apex bank trimmed both its one-year loan rate and one-year deposit rate by a quarter-percentage point to 5.1% and 2.25%, respectively. It also gave more flexibility to Chinese banks on deciding how much they pay depositors. Banks are allowed to raise one-year deposit rates to a maximum of 3.375%.
At the end of the month, Chinese shares dropped sharply. Brokers’ moved to tighten margin lending, and this had a negative impact on the broader markets. Brokers took this stance in order to curb risks persisting in the Chinese markets. China’s Shanghai Composite index tanked 6.5% last Thursday and also fell on Friday.
Encouraging Earnings
A handful of upbeat earnings results boosted investor sentiment. Berkshire Hathaway Inc. BRK.B, Cognizant Technology Solutions Corporation CTSH, Comcast Corporation CMCSA, The Estée Lauder Companies Inc. EL, The Walt Disney Company DIS, Tesla Motors, Inc. TSLA and The Priceline Group Inc. PCLN posted better-than-expected first quarter earnings results.
FOMC Minutes
Minutes from the Federal Open Market Committee’s (FOMC) Apr 28-29 meeting stated officials opined that a rate hike in June is “unlikely” as they remained concerned about weak economic growth in the first quarter. Federal Reserve officials are unsure about raising short-term interest rates in June. They want to wait to see further improvement in labor market conditions and inflation touching its target rate of 2%.
Fed officials believed “transitory” factors were affecting the economy. While housing numbers and employment growth picked up in April, industrial production, producer price index, consumer sentiment and retail sales numbers were discouraging.
Meanwhile, some long-term factors continue to weigh on Fed officials’ decision on the timing of a rate hike. The minutes said: “A number of participants suggested that the damping effects of the earlier appreciation of the dollar on net exports or of the earlier decline in oil prices on firms’ investment spending might be larger and longer-lasting than previously anticipated.”
However, the Fed minutes also stated hiking federal funds rates isn’t completely off the table. Some officials believe they had enough confidence to increase interest rates from near zero levels at the June 16-17 meeting.
Fed Chair Confident
Federal Reserve Chairwoman Janet Yellen said she expects the Fed to raise short-term interest rates sometime this year. Yellen believes the U.S. economy is well poised to grow despite soft economic data. She said: “If the economy continues to improve as I expect, I think it will be appropriate at some point this year to take the initial step to raise the federal-funds rate target and begin the process of normalizing monetary policy.”
Yellen added that she needs to see further improvement in labor market conditions and to be “reasonably confident” that inflation moves closer to its target rate of 2%, before deciding on when to raise rates.
3 Star Performers for May
I ran a screen on Research Wizard for companies with the following parameters:
(Click here to sign up for a free trial to the Research Wizard today):
- Percentage price change over the last 4 weeks (as of May 29) greater than or equal to 20%
- Forward price-to-earnings Ratio (P/E) for the current financial year (F1) less than or equal to 20. This picks out stocks that are good value choices
- Expected earnings growth for the current financial year greater than or equal to 20%
- Zacks Rank less than or equal to 2: This ascertains stocks that have shown above-average returns over the last 26 years.
(See the performance of Zacks’ portfolios and strategies here: About Zacks Performance).
Here are the top 3 stocks among the 8 that made it through this screen:
Walker & Dunlop, Inc. WD is engaged in providing commercial real estate financial services in the United States, with a primary focus on multifamily lending.
Price gain over the last 4 weeks = 28.6%
Expected earnings growth for current year = 35.6%
Walker & Dunlop holds a Zacks Rank #1 (Strong Buy). The stock’s forward price-to-earnings ratio (P/E) for the current financial year (F1) is 11.42.
Broadcom Corp. BRCM provides semiconductor solutions for wired and wireless communications.
Price gain over the last 4 weeks = 28.6%
Expected earnings growth for current year = 27%
Broadcom holds a Zacks Rank #1(Strong Buy) and it has a P/E (F1) of 19.05x.
Cal-Maine Foods, Inc. CALM is engaged in the production, cleaning, grading, and packaging of fresh shell eggs for sale to shell egg retailers.
Price gain over the last 4 weeks = 26.8%
Expected earnings growth for current year = 53.5%
Apart from a Zacks Rank #2 (Buy), Cal-Maine has a P/E (F1) of 16.34x.
Will Stocks Gain in June?
Disappointing economic reports have weighed on investor sentiment. However, weaker-than-expected economic data increased expectations that the Federal Reserve won’t hike interest rates in the near term, which eventually helped all benchmarks end in the green.
This view has been reinforced by a strong contraction in current Q1 GDP estimates. Weakness on the demand side means that the Fed may find it difficult to raise rates in the near future.
On the foreign front, Greece has dominated the investor mindscape. This is a trend which is likely to continue until an agreement is reached. A pickup in demand is needed to improve market fundamentals. Until then, investors may have to contend with significant volatility.
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