Published June 15, 2018
Our favored Nasdaq 100 (QQQ) has been marching strongly upward, along with the small-cap Russell 2000, breaking to new highs and continuing to find buyers. Unlike 2017, however, this market strength is not so broad-based. International stocks have been flat, with the rising U.S. dollar keeping the pressure on those indexes.
The chart below shows the performance of the market’s major sectors so far this year. We can see that very few of the market’s sectors are showing any significant gains. The two sectors on the left – technology and cyclicals – sport solid gains, joined by a modest lift in energy and a slight positive in healthcare.
Though the above chart makes it appear that the bulk of the market is going nowhere, with 5 of the 9 sectors flat to down on the year, we are reminded that technology and consumer cyclical stocks (aka Consumer Discretionary stocks) comprise a very large chunk of the market’s weighting. The table below of the S&P 500 tells us that these two groups account for almost 40% of the broad market index. Add in Energy and we are very close to accounting for half of the S&P 500. With the only real drag on performance coming from the relatively small consumer staples group, the broad market index moves higher with half of its weight rising.
Looking at the lagging sectors, they are the more interest rate-sensitive sectors: Consumer Staples and Utilities. They are holding losses for the year, which is not surprising given the rise in rates this year. The 10-year U.S. Treasury bond yield has shot from 2.4% to 3.0% through the first half of the year.
Despite this sharp rise in interest rates, financial stocks have struggled to move higher. This is a surprise to many as the rise in rates was widely expected to be helpful to financials. Perhaps the issue has been that the yield curve has been flattening. Banks make money by borrowing at lower short-term rates and lending at higher longer-term rates. Another factor could be the group’s strong rise over the prior 18 months, a 50%+ increase. The chart below suggests the financial sector is merely resting and consolidating that large gain before launching another leg upward. About 40% of the sector is comprised of the large banks – e.g. JP Morgan, Bank of America, Wells Fargo – with insurance and brokers/investment banks covering about 20% each. A strong economy and a wider spread between short-term and long-term interest rates should trigger a big move higher in this group.
In summary, the stock market’s rise through the first half of the year has been focused on consumer-related stocks with few other market sectors participating. Consumer spending accounts for about 70% of the U.S. economy, with a large and increasing chunk of that spending occurring with online companies like Amazon and Netflix – companies that drive the market-leading Nasdaq 100 (QQQ) index. So it’s not surprising to see continued strength here. Financials, industrials, and other market sectors have not participated much in this rally, perhaps because their global revenues might be negatively impacted by a sharply rising U.S. dollar. However, financials look like they might ultimately make another move higher as rising interest rates should improve their profit margins at some point and drive stronger earnings.
Investors turned their attention to the Federal Reserve this week with the central bank expected to raise interest rates for the second time this year. The Fed controls short-term interest rates most directly while trying to influence the market for longer-term rates. Prior to the Fed’s Wednesday announcement on rates, stocks were little changed Monday and Tuesday, showing +0.1% moves each day. The market-leading Nasdaq and Russell 2000 small-cap index outperformed with +0.6% gains Tuesday as consumer stocks continued their strength. The Wednesday Fed announcement of a 0.25% increase in short-term interest rates sent stocks lower as the Fed’s language suggested there would likely be four rate increases this year; the market had been expecting only three. Additionally, Wednesday afternoon brought a Wall Street Journal report signaling White House intent Friday to implement a wide range of tariffs on Chinese goods. Stocks fell -0.4% on the day with the Nasdaq only dipping -0.1%. Interestingly, the 10-year U.S. Treasury yield barely moved despite the expectation for more rate increases, perhaps as some investors bought bonds in a safety play on the tariff news. Thursday brought the European Central Bank announcement that they will end their bond buying program by year’s end. The news sent the Euro currency down and the U.S. dollar rising, both sharply. Investors sought comfort in tech/consumer stocks pushing the Nasdaq to a record close on a +0.8% rise while the broad market S&P 500 posted a lesser +0.2% lift. Financial stocks suffered as the difference between the 2 and 10-year yields flattened to its tightest spread in a decade. Friday brought the aforementioned tariff announcement and a selloff in commodities. Oil slumped -3%, dragging energy shares lower. The Dow Industrial Average was down over -1% midday before recovering late to a -0.3% close.
A late afternoon Friday rally trimmed that day’s losses bringing the S&P 500 back near flat on the week. The index closed with a +0.07% weekly tally. The Nasdaq 100 (QQQ) continued its winning ways, rolling upward by +1.46%. The small-cap Russell 2000 (IWM) added +0.71% for the week.
Warm wishes and until next week.