The equity markets are rallying today due to comments of “gradual interest rate increases” by Federal Reserve Chairwomen Janet Yellen. The equity markets like this thinking because it implies slow increases in rates rather than swift, so thereby a lower chance of the economy slowing due to aggressive interest rate hikes by the Fed.
LPL Research informed us today that the S&P 500 has officially gone more than one-year without a 5% correction (using closing prices). This is only the sixth time since 1950 that it has ever made it this far without a 5% correction and the first time since 1995. The longest streak ever was a nearly 20-month streak ending in July 1996. It is important to note how rare this recent action has been and that some second half volatility would be perfectly normal. Why, you ask? One never knows with the stock market short term, but one can certainly say we are due.
Pullbacks in equity prices are a normal part of the investment process. Going back to 1950, LPL Research found that 91% of all years pulled back at least 5% at some point during the calendar year. Taking it a step further, 53.7% of all years pulled back at least 10% at some point during the year. In other words, historically, the 2.8% pullback so far in 2017 is extremely rare and the odds do favor a pullback.
So why haven’t we seen a correction yet? It partly is because the earnings data in the first quarter in 2017 had an easy annual comparison. The first quarter of 2016 was the trough of the earnings recession, so the first quarter of 2017 had the easiest annual comparison. Growth improved (fell less) in the second quarter of 2016 as corporate America began to emerge from the earnings recession, lifting the base for comparison for the just completed second quarter. LPL Research believes the second quarter of 2017 will see double digit earnings growth for the S&P 500 and it is possible even though the comparison to second quarter 2016 is not as easy as it was in the first quarter. Basically, they see solid overall economic data along with a strong rebound in energy sector profits, and solid financial and technology sector earnings gains. Earnings estimates have been resilient and the ratio of positive to negative pre-announcements is as positive as it has been in three years.
The headwinds are a strong U.S. dollar (up 4% year over year based on average prices in the second quarter 2017 versus 2016), lower inflation which translates into less pricing power and consequently lower revenues for many industries, and a flatter yield curve, which impacts financials as the gap between lenders’ cost of funds and lending rate narrows.
So, there you have it. Good economic fundamentals, but the data says that we should see a market pullback in the not too distant future because historically, this is what happens. I wish you all a wonderful summer and do not hesitate to contact us if you have any investment questions. – Mark
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. No strategy assures success or protects against loss. Economic forecasts may not develop as predicted. Some of this research material has been prepared by LPL Financial. All indices are unmanaged and may not be invested into directly. Referenced material: LPL Research Weekly Market Commentary dated July 10, 2017 and the LPL Research Daily Market Update, dated July 12, 2017. Approved Tracking #: 1-625816