Happy Summer! The U.S. equity markets have recently made new highs and are near those levels as I write this newsletter. Gold is holding near its recent high point and is currently $1,283/oz and interest rates (long and short) continue to hold at record lows. It is a strange financial mix we live in these days because there seems to be more concern than joy. 428 companies of the S&P 500 have reported their 2nd quarter earnings and the numbers show a 2.6% year over year decline, just 1.2% better than expectations as of quarter end (June 30, 2016).
So why then are U.S equity markets high? Simply put, corporate profit margins are near record highs (excluding energy) and expectations for the future are for continued earnings improvement. The reason so many financial analysts and investors are concerned is, are the markets also at lofty levels because there just aren’t many investment options left to us other than equity markets and we all feel a pressure to try and get positive returns on our money. If the last reason is the case, what would happen to equity markets if interest rates rise or an unforeseen condition occurs that causes corporate earnings to erode? The answer then is there would be an increased possibility of an equity market correction.
So, cautiously optimistic is the appropriate track. We watch interest rates carefully, because fixed income investments are vulnerable to rising rates and holding some cash or cash equivalent allocations are appropriate. We hold equity investments because in spite of ups and downs, we believe the long term will prevail and we try to mute volatility with value investments and diversified portfolios.
LPL Research believes that earnings will rebound in the second half of the year. The latest data on Gross Domestic Product (GDP) is that the United States is tracking between 2.5% and 3.5%. Recent readings on the Institute for Supply Managements (ISM) Manufacturing Index, one of LPL’s favorite earnings indicators, has been solidly in expansion territory (five straight months over 50), with particular strength in new orders and production. Technology has been a standout sector and has produced significant upside to prior second quarter forecasts, with positive revisions to third and fourth quarter estimates.
One question mark in the confusing mix is oil. After prices fell to mid $20’s/barrel, oil then rallied into the $50’s and then recently has declined again to almost $40. As much as we like cheaper gas, it is important to note that energy companies represent a significant portion of the economy and the markets take notice of the price of oil and its impact on them. – 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. The Standard & Poor’s 500 Index is a capitalization weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. All indices are unmanaged and may not be invested into directly. Referenced material: LPL Research Weekly Economic Commentary & LPL Research Weekly Market Commentary, both dated August 8, 2016. Approved Tracking #: 1-525291.