A Look Under the Hood
Doug Walters
In a week full of big corporate earnings surprises, Washington intrigue, and possible signs of cracks in the high-flying Technology space…the U.S. equity market was flat.
Market Review
Contributed by Doug Walters
The S&P 500 was flat this week, but the mundane result hides some interesting dynamics under the hood. GDP growth rebounded in the second quarter, but not as much as expected. Washington continues to be the best reality show on TV, with a dramatic return to the Senate floor of John McCain, and equally dramatic failure in the attempt to push health care reform forward. The week was capped with the ousting of White House Chief of Staff, Reince Priebus.
Cracks Forming
Second quarter GDP rang in at 2.6%, which compares to the relatively weak print of 1.2% in the first quarter. However, the result was short of expectations which had already been pared back due to Washington gridlock. While the market moves on the surface this week were unspectacular, we did see meaningful declines in some of the market’s high-flyers, like Amazon (AMZN) and Apple (AAPL). There are many large cap stocks in today’s market for which we struggle to justify the valuation. We may be starting to see some cracks in those lofty names.
A Skinny Maverick
John McCain made a dramatic return to the Senate floor after being diagnosed with cancer. His first action was the deciding vote to push forward the health care debate. McCain later was instrumental in helping to defeat a “skinny repeal” bill, aimed at getting rid of the Affordable Care Act’s individual mandate provision. Health care reform now appears to be officially dead unless Congress decides to pursue a novel new concept being discussed called, “bipartisanship”. With health care pushed to the wings, lawmakers appear to be focusing their sights on tax reform. Corporate tax reform could have big, positive implications for many companies.
| Indices & Price Returns | Week (%) | Year (%) |
|---|---|---|
| S&P 500 | 0.0 | 10.4 |
| S&P 400 (Mid Cap) | -0.7 | 6.1 |
| Russell 2000 (Small Cap) | -0.5 | 5.3 |
| MSCI EAFE (Developed International) | 0.2 | 14.7 |
| MSCI Emerging Markets | 0.3 | 23.3 |
| S&P GSCI (Commodities) | 4.2 | -2.9 |
| Gold | 1.2 | 10.1 |
| MSCI U.S. REIT Index | 0.5 | 1.7 |
| Barclays Int Govt Credit | -0.1 | 1.1 |
| Barclays US TIPS | 0.1 | 0.4 |
Economic Commentary
The Steel Cycle
This week, President Trump mentioned he would take his time in determining whether to restrict steel imports. Expectations of steel import tariffs have increased since the election, with the price of steel up 27% since then. Robust worldwide building construction demand has supported the price as well.
The Commerce Department began its investigation in April into whether foreign-made steel imports threaten U.S. security. The protectionist case being made is that:
- Steel producers supply mission-critical military grade forms, and alloys and must keep their other production lines utilized to stay financially viable and,
- State owned entities in China produce steel regardless of whether they are profiting and have flooded the market.
Despite the election-to-date rally, there is still a glut of worldwide steel inventory supply and any softening in Asian demand could cause the price of steel to nose dive the way it did in 2015. US Steel producers are often commodity price-takers with low quality of earnings, as they do not have a moat to protect their business. Import tariffs would, however, provide short term relief and help to widen their margins. As the chart below shows, the price of steel is volatile with growth in Chinese industrial production a key driver.
The protectionist policy may be a positive short-term trade catalyst, but end market construction demand, the auto-cycle rolling over from its peak, and the switch from steel to aluminum are longer-term factors for investors to consider.
Week Ahead
INEPT (example: U.S. Senate addressing health care)
ISM Manufacturing index is expected to book a small decline from the previous month’s reading. However, economists remain optimistic on growth in manufacturing with consensus estimating an ISM print of 56%.
- An index reading above 50% would imply growth in manufacturing activity.
- The highest ISM index level was in May 2004, with a reading of 61.4%.
Non-farm payrolls will be released on Friday, with analyst consensus of 180,000 jobs added.
- Some investors see this as robust growth, while others believe we need to return to the 250,000+ readings of the 90’s to declare the market healthy.
Earnings continue with our focus on Apple (AAPL) and the Energy sector, with Phillips 66 (PSX), Occidental Petroleum (OXY), and EOG Resources (EOG) reporting.
- Investors will be seeking more insight about the iPhone 8 release date and any changes to the guidance for the 3rd and 4th quarters.
- Analysts will be looking for any insight on profitability as oil prices have rebounded modestly.
Personal income and spending for the month of June will be released on Tuesday with both measures expected to maintain similar growth to that in May.
- Income growth is closely tracked by analysts, as they believe higher growth in income will lead to higher growth in inflation.
Trade deficit is expected to decline in June vs. the prior month, but will likely remain at a rate of $45 billion per month.
Strategy Updates
Contributed by Max Berkovich ,
STRATEGIC ASSET ALLOCATION
Dollar Moves
The dollar has been falling in 2017 thanks to a weakening case for further interest rate tightening this year, combined with talk from the ECB about curbing their bond buying program. Investors are wondering if there is going to be resistance, as there has been in recent years, for the dollar when the U.S. dollar index (DXY) nears $92-$93. A cheaper dollar against other currencies would likely be a boost for gold, as the two have historically been negatively correlated.
- DXY has maintained a price above $92 level since January 2015.
- Gold has maintained the $1,200 level since February 2017.
STRATEGIC GROWTH
Digging for Dirt
Earnings dominated sector direction this week. The Energy sector was the top dog with crude prices moving higher this week and a glowing outlook from an exploration company EQT, Inc. (EQT) who specializes in natural gas also helped. Health Care, dragged down by political news, finished last. The Industrial sector wasn’t far behind because…
- Johnson Controls Intl. plc (JCI) reported an inline quarter, but weak organic growth and a free cash flow shortfall dragged the company down.
- Caterpillar Inc. (CAT) on the other hand reported an eye-popping beat when it reported earnings. The company demonstrated strength in its Construction and Resources business and also raised its profit outlook for the future.
STRATEGIC EQUITY INCOME
We Can Hear You Now!
Health Care received a bad dose of political medicine this week and found itself as a laggard again, while the Industrial sector was the second-best sector thanks to soaring orders for planes from Boeing Co. (BA). The Telecom sector was the leader because…
- Verizon Communications Inc. (VZ) reported an in-line quarter but caught investor off-guard when it reported 614,000 new additions on the wireless side. Investors feared that the wireless subscription adds from competitors were coming at the expense of Verizon, but this report put those fears at ease. The company continues to be actively involved in multiple merger and acquisition rumors, both as a buyer and a seller. It is no surprise that a small acquisition is rumored this week; a purchase of privately held WideOpenWest, a fiber network in Chicago, for $200 Million.
About Strategic
Founded in 1979, Strategic is a leading investment and wealth management firm managing and advising on client assets of over $1.8 billion.
OverviewDisclosures
Strategic Financial Services, Inc. is a SEC-registered investment advisor. The term “registered” does not imply a certain level of skill or training. “Registered” means the company has filed the necessary documentation to maintain registration as an investment advisor with the Securities and Exchange Commission.
The information contained on this site is for informational purposes and should not be considered investment advice or a recommendation of any particular security, strategy or investment product. Every client situation is different. Strategic manages customized portfolios that seek to properly reflect the particular risk and return objectives of each individual client. The discussion of any investments is for illustrative purposes only and there is no assurance that the adviser will make any investments with the same or similar characteristics as any investments presented. The investments identified and described do not represent all of the investments purchased or sold for client accounts. Any representative investments discussed were selected based on a number of factors including recent company news or earnings release. The reader should not assume that an investment identified was or will be profitable. All investments contain risk and may lose value. There is no assurance that any investments identified will remain in client accounts at the time you receive this document.
Some of the material presented is based upon forward-looking statements, information and opinions, including descriptions of anticipated market changes and expectations of future activity. Strategic Financial Services believes that such statements, information, and opinions are based upon reasonable estimates and assumptions. However, forward-looking statements, information and opinions are inherently uncertain and actual events or results may differ materially from those reflected in the forward-looking statements. Therefore, undue reliance should not be placed on such forward-looking statements, information and opinions.
No content on this website is intended to provide tax or legal advice. You are advised to seek advice on these matters from separately retained professionals.
All index returns, unless otherwise noted, are presented as price returns and have been obtained from Bloomberg. Indices are unmanaged and cannot be purchased directly by investors.