Presented by Joe Smalley, Accredited Investment Fiduciary®
Another weak first quarter for the U.S. economy, but signs of spring
The gross domestic product (GDP) report, released at month-end, showed that the U.S. economy had grown marginally faster, 0.8 percent, in the first quarter of 2016 than the 0.5-percent uptick initially estimated. This was consistent with the experience of the last two years, where a weak first quarter was followed by faster growth. In line with that, May’s economic data was mixed. Overall, however, the month’s numbers suggested that growth should increase substantially going forward.
Weak data came from manufacturing and capital investment, with the ISM Manufacturing survey indicators still hovering between expansion and contraction. In addition, orders for durable goods and capital equipment continued to run below expectations and are either flat or down over the previous 12 months. The effects of the strong dollar and low oil prices on the U.S. industrial economy linger, and even though those headwinds are fading, we have not yet seen significant improvement.
Offsetting this is substantial improvement in the service sector and consumer demand, which each constitute a much larger share of the economy. The ISM Nonmanufacturing survey rose more than expected, and the most forward-looking component, the new orders index, hit a six-month high. At seven-eighths of the economy, the service sector matters.
Similarly, in April, as announced in May, consumer spending rose by the most in two years, with upward revisions to previous months also reported. Consumer spending represents two-thirds of the economy, so faster growth should lift overall growth in the second quarter. Housing sales also surprised to the upside across the board, with new home sales particularly strong, as illustrated in Figure 1.
A strong end to a weak month
U.S. financial markets ended strongly in May, as economic reports improved and the Federal Reserve (Fed) suggested that the economy had healed enough for it to start raising rates. After dropping between 1 percent and 2 percent mid-month, stocks rallied at month-end. All major U.S. equity markets posted gains, with the Dow Jones Industrial Average up 0.49 percent, the S&P 500 Index up even more at 1.80 percent, and the Nasdaq doing better yet, increasing a surprising 3.62 percent.
The good performance in May was driven by unexpectedly positive corporate earnings news. Although down 6.7 percent, first-quarter earnings declined less than the 8.8-percent drop expected. Moreover, for first-quarter earnings reported by the end of May, seven of ten sectors had posted higher growth rates; this, too, was a consequence of positive earnings surprises.
Despite the less-than-stellar overall earnings results, many companies did do well. Almost three-quarters of companies, 72 percent, beat earnings expectations, which was above the average percentage of beats in past quarters. In addition, six of ten sectors showed revenue growth and four of ten sectors showed earnings growth. While results for the first quarter of 2016 were weak, conditions improved substantially—especially looking forward to the rest of the year—and the market reacted accordingly.
Technical factors remained supportive for U.S. markets. All three major indices finished May well above their 200-day moving averages, with the Nasdaq making that technical leap toward month-end, improving on its results for April.
Developed international markets didn’t fare as well as their U.S. counterparts, experiencing a similar pullback during the month but a smaller rally at month’s end. Even though the MSCI EAFE Index was down about 2 percent in mid-May, it finished the period with only a 0.91-percent loss. Just as with U.S. markets, the catalyst for the EAFE rally was improving economic and company news. This was offset, however, by continued political worries in Europe and disappointing news from Japan. Nevertheless, technical factors for the index improved, and it closed slightly above its 200-day moving average, suggesting that fundamental market trends may be getting better.
Emerging markets, as reflected in the MSCI Emerging Markets Index, were hit even harder than developed markets but managed to recover from a 7-percent loss mid-month to drop “only” 3.71 percent at month-end. Continued concerns about an expensive dollar and its effect on emerging markets, exacerbated by worries about a potential Fed rate increase, drove markets down. Here the technical picture was also better, as the index did move slightly back above its 200-day moving average.
Broad fixed income markets also had a weak May, with the Barclays Capital Aggregate Bond Index reporting a small 0.03-percent gain. U.S. Treasury rates dropped slightly, helping the performance of U.S. government debt, but the release of hawkish Federal Open Market Committee (FOMC) minutes increased volatility during the month. High-yield, as represented by the Barclays Capital U.S. Corporate High Yield Index, performed well, rising 0.62 percent.
Another weak first quarter for the U.S. economy, but signs of spring
The gross domestic product (GDP) report, released at month-end, showed that the U.S. economy had grown marginally faster, 0.8 percent, in the first quarter of 2016 than the 0.5-percent uptick initially estimated. This was consistent with the experience of the last two years, where a weak first quarter was followed by faster growth. In line with that, May’s economic data was mixed. Overall, however, the month’s numbers suggested that growth should increase substantially going forward.
Weak data came from manufacturing and capital investment, with the ISM Manufacturing survey indicators still hovering between expansion and contraction. In addition, orders for durable goods and capital equipment continued to run below expectations and are either flat or down over the previous 12 months. The effects of the strong dollar and low oil prices on the U.S. industrial economy linger, and even though those headwinds are fading, we have not yet seen significant improvement.
Offsetting this is substantial improvement in the service sector and consumer demand, which each constitute a much larger share of the economy. The ISM Nonmanufacturing survey rose more than expected, and the most forward-looking component, the new orders index, hit a six-month high. At seven-eighths of the economy, the service sector matters.
Similarly, in April, as announced in May, consumer spending rose by the most in two years, with upward revisions to previous months also reported. Consumer spending represents two-thirds of the economy, so faster growth should lift overall growth in the second quarter. Housing sales also surprised to the upside across the board, with new home sales particularly strong, as illustrated in Figure 1.
Figure 1. New Single-Family House Sales, Monthly Percentage Change,
2012–Year-to-Date 2016
