Small caps are having a strong year, with the Russell 2000 Index up nearly 6% year to date, versus about 2% for the S&P 500 Index. We came into this year expecting small cap out performance, and after a slow start in early 2018 they have delivered in recent months. Many factors have aligned to drive continued potential leadership from this group. Here we highlight three keys to our small cap outlook.
The Federal Reserve (Fed) reassured markets that its rake hike pace would remain gradual with the release of its May 1–2 policy meeting minutes last Wednesday. While the minutes revealed a generally upbeat assessment of the economy consistent with Fed views since the start of the year, markets read the overall tone of the minutes as modestly dovish, helped by some context on the Fed’s additional emphasis that its 2% inflation target is “symmetrical.” The language has been widely used in the minutes and statement for some time, but garnered closer scrutiny after the policy statement added the phrase again in a key passage. By highlighting that its inflation target was symmetrical, the Fed reminded markets that it does not think of its target as a line in the sand, but as a goal that will have some wiggle room.
The U.S. dollar has come back strongly. After losing nearly 10% in 2017 and an additional 4% in January, the U.S. Dollar Index has rallied more than 5% off of its February lows [Figure 1]. Gains have been driven by several factors, particularly rising U.S. interest rates, partially due to increasing Federal Reserve (Fed) rate hike expectations, and repatriation of overseas profits as prescribed by the new U.S. tax law. Weakness in emerging market (EM) currencies as a result of several flare-ups in trouble spots such as Turkey and Argentina, along with the populist wave in Italy, have added to support for the dollar. The dollar is important for many reasons, including its impact on international trade and on overseas corporate profits. So, where does the dollar go from here?
We continue to prefer emerging market (EM) equities in tactical asset allocations. EM equities have given back strong early-year gains, pushing the MSCI EM Index into negative territory year to date on a total return basis. Many headwinds have weighed on EM stocks, including rising interest rates, U.S. dollar strength (and related weakness in EM currencies), and trade war fears. Here we highlight five keys to our EM outlook.
Last June, oil hit an interim low of about $42.50 and started to climb. By May 7, 2018, it had crossed $70 for the first time since 2014. President Trump announced the U.S. would be withdrawing from the Iran nuclear deal the next day. We view rising oil prices as largely a result of rebalancing supply and demand, and believe prices will stabilize as markets digest the recent news. The Organization of the Petroleum Exporting Countries (OPEC), its partners, and U.S. production growth should be able to compensate for reduced Iranian supply. Even if prices stabilize at current levels, it will be a modest hit for consumers, especially those at lower income levels, and it may temporarily push headline inflation higher; however, we believe the impact may be small compared to economic support from a strong job market and the new tax law.
First quarter earnings season was excellent by almost any measure. The numbers were strong even without the boost from the new tax law. In this week’s commentary, we recap the outstanding near-complete first quarter earnings season, highlight some of the key themes, and show why a potential peak in earnings growth is not cause for immediate concern.
“Sell in May and go away” is probably the most widely cited stock market cliché in history. Every year a barrage of Wall Street commentaries, media stories, and investor questions flood in about the popular stock market adage. This week, we tackle this commonly cited seasonal pattern, while focusing on some reasons it may not apply this year.
The first week of May brought a deluge of economic data, including the April jobs report, key surveys on business activity, and some important readings on inflation. Add in a Federal Reserve (Fed) policy meeting, and it’s fair to say that the most important week of economic data in May is already behind us. Looking at these reports together, the economy still appears to be in an economic sweet spot, producing solid growth but not enough to cause us concern about an overly aggressive Fed. Rates will still push higher at a moderate pace and it’s natural for financial conditions to tighten as we move later into the economic cycle, but as long as these are driven by steady economic growth with a minimal build-up of excesses, we expect the economic expansion to continue largely uninterrupted.