The S&P 500 fared well in July, advancing slightly below 2% for the month. Investors appeared to be encouraged by progress made in the Greek bailout negotiations, and by consistent messages from the Federal Reserve emphasizing that the pace of eventual rate hikes will be gradual. While commodities tumbled during the month, we remain optimistic that U.S. economic activity will continue to accelerate throughout the year, and that stocks can continue to move higher.
Early in the month Greece and its creditors reached an agreement in principle on a new three year bailout package. While final details still need to be negotiated, it has been reported that the deal will include up to 86 billion euros in loans. In exchange for this assistance, Greek Prime Minister Alexis Tsipras agreed to far-reaching measures including government spending reductions, pension reforms, and tax increases. Subsequently, Greek banks and the stock market, which had been closed for weeks, reopened. While we do not see this deal as a permanent solution to the country’s problems, we do think it is significant as it likely removes a near-term risk factor from equity markets.
In contrast to the good news coming out of Greece, commodity markets declined sharply during the month. The S&P GSCI commodity index saw its largest monthly decline since 2008 and closed at its lowest level since 2002. Both iron ore and copper hit multi-year lows, and U.S. crude oil prices fell by over 20%. We believe that slowing demand out of China and other emerging markets is primarily responsible for these declines. As we see few signs that these economies are poised to rebound, we believe it is conceivable that prices will remain depressed, and therefore do not view this as a buying opportunity for commodity-exposed stocks.
In the U.S., investor attention turned to second quarter earnings season. As of this writing, with approximately 60% of S&P 500 companies having reported, profits are on track to decline by nearly 1%. While not a stellar performance by any stretch, this compares favorably with initial consensus expectations for a 4.5% decline. Moreover, with oil prices down precipitously on a year over year basis, much of the weakness is coming from the energy sector while other areas of the economy are seeing profit growth. In terms of the aggregate profit outlook, full year estimates have largely remained unchanged. Overall, we would consider this a mediocre earnings season, and consistent with an economy which grew by a lackluster 2.3% during the quarter. Still, we continue to look for a resumption of earnings growth during the back half of the year based on our forecast for a strengthening economy, supported by improving labor conditions and lower commodity prices.
Turning to monetary policy, in her semi-annual report to Congress, Fed Chair Janet Yellen noted that the headwinds from China and Greece would be unlikely to deter the Central Bank from beginning to hike rates later this year. She also stated her preference to raise rates sooner and at a measured pace as opposed to waiting and risk having to act rapidly at a later date. We were encouraged to hear this, as our view is that stocks can handle a slow and steady normalization of monetary policy, but could be at risk if the Fed were to tighten precipitously. We also note that with weak commodity prices likely keeping a lid on inflation, there is all the more reason to expect that the Fed will move in a very deliberate fashion.
We continue to have a favorable outlook for stocks. Our view is that earnings can pick up during the second half of the year as improving labor conditions and lower commodity prices are likely to spur consumption, the largest driver of the U.S. economy. We see the potential combination of improving economic conditions, a return to positive earnings growth, and a Federal Reserve normalizing policy at a cautious pace as a healthy backdrop for stock prices.
One risk to our outlook is tepid wage growth, where the most recent data points have come in below our expectations. Should this persist, the consumer would be hard pressed to lead the economy in the back half of the year. We continue to believe, however, that lower unemployment rates should ultimately lead to an acceleration of wages.
We are also keeping a close watch on stock market volatility and slowing growth in China and other emerging markets. Given the size of China’s economy, we believe the situation bears careful monitoring for any signs of broader contagion, particularly now that the central bank has decided to engage in a devaluation of the currency.
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