While the first half of 2017 has been dominated by mostly negative political headlines, the global markets appear to be more focused on improving economies around the world, building stronger corporate earnings and increasing the potential for pro-business policies to be implemented in the United States.
Equity markets have done well so far in 2017, with Emerging Markets being the strongest performer year-to-date, followed by Europe and the United States. Earnings growth has been strong across the board, and the forward-looking returns for equities may be dependent on earnings sustainability. For the second quarter, the proxy for U.S. large company stocks (S&P 500) was up 3.09%, while the Russell Mid-Cap index returned 2.70%, and the Russell Small Cap index gained 2.46%. International stocks in the developed markets of Europe and Japan, as measured by the MSCI EAFE index, rose 6.12%, and the MSCI Emerging Market benchmark did slightly better, gaining 6.27%.
After a surge in yields at the end of 2016, there has been a reversal to the 2.2% to 2.3% range on the 10-year Treasury. The Federal Reserve has increased short-term interest rates twice to the 1.0% to 1.25% level, and there may be one more hike later in the year. Most economists believe the Fed will continue to gradually move the Fed funds rate higher to the 2.5% to 3% range, which would still be below historical rates. In spite of all of this interest rate movement in 2017, the Barclays Aggregate Bond Index was up 1.45% for the April-June timeframe.
In terms of the economy, U.S. GDP growth for the second quarter is expected to accelerate from a mediocre first quarter reading, and job creation continues to push the unemployment rate down while helping consumer confidence. Importantly, the populist movement around the globe has somewhat dissipated with anti-establishment/anti-European Union candidates being defeated in Austria, the Netherlands and France. Also, Angela Merkel appears to be in a better position to win in the German elections later this year.
Looking ahead to the second half of 2017, the direction of the markets will likely depend on whether politics remains in the news or whether economic and company fundamentals are the focus. If it’s the latter, then the global markets may be able to continue their march higher. Some type of corporate/individual tax reform, as well as an infrastructure policy, could be just what the markets need to bring money off the sidelines and out of the bond market into stocks. After being out of favor for more than five years, International Developed and Emerging Market stocks seem to have the wind at their backs. In spite of the volatility that always accompanies these categories, investors appear to be embracing the story of more attractive valuations, better earnings growth potential and the technical aspect of improving fund flows into these markets. Having said that, global markets typically experience a 5 to 10% decline at some point during most 12-month periods; therefore, it would not be a complete surprise for this to occur in the last half of the year. In summary, stock valuations are not cheap, but they’re not excessive either, and there is very little near-term concern about a U.S. recession. Long-term investors should view any significant market pullback as a buying opportunity.