September 1, 2016
If you were paying attention to the stock market in August, you noticed the lack of volatility. If you instead found yourself preoccupied with weddings, weekends at the cabin, or other end-of-summer shenanigans, well, you didn’t miss much.
None of the three major US equity indices moved as much as 1% in either direction, which some investors may view as a welcomed lull following the Brexit bombshell at the end of June and the parade of political conventions in July. Boring isn’t always bad in the investment world.
Four of the 10 sectors in the S&P 500 were positive in August with Financials (+3.83%) performing the best. Telecom (-5.67%) and Utilities (-5.62%) fell the most. The prospect of higher interest rates on the horizon certainly contributed to these results.
|Index||August 2016||YTD 2016|
Discussions about “When the Federal Reserve will raise interest rates” has become a tired subject. So, we certainly sympathize with our readers if you have a full blown case of Fed Fatigue by now. But despite the mixed signals and false starts over the last 12 months, we expect the Fed will hike rates before the end of the year.
Fed Chairwoman Janet Yellen’s comments on August 26 supported that possibility. At the Fed’s annual summit in Jackson Hole, Yellen admitted “the case for an increase in the federal funds rate has strengthened in recent months.” The earliest date for an upcoming move would be at the Fed’s Sept. 21 meeting, but regardless of when that next increase actually occurs, the more important question is whether the Fed does another “one-and-done” increase (as it did late last year), or begins a steady dose of quarterly hikes.
A single rate increase could reinforce what many perceive as a Goldilocks environment for stocks. That is, a US economy strong enough to justify an increase, but a change small enough to prevent a rapidly strengthening US dollar or stoke fears of inflation. Yellen understands this, of course, and will likely avoid broadcasting the details of the Fed’s long-term strategy.
The expectation of a looming Fed hike directly impacted sector performance in August. Financials, which historically benefit most from a rising rate environment, finally gained some momentum. On the other hand, typically defensive sectors that offer the highest dividends have clearly lost some luster.
Telecom and Utilities remain the two best-performing sectors in the S&P 500 year-to-date, but investors in August rotated more dollars into economically cyclical names. Because of their larger dividends, those sectors typically get hit the hardest when interest rates rise. As Yellen moves her hand closer to the Fed’s big red HIKE button, investors are beginning to distance themselves from the yield-heavy categories.
Bonds have been affected by potential rate movements as well. The 10-year Treasury yield finished August at 1.57% compared to 1.46% a month ago. That remains far below where it began the year (2.27%) but is trending away from the all-time low set in early July (1.34%).
Volatility in equities evaporated last month due to light trading volume and the lull between earnings seasons. The VIX Volatility Index fell to a 52-week low on August 9, an indication of the exceptionally calm conditions. Expect that to change with the kids heading back to school and traders heading back to work following Labor Day weekend.
Oil prices increased 8% in August following a 15% drop in July. West Texas Intermediate crude closed at $44.86. Energy stocks rank third among equity sectors with gains north of 15% year-to-date, but remain out of favor by some measures. Similar to Financials and Technology stocks, Energy companies typically perform well when interest rates are moving higher and could become more attractive in the coming months.
The economic data reported in August remained solid. Existing home sales dropped 3% from June to July due in part to a lack of inventory, but sales of newly built homes jumped 12% to the highest level since October 2007. In terms of real estate prices, home values nationally have risen 5.1% over the last year (through June 30), according to the Case-Shiller index.
The latest employment data from ADP payrolls showed 177,000 new jobs created in August. And July figures were revised higher to reflect 194,000 new jobs. The last three months have given us 190,000 new jobs per month on average. Nationally, unemployment remains below 5%.