The second full week of June, which yielded more flat market performance with the S&P500 barely changed at +0.1%, seemed to offer a little bit of something for everyone. Volatility and the daily trading range observed was up a touch relative to the sleepy pattern investors have grown accustomed to so far in 2017, but remains low by historical standards. Perhaps the most notable development throughout the week was the Fed decision to raise short-term interest rates by another +0.25% bringing its target up to between 1.00% and 1.25%. This hike came despite some recent readings suggesting softer than anticipated and desired inflation. With that, the bearish camp can find support for their case in observing the continued flattening of the yield curve (inverted yield curves have served as a reliable leading recession indicator), weakness in oil, or the recent reversal in what has been the high-flying tech sector so far this year. The glass-half-full crowd might instead choose to focus on the rotation by the market into Financials (often described as the transmission of the economy) despite flatter yield curve, the weakness in gold stocks, or the resiliency from the Industrials sector. Whatever side you find yourself, the market continues to send mixed signals.
From a fundamentals perspective, we already highlighted perhaps the biggest development with the Fed rate increase last week, although the decision was well telegraphed and of essentially no surprise to market participants. Outside of that news, there was a package of stronger data around the world including key manufacturing indexes, Eurozone and Canadian employment, bank lending in China, Indonesia imports, and retail sales in Singapore. Those insights would tend to suggest then that recently cooler inflation readings despite continued labor market tightness are due to more transitory factors such as sliding oil prices on too much production and technology disrupting other goods and services pricing structures than an indication of a slowing economic environment. On the weaker front, some recent housing metrics in the form of new permits and mortgage have been disappointing relative to the time of year, as well as slumping auto sales; these are two sectors of the US economy that have significant trickle-down impacts so downshifts in activity are worth noting.
As observed in our update a week ago, perhaps the most unsettling attribute of recent market dynamics is the flattening yield curve. In that vein, the Fed decision and relatively hawkish press conference did not help. Either forward growth and/or inflation expectations need to lift for the yield curve to steepen when the Fed is in the process of propping up short-term rates. Further, stocks are admittedly not cheap, but it is important to also note that neither are bonds, real estate, or about anything else that is investable. If the financial crisis and unprecedented level of monetary stimulus applied in its aftermath in pursuit of stabilizing the economy has done nothing else, it has created a lot of money that generally remains underutilized and unproductive on corporate balance sheets or being hoarded earning decidedly less than inflation. It is from that perspective that valuations cannot be viewed as a timing tool, because significant sums of that money remain in search of more productive or opportunistic uses. Further, this logic probably also goes a long way toward explaining why the Fed continues to communicate a plan of additional rate increases, albeit at a still slow pace. After all, this has never been a normal economic or rate cycle, but the economy is strong enough now to pursue normalization (very slow but incremental steps away from extraordinary accommodation). In the short run, we suspect that what is a more difficult seasonal stretch of the year, coupled with mixed data and hawkish speak from the Fed will produce some anxiety for the markets, but that is unlikely to mark the end of this cycle.