Market Commentary: July 12, 2017

July 12, 2017

JULY 12, 2017

Stocks as measured by the S&P 500 Index are down about 1% from the June 19th record high of 2453. Looking at the first half of 2017, the index returned 9.34% when including dividends. Amazingly, about a third of this gain was driven by just five companies—Amazon, Facebook, Netflix, Apple, and Microsoft. All five of these stocks returned over 30% in the first six months of the year.

Since the end of the 2nd quarter, however, stocks have been going through a bit of a tug of war. Holding back the market has been the recent rise in interest rates both in the U.S. and overseas. The yield on our 10- year Treasury has risen from 2.2% to 2.4% over the past two weeks. Even more remarkable is the near doubling in the yield on the 10-year German Bund from .30% to .57%. While still remarkably low, this sharp increase drew investor attention and was a reminder of the risks to bond investors of a change in central bank policy. The rise was sparked by rhetoric from the European Central Bank suggesting they may review their current ultra-stimulative monetary stance given the improved economy.

Countering interest rate worries has been the positive outlook for corporate profits. For the 2nd quarter, the consensus forecast is for earnings to grow 8% over last year’s 2nd period. The revenue increase is estimated to be just under 5%. PepsiCo got things started this morning by reporting earnings and sales well ahead of analyst projections. This Friday several major banks will be reporting results which we expect to reflect solid improvement.

Stock groups that should show the strongest improvement include industrials, technology, and financials.

Industrials are benefitting from the decline in the dollar and a nice pick-up in overseas demand. Included in the industrial sector are defense contractors. Companies like Raytheon, Harris, Lockheed, and General Dynamics are seeing strong order growth from the U.S. government, NATO allies, and Middle East customers. Other industrials that are well positioned are Pentair (water treatment), Waste Management, Honeywell, and Eaton. While these companies are trading near all-time highs, they are still reasonably valued given their strong global business outlook.
Technology companies will similarly benefit from the decline in the dollar and a resurgence in global demand. Names like Microsoft, Cisco, and Apple offer nice dividend yields and are priced at discounted valuations to the overall market. They also have significant overseas cash holdings. If policymakers in Washington were to reduce the tax rate on repatriated funds, all three would likely bring back dollars to repurchase stock and raise dividends.

One of the least expensive groups in the market are banks. A modest rise in interest rates and continued loan growth should support higher earnings over the next few years. Multi-national banks like J.P. Morgan and Citigroup, while benefiting from steady growth in the U.S., are also well placed in faster growing regions in Europe, Asia, and emerging countries. Adding to the group’s attractiveness is that the top banks just passed the recent rigorous Federal Reserve Bank capital stress test. As a result, banks received approval to raise their cash dividends and repurchase stock with their excess capital.

Finally, there has been much hand wringing over how markets would react if Washington becomes hopelessly gridlocked and nothing gets done. It has been widely felt that prospects for stocks would be significantly helped if we got a new healthcare bill, tax reform, and a big spending package for infrastructure. Interestingly, there has been developing view since the election that the stock market would do just fine if little came out of Washington. The favorable business cycle in the U.S. has good momentum thanks to less regulation, low interest rates, and improving economic conditions in Asia, Europe, and emerging economies where the U.S. stands to see sustained export growth.

Bill Hegarty
Chief Investment Officer
McDonald Partners LLC

The opinions and recommendations expressed herein are those of Bill Hegarty, Chief Investment Officer at McDonald Partners,
LLC and do not necessarily reflect those of the firm and are subject to change without notice. This information is not to be
construed as an offer to sell or the solicitation of an offer to buy any securities. The information contained herein has been
derived from sources believed to be reliable but is not guaranteed as to accuracy and does not purport to be a complete analysis
of the security, company, or industry involved.