Market Update for the Month Ending November 30, 2015

Posted December 3, 2015

Markets struggle with conflicting news
After a strong October, U.S. stock markets bounced around throughout November, with early gains vanishing by mid-month though returning at month-end. The Dow Jones Industrial Average was up 0.71 percent, and the S&P 500 Index showed a smaller gain of 0.30 percent. The Nasdaq was once again the champion, increasing 1.09 percent for the month.

The best-performing stocks in November were those of small companies, with the smallest firms posting the largest gains. Growth outperformed value in the smaller companies but not in the larger. Although the U.S. markets in general treaded water, the outperformance of smaller companies suggests that investor risk appetite remains solid, though there may be concerns about the pricing of larger companies.

The small gains for most indices were driven by mixed fundamentals. Per FactSet, with 98 percent of S&P 500 companies reporting by November's end, almost 74 percent had beaten their estimated earnings, but only 45 percent had higher-than-expected revenues. In the aggregate, third-quarter earnings declined 1.3 percent. Although this is much better than the 5.1-percent decline expected at the start of the quarter, it is still the second quarterly earnings decline in a row—the first time that has happened since 2009.

Technically, markets remain well supported. At month-end, all major indices were well above their 200-day moving average trend lines, typically a sign of continued strength. Seasonal factors are also supportive, with year-end often a strong time for the markets.

U.S. fixed income struggled. The Barclays Capital Aggregate Bond Index was down 0.26 percent for the month, driven by an increase in rates, as the 10-year U.S. Treasury bond yield rose from 2.16 percent at the start of November to 2.21 percent by month-end. The prospect of an increase in rates by the Federal Reserve has started to concern investors, but low yields in Europe and Japan, spurred by continued central bank stimulus, acted as an anchor on U.S. rates. High-yield, as reflected in the Barclays Capital U.S. Corporate High Yield Index, fared even worse, down 2.22 percent, primarily on worries about the energy sector. This decline led the index into negative territory year-to-date.

International equity markets did significantly less well than their U.S. counterparts. The MSCI EAFE Index, which covers developed countries outside the U.S., lost 1.56 percent, giving back some of October's gains, as the refugee crisis in Europe continued to both hurt growth and provoke political confrontations. In response to the prospect of increased interest rates, the MSCI Emerging Markets Index was hit even harder, declining 3.96 percent for the month and taking back more than half of its October gains. Technically, both MSCI indices showed signs of weakness, trading below their respective 200-day moving averages and suggesting further weakness ahead.

U.S. economy growing, but showing signs of slowing
The U.S. economy continued to grow, although there were signs of a slowdown. Driven by lower-than-expected declines in inventory growth, gross domestic product growth for the third quarter of 2015 was revised up—to 2.1 percent from the disappointing initial estimate of 1.5 percent. This encouraging news was reinforced by a very strong jobs report at the start of November, with 271,000 jobs created—almost 50 percent above expectations—and with wage growth finally showing an increase. Personal income also showed strong growth, at 0.4 percent for October, up from 0.2 percent in September.

But even as jobs and income increased, consumer confidence declined in November, per both major surveys, and spending growth remained weak. Retail sales were up only 0.1 percent, while the more inclusive personal consumption numbers were also at 0.1 percent, indicating that the economic impact of the improved employment conditions has been limited. Other signs of slowing growth included the housing market, where many measures—housing starts, new home sales, and existing home sales—were down from previous months, while other measures grew but failed to meet expectations.

Much of the economic weakness appeared to be concentrated in the industrials sector, with the ISM Manufacturing survey dropping in November to its lowest level since 2009 (see Figure 1). A large portion of the drop was due to a continued decline in durable goods orders. At the same time, however, the services sector continued to do relatively well. Business confidence, from the ISM Nonmanufacturing survey, stayed at high levels despite small declines, and the more forward-looking indicators—employment and new orders—were up strongly. Because services comprise seven-eighths of the economy, this is a positive indicator.

Figure 1. ISM Manufacturing PMI Composite Index Performance, 2006–2015

Overall, although the data indicates some softening, the economy is still growing, albeit at a slower rate. Many of the weak statistics appear to be based on one-time factors, and there are signs that conditions might be better than they seem. The consumer confidence data and low spending growth, in particular, could well be driven by slow third-quarter growth rather than by the more upbeat recent employment figures. The Fed seems to think so.

The October meeting minutes for the Federal Open Market Committee suggested that the Fed sees the economy as continuing to grow at a solid pace. Weakness seems attributable to a mix of the strong U.S. dollar and slow growth elsewhere in the world, rather than in the U.S., making export markets weaker and slowing demand for U.S. goods.

The rest of the world continues to weaken
Europe is still struggling economically, particularly in the peripheral countries, compounded by the political issues associated with the influx of Syrian refugees. The European Central Bank has continued its stimulus program and is widely expected to dial stimulus up at its next meeting. Europe, while not actually moving back into recession, has shown very slow growth levels. It remains quite possible that the continental economy will start to contract, as even Germany's growth has declined and as major economies such as France and Italy face the need to cut spending.

Japan also continues to grow slowly, despite its own central bank's quantitative easing program designed to create inflation and reduce the value of the yen. Other countries with economic worries include Russia, which is suffering from sanctions because of its actions in Ukraine, as well as low oil prices, and China, which continues to report growth but at the cost of central bank-financed stimulus. In both Russia and China, the likelihood is for slower rather than faster growth ahead.

This global weakness will continue to hurt U.S. exports, either through lower sales or a stronger dollar, both of which are already happening. Exports, however, are a relatively small part of the domestic economy, so damage should be limited. Further limiting any damage will be the positive effects of a stronger dollar, in particular the effect of making imports cheaper, especially oil. With oil prices already low, and with continuing strong U.S. production, low oil prices may be with us for a while, which should create a boost to growth that could be larger than the losses incurred by reduced exports.

Positive trends should persist through year-end
The many concerns around the world and the very real risks at home notwithstanding, the signs at this point are still positive. Trends for financial markets, employment, and economic growth are all good, and even the risk factors—primarily the strong dollar and weakness elsewhere—have offsetting advantages for the U.S. At the same time, however, the positive conditions have led to richly priced U.S. markets, leaving them open to the possibility—as we saw in the third quarter—of a pullback.

Because of this risk, I believe a diversified, regularly rebalanced portfolio that harvests gains from fully priced areas and invests in more attractively priced options remains the best solution for most investors. A long-term perspective is still the outlook to adopt in an uncertain world.

Authored by Brad McMillan, senior vice president, chief investment officer at Commonwealth Financial Network.

All information according to Bloomberg, unless stated otherwise.

Disclosure: Certain sections of this commentary contain forward-looking statements that are based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is not indicative of future results. Diversification does not assure a profit or protect against loss in declining markets. All indices are unmanaged and investors cannot invest directly into an index. The Dow Jones Industrial Average is a price-weighted average of 30 actively traded blue-chip stocks. The S&P 500 Index is a broad-based measurement of changes in stock market conditions based on the average performance of 500 widely held common stocks. The Nasdaq Composite Index measures the performance of all issues listed in the Nasdaq Stock Market, except for rights, warrants, units, and convertible debentures. The Barclays Capital Aggregate Bond Index is an unmanaged market value-weighted index representing securities that are SEC-registered, taxable, and dollar-denominated. It covers the U.S. investment-grade fixed-rate bond market, with index components for a combination of the Barclays Capital government and corporate securities, mortgage-backed pass-through securities, and asset-backed securities. The Barclays Capital U.S. Corporate High Yield Index covers the USD-denominated, non-investment-grade, fixed-rate, taxable corporate bond market. Securities are classified as high-yield if the middle rating of Moody's, Fitch, and S&P is Ba1/BB+/BB+ or below. The MSCI EAFE Index is a float-adjusted market capitalization index designed to measure developed market equity performance, excluding the U.S. and Canada. The MSCI Emerging Markets Index is a market capitalization-weighted index composed of companies representative of the market structure of 26 emerging market countries in Europe, Latin America, and the Pacific Basin. It excludes closed markets and those shares in otherwise free markets that are not purchasable by foreigners.