Don't Bet Against U.S. Consumers
- Consumers Are Driving Growth
- Diversification Wins
- Looking Ahead
U.S. stocks eked out a gain in April only to drift a bit lower in May’s first trading days. This is not a surprise. Stock prices had been bid up on expectations of strong first-quarter earnings, and once that trend was confirmed, short-term traders with a “what have you done for me lately?” mentality sold on the news.
Consumer strength is driving the growth in corporate profits along with the first impacts of a lower corporate tax rate and first-quarter earnings have come in higher than expected. Projecting how the rest of the year will fare, corporate managers remain apprehensive about the possibility of tight labor supply leading to wage inflation and increased commodity pricing pressures as well as tariffs and potential trade wars.
Those concerns, however, haven’t kept companies from hiring. Employers added 164,000 workers in April, marking the 91st consecutive month of job growth. While the headline unemployment rate fell to a 17-year low of 3.9%, the drop was due to a smaller overall U.S. workforce, which shrunk by 236,000 workers.
For the year through Thursday, the Dow Jones Industrial Average has declined 2.6%, while the broader S&P 500 index has dropped 1.1%. The MSCI EAFE index, a measure of developed international stock markets, is essentially flat, down just 0.1%. As of Thursday, the yield on the Bloomberg Barclays U.S. Aggregate Bond index has climbed to 3.30% from 2.71% at 2017’s end. On a total return basis, the U.S. bond market has fallen 2.3% for the year.
Consumers Driving Growth
While consumers curtailed spending early in the year to regroup and pay off bills from the biggest holiday shopping season since 2011, they went back to spending on goods and services in March. Spending increased 0.4% from February as the strong job market pushed wages higher. Confidence in the economy remains elevated.
Notably demonstrating consumers’ confidence, purchases of durable goods—big-ticket items intended to last three or more years, such as appliances and furniture—rose 0.8% in March. Sales of the largest and most expensive consumer durable of them all, cars and trucks, remain robust. What’s particularly encouraging is the persistent demand for large vehicles—pickup trucks and SUVs—even as fuel costs climb.
Car sales and increased spending reflect a consumer in fine fettle, benefiting from job security, rising incomes and healthy household balance sheets.
Diversification Wins in the Long-Term
One trend we’ve been watching is the divergence in performance between large-cap stocks and small-cap stocks. Remember, small-cap stocks (“cap” refers to a company’s capitalization, or the market value of its shares) are typically domestic companies worth between $300 million and $2 billion. They tend to be under-analyzed relative to name-brand large-caps found in the Dow and S&P 500 indices, making them both riskier and potentially more rewarding. It is commonly accepted market “wisdom” that small-cap stocks beat large-cap stocks over time.
Through Thursday night, the Russell 2000 index of small-cap stocks is up 0.7% for the year, while the S&P 500 index is down 1.6% (that’s without including dividends). Pundits have been noting this divergence as if it’s a permanent trend.
Over the long run, small-cap and large-cap stocks have performed just about the same—in fact, large stocks have had a slight edge over small stocks. From the end of 1978 through the end of April, the S&P 500 index gained 8,051% (including dividends) while the Russell 2000 index gained 7,513%. So much for market “truisms.”
These 40-year end-to-end returns mask the fact, however, that along the way there were periods when large stocks trounced smaller ones, and other times when the reverse was true. If you only owned small stocks or only large ones, you would have suffered through many difficult periods of buyer’s remorse.
Next week, in addition to further first-quarter earnings reports, we’ll also get reads on consumer credit, job openings, small business confidence, inflation and consumer sentiment.
With robust earnings and economic reports astern, we expect increased volatility ahead, which can be either good or bad news on any given day. Rest assured that your portfolios are well-positioned for both the downside and upside that volatility presents.
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Please note: This update was prepared on Friday, May 4, 2018, prior to the market’s close.
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