What the stock market is thinking about
Markets were relatively flat this week. On the domestic front, the Fed reported the results of its “stress test,” which measured large bank’s ability to survive if we experience another downturn in the economy. All passed, which was expected given the stringent regulations under the Dodd-Frank act. Also, the Senate GOP released its health care bill which will likely go through several changes as it currently lacks the support to pass.
The Fed seems intent on raising rates one more time this year, as well as shrinking its balance sheet. This will be an important issue going forward as the markets will look for continued economic strength to justify the rate increases. This kind of tension always exists during a Fed tightening cycle. There is some concern among analysts that the Fed will make a policy mistake and tighten too much too fast. Fed officials worry that measures of inflation are still too low to justify another rate increase before the end of the year.
Seemingly persistent low inflation, even with rates being low since the financial crisis, some wonder if there is something global going on that we do not understand. For example, unemployment at a 4% level that would usually lead to higher wages and rising prices. Yet this has not materialized. It could be that advances in technology have ushered in a new era where traditional inflationary pressures do not have the effect they historically have.
We’ve seen a continuing rotation into health care stocks, especially the biotech sector. Some of this is due to the release of the Republican’s health care bill. This makes sense since health care has underperformed since the summer of 2015. We also saw money move back into the technology sector, which has the best earnings momentum. With market averages near all-time highs and stocks thought to be richly valued, it’s not unusual to see money rotate among various market sectors.
One area that has performed well is dividend stocks. Here, investors benefit from some capital appreciation in addition to dividends. In this environment, where the Fed is raising interest rates, companies that raise their dividends every year usually outperform. As their dividends increase over time so will the stock price.
Going forward, the next catalyst for the markets will be when companies start reporting their 2nd quarter earnings in the middle of July. Politics could provide some optimism if health care reform is well received and the market senses that tax reform would then be on the table. On the other hand, the lack of progress in these areas could turn into headwinds. The likely scenario is the markets continue a period of consolidation with averages in a narrow trading range.
D. Scott Peterson is CEO and head investment manager for Peterson Wealth Management. He may be reached at 775-673-1100/775-423-8007 or at http://www.PetersonWM.com.