School is out and we are almost halfway through 2017.  As we are reviewing May’s month-end performance, it’s a good time to look at the big picture themes driving markets as we enter into the summer months.  Here are four big picture observations as we review results so far this year within client portfolios:

1. Foreign Stocks are the market leaders.  Reviewing the year-to-date performance across asset classes, it is clear that market leadership is coming from outside of the U.S.  Emerging markets (think India and China) and developed international markets (think European countries and Japan) are both outperforming the broader U.S. market so far in 2017.  Stocks outside of the U.S. are enjoying a “trifecta” of performance drivers – first, economic growth is accelerating at a faster rate overseas; second, valuation metrics show foreign stocks are broadly cheaper than U.S. stocks; and third a weaker U.S. dollar is providing a tailwind to returns for U.S.-based investors.  We believe these trends are in the “early innings.”

2.Within the U.S., Technology Stocks are Winners, while Energy Stocks are Losers.  Looking at the various sectors which make up the S&P 500, there is a big gap between the best and worst performers.  So far this year (through May 31) an index tracking technology stocks within the S&P 500 is up about 17.3%, while an index tracking energy stocks within the S&P 500 is down about  -12.6%…that’s a difference of almost 30%!  When we look at sector performance here in the U.S. it is interesting to note 2017 leadership is completely the opposite from the late 2016 post-election rally.  Following President’s Trump’s election, energy and financials were the two best performing sectors, while technology and health care were relative laggards.  So far in 2017, technology and health care are the best performers, while energy and financials are the two worst performers.

3.Small cap U.S. stocks are being left behind the in the broader market rally.  One area which stands out due its lack of performance is small cap stocks.  According to data from Morningstar, the Russell 2000 index for small cap stocks is up only 1.48% so far this year (through May 31).  We believe the lack of participation from small cap stocks has to do with politics.  After President Trump’s election, small cap stocks surged, largely on hopes of corporate tax reform.  Data shows small cap stocks have a higher effective corporate tax rate than large cap stocks and therefore stand to benefit the most from corporate tax reform.  As the odds of Congress agreeing on a tax reform bill have diminished, so has the performance of U.S. small cap stocks.  It is worth noting that small cap underperformance is a U.S.-only phenomenon.    Based on data from Morningstar, foreign small company stocks are outperforming foreign large company stocks by approximately 3% so far in 2017.

4.Bonds have positive performance due to falling long-term interest rates.   The Federal Reserve may be increasing short-term interest rates, but longer-term interest rates have been moving in the opposite direction.  In March, the Fed increased short-term interest rates by 0.25%, and the market is pricing in virtually a 100% chance the Fed will hike short-term rates by another 0.25% when the Fed meets in mid-June.  However, longer-term interest rates are moving in the opposite direction.  The benchmark 10-year Treasury bond, which started the year with a rate of 2.45% has moved DOWN by 0.25% to 2.20% as of May 31st.  The 10-year Treasury rate is more influential for mortgage rates and most intermediate bond portfolios and as a result, mortgage rates are lower and bond prices are higher than they were at the start of the year.

Overall, foreign stock leadership combined with positive performance from most other asset classes has meant solid results from globally diversified portfolios during the first 5 months of 2017.  We look forward to reviewing portfolios with our clients and discussing our outlook for the back of the year in the weeks ahead.

Have a great week!