Key Points
• Stocks moving nowhere for over a year, and a continued low yield environment is fueling investor frustration. There doesn’t appear to be a lot of impetus for that to change soon, but investors should remain patient as positive signs are emerging.
• For the frustration to end, we believe businesses need to pick up their capital spending. For now, a relatively healthy consumer and housing are keeping the U.S. economy afloat and making it possible that we’ll see a Fed hike this summer.
• The discontent in the UK has led to an upcoming vote on whether to leave the European Union or not. We believe they’ll stay, but there are risks, and unfortunately stocks likely won’t rally on a vote to remain, but could slide on a vote to leave.

Summer fun or frustration?
As amusement park visits rise in the summer months, the ever-popular roller coaster analogy seems appropriate for the stock market. Since the beginning of 2015, stocks have had some fairly major ups and downs, but we now sit about where we began. Unfortunately, it’s not as easy for investors to get off the ride, and we expect the frustrating, grinding environment to continue for the near future. Equities have yet been unable to break through to new highs, while fixed income continues to offer little in terms of yield.

We know discontent among investors is elevated from talking to them around the country; but also by the continued outflow we are seeing in U.S. equity funds. Through May 25, according to Evercore ISI, the outflows had reached $71 billion, which almost reaches the total of $72 billion from last year, and the $77 billion outflow seen in 2008—the heart of the financial crisis. Although exchange-traded fund (ETF) flows are positive this year, they are more than offset by the drain from traditional mutual funds.

The positive caveat is that there is likely a lot of liquidity on the sidelines which could be the fuel for another market advance. Investor sentiment continues to be one of the stand-out bright spots in an otherwise fairly gloomy environment; hence our continued “neutral” rating on U.S. equities. As a reminder, this means investors should remain at their long-term strategic allocations and use volatility to tactically rebalance around that norm.

Glimmers of hope
We have been accused at times of wearing rose colored glasses, but we believe a default setting of optimism has been more rewarding for investors longer-term relative to one of doom. But we are aware of the risks.

Profit growth was nonexistent for the broad market through much of the first half of the year and business caution remains elevated, hampering potential further growth. Business optimism as measured by the National Federation of Independent Businesses (NFIB) remains relatively low, and according to the Federal Reserve, business spending actually declined in the most recent month.

Business optimism remains lackluster

Source: FactSet, Natl. Federation of Independent Business. As of June 7, 2016

Translating to weak business spending

Source: FactSet, U.S. Bureau of Economic Analysis. As of June 7, 2016.

There are modest signs that things may improve over the second half of the year. Profit growth estimates bottomed in February and have been moving higher, helped along by easier year-over-year comparisons for the energy sector. Additionally, we’ve seen some improvement in manufacturing as the Institute for Supply Management’s (ISM) Manufacturing Index gained slightly in May to 51.3 from 50.8; while new orders, the forward looking component, stayed fairly solid at 55.7. And as noted, we believe businesses need to get on board to really get the economy rolling. With productivity still running quite low there is hope that companies will start to spend more on longer-term capital investments vs. using excess cash to increase dividends and/or buy back their own stock.

The rise in wages that we’re starting to see alongside the tightening labor market could further incentivize businesses to invest more in order to boost productivity and improve longer-term profit margins. Notwithstanding the weak May jobs report, the improvement in job growth during this expansion has contributed to a stronger consumer and a healthier housing market, which have offset the drag from manufacturing and capital spending. The May jobs report was indeed much weaker than expected as only 38,000 workers were added to U.S. payrolls. Even taking into account the Verizon strike, the reading would have only been roughly 78,000. Although the unemployment rate did fall from 5.0% to 4.7%, it was for the “wrong” reason—the labor force participation rate fell. Average hourly earnings were a bright spot, increasing 2.5% year-over-year, while other measures of wages show even more upward momentum. At this point we believe the job market is maturing, which suggests a slower pace of payroll additions; but the trend needs to be watched carefully over the next couple of months. For further discussion of the U.S. job market, please read Liz Ann’s article,Are the Glory Days of Job Growth Over?

Rising wages

Source: FactSet, U.S. Dept. of Labor. As of June 7, 2016.

Could be helping consumer spending

Source: FactSet, U.S. Bureau of Economic Analysis. As of June 7, 2016.

As seen above, the strength to-date in the job market may be leading to an acceleration in consumer spending, as personal spending rose 1.0 % month-over-month in April. This was in conjunction with a strong retail sales report for the month and was the largest monthly increase since 2009. It’s much too early to call this a trend, but they are positive signs and what we have been expecting given the improvement-to-date in the job market and the lagged impact of lower oil prices. A more confident consumer should be supported by an improving housing market. According to the U.S. Department of Housing and Urban Development, new home sales rose a robust 16.6% month-over-month in April, while inventories fell to only 4.7 months, which should also support business confidence and the economy more broadly.