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The Beginning of the End for QE

ON THE HOMEFRONT

Despite some month end weakness, U.S. equities posted gains for June. The S&P 500 added 0.62% while the Dow Jones gained 1.74%. After leading the market higher most of the year, the tech-heavy NASDAQ Composite struggled shedding -0.86%.

As we reflect on the first half of 2017, it has been quite impressive overall. The Dow Jones and the S&P 500 have each added about 9%, while big-cap technology led the NASDAQ higher for a return of approximately 15%. Many attribute the rally to strengthening corporate earnings, improving global economies, deregulation, infrastructure spending, continued support from central banks, and confidence in President Trump implementing his campaign promise of tax cuts. 

In the 9th year of a bull market, with popular opinion grounded in the assumption that central banks will do whatever it takes to stimulate economic growth following the 2008-2009 crises, June 2017 may turn out to be a significant month in market history. During June, global stock and bond markets gyrated on comments from multiple central banks hinting towards less central bank intervention. Heads of the European Central Bank (ECB), the Bank of England, and the Bank of Canada raised the prospect of interest rate increases; will these institutions join the Federal Reserve in ending the era of ultra-low interest rates and asset purchases? Investors have interpreted these headlines as a shot across the bow that the central bankers believe their work is done and can begin removing their unprecedented aggressive stimulus policies.        

INTEREST RATES

In a sign of confidence, the Federal Reserve raised interest rates for the second time in three months. The Fed said it would begin cutting its holding of bonds and other assets this year; to some analysts, this gesture signals the Fed’s confidence in a growing U.S. economy and an improving job market. On June 14th, the benchmark lending rate was raised by a quarter percentage point to a target range of 1.00% to 1.25%. According to the forecast released by the policymaking Federal Open Market Committee (FMOC), one more rate increase is expected this year. The 2017 rate hikes have been widely anticipated. More importantly, the Fed provided the blueprint of the plan to reduce its $4.2 trillion portfolio of securities purchased through the quantitative easing programs in the wake of the financial crisis of 2008 and 2009, marking a new chapter for Fed operations.

In comments following the announcement, Fed Chairwoman Janet Yellen said, if the economy performed in line with the central bank’s forecasts, the Fed could begin the program “relatively soon,” which many analysts predict to be in September or October. The Fed intends to communicate their plans to avoid market strains or another 2013 “taper tantrum”.

Interestingly, even in the face of falling inflation numbers, the Fed still seems committed to removing accommodation. The Fed’s preferred measure of inflation, core Personal Consumption Expenditures (PCE) rose 1.44%--well below the Fed’s 2% target and the lowest level since December 2015. Fed officials lowered their projections for inflation this year, though they still expect price gains to reach their target by the end of 2018.  With the unemployment rate running at its lowest level in 16 years, the Fed appears to be brushing off weakening inflation and focusing more on its employment mandate which could impact long-term inflation. Typically, a tight labor market will push up wages leading to higher inflation.

After several months of a steady decline in interest rates, global bond prices reacted negatively to concerns that central banks in the developed world are moving towards less-accommodative monetary policies.  On hawkish remarks from the European Central Bank (ECB), the yield on the benchmark 10-year Treasury rose from 2.12% to 2.28% during the last week of the month.  Yields on 10-year government bonds in Germany, the U.K., and Canada all closed near levels last seen in March.    

INTERNATIONAL

International stock benchmarks remained fairly flat for the month of June but posted double-digit percentage gains for the first six months of the year. The MSCI Emerging Market Index posted an 18.55% gain along with the MSCI Developed Market Index tacking on a 14.22% gain.    

The U.S. Dollar Index continued its slide shedding another -1.50%. The Index is off -6.71% for the year. Investors have noticed global economic growth outpacing U.S. growth, potential rising rates overseas, and more attractive international valuations. The World Bank is forecasting global growth to hit 2.9% next year—up from 2.7% this year, which would be the fastest global economy pace in nearly seven years. 

The ECB is joining with the Fed on a movement for added restrictive monetary policies. The ECB hinted toward intent to taper its stimulus program in response to accelerating growth in Europe. 

In the June 9th UK Prime Minister election, British voters delivered a setback to Theresa May’s Conservative Party, which raised big questions about Brexit and the Prime Minister’s future. The defeat deprives the Prime Minister of a majority in Parliament and puts the country back into a period of uncertainty as it prepares to depart from the European Union (EU). The UK election could delay negotiations and may eventually result in a “softer” Brexit or potentially even a whole new vote on exiting the EU.

In a landmark decision, U.S. index provider MSCI said it will begin adding mainland Chinese stocks to one of its key benchmarks. After having rejected the idea for three years, the decision recognizes the Chinese government working to open its capital markets. According to analysts, the inclusion of Chinese stocks in the widely tracked MSCI Emerging Markets Index could pull more than $400 billion in funds from asset managers over the next decade.  The inclusion is expected to take effect in two stages roughly a year from now.  

TECHNICALLY SPEAKING

The market experienced some deterioration late in the month as weakness in the technology sector bled into the broader markets and investors grew anxious with the possible wind-down of global central bank intervention. The S&P 500 successfully tested its 50-day moving average, while the NASDAQ Composite fell below its 50-day moving average. Value stocks outperformed growth stocks—a reversal from the past few months. This performance could be a sign that investors may begin taking a more defensive approach. For June, Financials and Healthcare were the top performing sectors. 

Market breadth is still mostly positive. The S&P 500 Advance-Decline remains near all-time highs and stocks are still trading above their 50-day and 200-day moving averages.  However, both indicators are trending lower. The weakness began in the last few trading days of the June, and it will be interesting to see if it follows through as we move further into summer.  


2017 is off to a solid start.  At this time, the parade of central banks paring their balance sheets may present the biggest unknown to the markets.  To avoid a hard landing, the Fed will have to thread a needle in shrinking its balance sheet while raising rates—a process that has never been attempted before.

The end of “easy” money unleashed by global central banks could test the equity and fixed income markets both domestically and abroad.  Stadion will proceed cautiously, following our disciplined investment process to respond to market developments, not attempting to predict them.


Past performance is no guarantee of future results. Investments are subject to risk, and any of Stadion’s investment strategies may lose money. The investment strategies presented are not appropriate for every investor and financial advisors should review the terms and conditions and risks involved. Stadion’s actively managed portfolios may underperform during bull markets. Some information contained herein was prepared by or obtained from sources that Stadion believes to be reliable. There is no assurance that any of the target prices or other forward-looking statements mentioned will be attained. Any market prices are only indications of market values and are subject to change. The NASDAQ Composite is a stock market index of the common stocks and similar securities listed on the NASDAQ stock market and it is highly followed in the U.S. as an indicator of the performance of stocks of technology companies and growth companies. The Dow Jones Industrial Average is a price-weighted average of 30 significant stocks traded on the New York Stock Exchange and the NASDAQ. The S&P 500 Index is the Standard & Poor’s Composite Index of 500 stocks and is a widely recognized, unmanaged index of common stock price. The VIX is the Chicago Board Options Exchange Market Volatility Index, a popular measure of the implied volatility of S&P 500 index options. Often referred to as the fear index or the fear gauge, it represents one measure of the market's expectation of stock market volatility over the next 30 day period. The MSCI EAFE (Europe, Australasia, and Far East) Index is a stock market index that is designed to measure the equity market performance of developed markets outside of the U.S. & Canada. The MSCI Emerging Markets Index is a float-adjusted market capitalization index that consists of indices in 21 emerging economies: Brazil, Chile, China, Colombia, Czech Republic, Egypt, Hungary, India, Indonesia, Korea, Malaysia, Mexico, Morocco, Peru, Philippines, Poland, Russia, South Africa, Taiwan, Thailand, and Turkey. The U.S. 10-Year Treasury Note is a debt obligation issued by the United States government that matures in 10 years. The Sharpe ratio measures the excess return per unit of deviation, or risk. Yield is the annual return on an investment, expressed as a percentage of the price. For stocks, yield is the annual dividend divided by the purchase price, also known as a dividend yield. For bonds, it is the coupon rate divided by the market price, called current yield. The core personal consumption expenditures index measures the prices paid by consumers for goods and services without the volatility caused by movements in food and energy prices. Any references to specific securities or market indexes are for informational purposes only. They are not intended as specific investment advice and should not be relied on for making investment decisions.

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Past Performance is no guarantee of future results. Investments are subject to risk, and any of Stadion's investment strategies may lose money.