Charles Schwab Report

CHARLES SCHWAB on the US Market

After a weak first quarter and a bounce back in the second quarter, we believe the second half of the year will show improving growth in the U.S. economy. Despite some signs inflation is picking up, the Fed remains quite dovish despite the continued tapering of quantitative easing (QE).

Low volatility and record highs have been the story over the last month. The first quarter brought an “internal correction” where many high-flying names sold off, potentially alleviating the need for an overall market correction that many have been looking for.

near-term. We do believe a

correction would be a healthy pause in an ongoing secular bull market.

The other

major surprise of the first half was the trend in interest rates. Yields on the 10-year Treasury fell from near 3% at the start of the year to below 2.5% at its low, confounding the consensus which

was

expecting yields to gradually rise.

No correction and falling

yields again provided evidence that trying to time the market in the short term can be treacherous. U.S. stocks still look attractive to us, with the U.S. economy continuing to gather momentum while monetary policy remains quite easy. U.S. midterm election years have historically featured typically-midyear corrections, nearly always followed by strong rallies. Sentiment measures are showing excess optimism, indicating the market’s vulnerability

Underpinning our belief in second half market momentum is the economic picture we see developing. The first half economy was somewhat hard to gauge as it featured the harsh winter weather in the U.S. throughout the first quarter and a snapback in the second quarter.

A less distorted

picture should emerge in the second half and

we

believe it will be a good one. Importantly, corporate confidence is improving, both among large and small companies; with capital spending plans increasing and hiring picking up. The most recent U.S. Job Openings and Labour Turnover Survey (JOLTS) showed a sharp increase in job openings— an encouraging sign for the future.

As a result of a tightening labour market, especially at the mid and higher end where specific skills are required, wages are finally starting to show signs of

increasing. This puts more money in consumers’ pockets, increases demand, and

pushes companies to

invest and hire more—the start of a

self-sustaining

expansion. Additionally, manufacturing surveys continue to improve with the Empire Manufacturing Index and Philly Fed Survey adding to their stellar recent gains; while Markit’s measures for both manufacturing and services surged in the latest report. And, the conglomeration of forward- looking data improved again as the Index of Leading Economic Indicators (LEI) rose 0.5%,

the fourteenth consecutive increase.

Housing data has recently been mixed.

Action in the first half of the year again illustrates why

Mortgage

applications across the U.S. have been weak and neither the latest housing starts (-6.5%) nor building permits (-6.5%) indicate that a substantial housing pickup is likely in the near future. But in a positive sign, sentiment among homebuilders as measured by the National Association of Homebuilders (NAHB) showed a nice improvement, rising from 45

FINANCEMONTHLY 17

to 49 (although still below the 50 mark that would indicate a healthy housing market). That said, both existing home sales (+4.9%) and new home sales (+18.6%) rose sharply in May; some indication that the trend may have turned. With prices rising, affordability has declined, and a slowdown in the improvement was expected. And, if housing remains mixed, but capital spending picks up, the economy should perform well. Non-residential investment (capex) is four times the weight in U.S. gross domestic product (GDP) than residential investment (housing).

trying to time the market is not generally a winning strategy for most investors. U.S. economic data continues to improve and we believe stocks will move higher; but the risk of a pullback has risen. It could be ignited by an inflation scare, which could also cause Treasury yields to rise relatively quickly, at least short-term.

Content is compiled from previously published articles authored by various parties at Schwab. Questions or comments concerning this article may be directed to Kully Samra, Managing Director for Charles Schwab, U.K, Limited at kully.samra@schwab.com