Markets gained once again in May on the back of continuing gains in oil prices and a change in investors’ stance toward an imminent rate hike. Rate hike possibilities increased following a series of encouraging economic reports and indications to that effect in the FOMC Minutes.
Additionally, the Fed Chair also hinted that a rate hike was likely in June. Initially, investors remained wary of the consequences of a rate hike. However, by the end of the month they were increasingly coming to terms with rate hike possibilities following speculation that a rate hike may indicate moderate economic growth.
For the month, the Dow, S&P 500 and Nasdaq advanced 0.1%, 1.5% and 3.6%, respectively. The technology sector was the biggest gainer during the month, while energy stocks were biggest laggards.
Meanwhile, FOMC’s minutes, higher-than-expected economic data and Fed officials’ comments boosted June rate hike chances, which weighed on investor sentiment. However, immediate rate increase possibilities pushed financials stocks upward and eventually had broad-based positive impact on markets. Oil prices rose in May, registering four straight monthly increases following multiple disruptions in global crude production.
Earnings were a mixed bag while Apple Inc (AAPL – Analyst Report) hit its worst closing level since June 2014, following concerns over a slump in iPhone sales. However, shares of Apple increased after in a regulatory filing Warren Buffett’s Berkshire Hathaway Inc. BRK.B reported that it has acquired 9.8 million shares or $1 billion stake in Apple during the first quarter.
Oil Prices Surge Higher
Oil prices rallied strongly during May even as a production freeze agreement remained elusive. Prices declined over the first week of the month, following China’s growth worries and concerns over global crude supply glut. Rise in crude production in Iraq, Saudi Arabia and Iran, and weekly increase in U.S. commercial crude oil inventories raised worries over global crude oversupply.
By the second week, supply shortages were boosting prices. Disruptions in Nigeria and Canada reduced crude oversupply worries by a significant extent, which also pushed oil prices upward. Both the WTI crude and Brent crude rose 3.5% and 5.3%, respectively for the week.
Crude prices hit a six-month high on May 16. During the third week of the month, Goldman Sachs (GS – Analyst Report) said there was a deficit in crude production following production disruptions in Nigeria and Canada. Also, U.S. Energy Information Administration (EIA) reported a fall in gasoline inventories by 2.5 million barrels for the week ended May 13.
Prices staged their greatest rally in seven years, crossing the $50 mark on May 26. Baker Hughes Inc. BHI reported a decline in U.S. rig counts from 318 to 316 for the week ending May 27. Recent production disruptions and decline in U.S. commercial crude inventories and rig counts helped prices post their third straight weekly rise.
Q1 GDP Revised Upward
The “second” estimate by the Bureau of Economic Analysis showed that first quarter output of goods and services increased at an annual rate of 0.8%, lower than the consensus estimate of 0.9% increase. However, first-quarter GDP data was revised upward from the previously estimated 0.5% rise.
The most notable feature of the report was evidence that corporate earnings were stabilizing. For a long time, this metric has been weighed down by a strong dollar and a downturn in the energy sector. Pretax corporate profits increased by 0.3%, the first sign of growth seen since early 2015.
Even though the estimate remained unchanged, personal consumption came in at a healthy 1.9% for the first quarter. Meanwhile expenditure on new home construction jumped to 17.1% for the first quarter compared with the earlier estimate of 14.8%. This is the largest such increase in around four years.
Job Additions Fall, Hourly Earnings Up
According to the Bureau of Labor Statistics (BLS), the U.S. economy created a total of 160,000 jobs in April, significantly lower than the consensus estimate of 203,000. The tally was also considerably lower than March’s downwardly revised job number of 208,000. The Labor Department also revised down jobs growth in the previous two months by 19,000.
Moreover, the unemployment rate in April was in line with the consensus estimate and March’s rate of 5%. Further, labor force participation rate fell 62.8%, declining for the first time in 7 months as 300,000 individuals quit jobs or gave up jobs searches.
However, the average hourly earnings gained 0.3% or 8 cents in April from previous month’s figure to $25.53 per hour, in line with the consensus estimate. This was the third highest monthly gain in a year. The average hourly earnings also witnessed a 2.5% rise from the year-ago figure.
Bullish Domestic Data
Data released through the month was mostly encouraging in nature. ISM Services Index increased in March, indicating expansion in servicing activity for the 75th straight month. New orders for manufactured goods increased 1.1% in March. Durable orders increased 3.4% in April to $235.9 billion, as compared to a rise of 1.9% in March. PPI for finished goods increased 0.2% in April while core PPI increased 0.1%.
Retail sales rose 1.3% in April reaching its highest level since March 2015. The reading was also favorable compared to March’s fall of 0.3%. Industrial production rebounded from a 0.9% decline in March to rise by 0.7% in April, posting its highest percentage increase since Nov 2014. Also, capacity utilization advanced from 74.9% to 75.4% in April.
The lone disappointment was the ISM manufacturing index, which decreased from 51.8% in March to 50.8% in April.
Housing Sector Strengthens
May’s housing indicators revealed that the housing sector was growing at a faster clip in spring. Sales of new single-family homes rose by 16.6% in April, its highest monthly percentage rise in 24 years. Moreover, existing home sales rose for the second straight month in April, per data released by the National Association of Realtors on May 20. Pending Home Sales Index increased 5.1% from March to 116.3 in April, reaching its highest level since Feb 2006.
U.S.housing starts rose 6.6% from a revised March number to an annual rate of 1,172,000 in April, surpassing market expectations. The number of building permits rose 3.6% in April, according to data released on May 17.TheNational Association of Home Builders (NAHB) home builder sentiment index (HMI) remained flat at 58.Construction spending increased 0.3% from February
Mixed Earnings Results
Earnings released during the month included reports from Sysco Corporation (SYY – Analyst Report) , Pfizer Inc (PFE – Analyst Report) , Time Warner Inc. (TWX – Analyst Report) , Home Depot, Inc. (HD – Analyst Report) and Wal-Mart Stores Inc’s WMT. All of these companies posted better-than-expected earnings results.
However, Priceline Group Inc (PCLN – Analyst Report) , Merck & Co. Inc. (MRK – Analyst Report) , Target Corp TGT, Walt Disney Company (DIS – Analyst Report) , Macy’s, Inc. M and Kohl’s Corporation KSS registered weaker than expected quarterly earnings.
The minutes of Federal Reserve’s April two-day policy meeting indicated that most of the Fed officials were optimistic that a decision to hike rates could be taken following the meeting scheduled for June. The minutes said that “most participants judged that if incoming data were consistent with economic growth picking up in the second quarter” then the Fed may opt for a hike next month.
Further. if “labor market conditions” continue “to strengthen” and inflation makes “progress toward the 2% objective”, then it might “be appropriate for” the Fed “to increase the target range for the federal funds rate in June.”
Fed Chair’s Comments
Fed Chairwoman Janet Yellen’s comments at an awards ceremony at Harvard University raised rate hike chances further. Yellen said “it’s appropriate” to increase interest rates “gradually and cautiously” in the near future. She also said that “such a move,” possibly over the “coming months,” might be “appropriate.”
Further, Yellen highlighted that after a weak first quarter, the economy had experienced considerable growth and the dollar and oil prices are “roughly stabilizing.” However, she maintained a cautious tone regarding the pace of rate hikes and said that if the Fed “were to raise interest rates too steeply” and “were to contribute to a downturn,” then it would have “limited scope for responding.”
4 Star Performers for May
I ran a screen on Research Wizard for companies with the following parameters:
- Percentage price change over the last 4 weeks greater than or equal to 20%
- Forward price-to-earnings ratio (P/E) for the current financial year (F1) less than or equal to 20. This picks out stocks that are good value choices
- Expected earnings growth for the current financial year greater than or equal to 20%
- Zacks Rank less than or equal to 2: This ascertains stocks that have shown above-average returns over the last 26 years.
(See the performance of Zacks’ portfolios and strategies here: About Zacks Performance).
Here are the top 4 stocks that made it through this screen:
Rose Rock Midstream, L.P. RRMS is an owner, operator, developer and acquirer of a number of midstream energy assets.
Price gain over the last 4 weeks = 51.9%
Expected earnings growth for current year = 25.3%
Rose Rock Midstream has a Zacks Rank #1 (Strong Buy). The stock’s forward price-to-earnings ratio (P/E) for the current financial year (F1) is 19.60x.
Price gain over the last 4 weeks = 47.1%
Ryerson Holding holds a Zacks Rank #1 and its expected earnings growth for the current year is more than 100%. It has a P/E (F1) of 12.84x.
Price gain over the last 4 weeks = 43.5%
Expected earnings growth for current year = 76.2%
Apart from a Zacks Rank #1, Tutor Perini has a P/E (F1) of 10.79x.
Price gain over the last 4 weeks = 27.6%
Expected earnings growth for current year = 34.5%
NetEase holds a Zacks Rank #1 and it has a P/E (F1) of 16.82x.
Will Gains Continue in June?
Investors have already changed their outlook toward a rate hike which looks like an increasing possibility. Financials have gained as a result as have broader markets. Stocks have been further boosted by a strong rally in oil prices. Additionally, economic reports have been largely positive in nature. Tech stocks have also staged a strong rebound. Given the prevailing investment climate, markets are likely to notch up gains over the next month.
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