School’s out, but can investors afford to be away on vacation?

S&P 500 volatility (daily standard deviation) has turned up, with second-quarter volatility more than 10% higher than it was in the first quarter. The S&P VIX (fear index) had been trending higher since the index bottom with the market highs on June 19. (The VIX did turn lower on Friday, July 7.)

This added volatility has not hurt stocks much—although, it did suggest some greater weakness in tech issues. While the S&P was down 1% from the June 19 top, the damage to the tech-heavy NASDAQ has been worse, with the NASDAQ 100 falling a bit more during that time. This suggests greater vulnerability in the NASDAQ, as does its 46%-plus increase in volatility in the second quarter versus its reading in the first.

Still, as the second quarter ended, the S&P 500 Index was up 9.33%, and the value of the NASDAQ 100 was up 16.77%. But so much of their gains were achieved in the first quarter. Fully two-thirds of the S&P gains and three-quarters of the NASDAQ’s came during the year’s first three months. Clearly, the rally has been running out of steam.

It’s easy to see why. Progress toward the president’s agenda has slowed in Congress. North Korea has been rattling its rockets. Interest rates, in terms of Fed policy and in bond yields over the last few weeks, have climbed higher.

Despite this, the U.S. Aggregate Bond ETF (AGG) and the Total Bond Market ETF (BND) both gained around 2.4% in the first half, although most of that came from the about 1.6% gains in the second quarter.

The underwhelming performance of bonds reflected the fact that economic reports have had more negative surprises in the last month than any time in the last five years. Last week was no different, as 11 of the 18 published reports failed to meet economists’ expectations.

Earnings reporting season, which has been the boon of the last two quarters, has yet to commence in earnest. In fact, most of the reports do not begin to be published for two more weeks.

# of Earnings Reports by Day this Season (Q2 2017)

In the first half of the year, large-cap growth stocks were the big winners. This was especially noticeable in Health Care (the number one sector) and Technology (the number two sector).

Growth issues continued to dominate value issues in the second quarter, as large-cap stocks maintained their command over small-cap issues. But while Health Care remained number one, Technology slipped down the list and was replaced by Financials, which presumably can take advantage of the higher-interest-rate environment.

The story everyone is talking about is the ascendancy of international stocks over their domestic brethren. While the latter have dominated the former for the last three years, suddenly the first-half performance numbers seem upside down. As good as the first half has been for U.S. equities, it has been even better for the international variety.

Developed-country stock indexes (EAFE) soared 14.78% in the first half, while emerging-market issues (EEM) gained 18.77%. And although a great deal of the media focus has been on the emerging-market results, it is the developed countries that have sustained the advance through both the first and second quarters. The EAFE gains were spread evenly through both quarters, while 66% of the EEM gains came in the first quarter.

Finally, in the world of alternative asset classes, commodities continued to struggle. Losses were sustained in both quarters, leading to an 8.78% loss in the first half. And almost 60% of the loss was sustained in the second quarter. Oil was the standout loser, as a near 19% decline in prices was recorded. No wonder July 4th gas prices were the lowest in years!

Gold had a good first half, recording equity-like returns. Its 7.7% gains for the first half topped all of the S&P stock style boxes except mid-cap and large-cap growth. Here again, though, it was a tale of two quarters. All of the first-half gains and a little bit more were obtained in the first quarter, while gold actually fell slightly (0.59%) in the second quarter.

The turnaround in commodities generally comes at a strange time for such an occurrence, as the dollar was in a severe sell-off. This is normally good for commodities. Not this time, however. The culprit—or, more accurately, the missing ingredient—was inflation. Despite rising interest rates and a falling dollar, inflation slipped lower each of the last three months of the second quarter.

We’ll see if the reduced inflation rates can continue this week. Thursday and Friday bring monthly reports from the government on the Producer Price Index (PPI) and the Consumer Price Index (CPI).

So far, the growing gross domestic product (GDP) numbers have outweighed the effects of inflation. Both quarters this year have seen gains in the GDP. When this occurs, it tends to overwhelm the inflation numbers regardless of whether they are increasing or decreasing. The result is either a “normal” regime (GDP and CPI mutually rising) or an “ideal” regime (GDP rising and CPI falling). Both are good for stocks. GDP will not be reported until the middle of the month.

In contrast, if stock market volatility should continue to increase, investors will move into a low and rising period. This tends to signal an end to stock market rallies.

Finally, the trend continues to be our friend. Last week, we saw an assault on the bellwether 50-day moving average of the S&P, but the outstanding job report on Friday caused the Index to reverse direction and rally.

S&P 500: Last Twelve Months

Our short-term stock market indicator, however, remains negative. Month-end positive seasonality has expired. Our intermediate-term trend indicators remain weaker but still positive. The longer-term among them continue strong with some leveraged long positions remaining. Mean-reversion indicators maintain their neutral state.

Summer is the time to get away. It is hard to resist bundling the family in the car for the ride to the beach, or sampling the delights of Europe or the cool breezes of the mountains. But it’s difficult to do that and keep up with the news in the stock and bond markets, and the reports on the economy or company earnings.

Following broad-market indicators simplifies the task, but using professional money management in a quantified, risk-managed separately managed account allows you to have the best of both worlds. So, what the heck! Enjoy your vacation. With great marks for the first half of the year, you’ve earned it.

Disclosure: No communication by Dynamic Performance Publishing or our employees to you should be deemed as personalized investment advice.  Any investment recommended in this newsletter should be made only after consulting with your investment advisor and only after reviewing the prospectus or financial statements of the company.  Dynamic Performance Publishing, its affiliates, and clients may hold positions in the recommended securities.  Results are not indicative of holdings for clients of Flexible Plan Investments.  Forwarding, copying, or otherwise duplicating this information for the use by anyone other than the intended recipient is expressly forbidden.  These results are not representative of those achieved by clients of Flexible Plan Investments, Ltd. (FPI) due to differences in security selection, timing of trades, transaction fees, and FPI’s management fees.