Despite A Late June Correction, Stocks Rise 8+% In The First Half

Most market measures fell in the last week of June, but they were up surprisingly well in the first half of 2017. For instance, the NASDAQ Composite was down 2% last week but up over 14% year-to-date. The more volatile NASDAQ 100 was down 2.7% last week, but is still up 16.1% YTD. The broader blue-chip S&P 500 was up 8.24% (or 9.34%, including dividends) in the first half - a near-20% annual rate.

Technical analysts do not like the fact that the NASDAQ 100 made a new near-term low last Thursday, but market retests are common. One key metric is trading volume. I like to see volume being exhausted on each subsequent retest. Other retests of this new low are possible, but it is also possible that this was the final capitulation day! I must stress that when technology stocks correct, the money is not leaving the stock market - it is just being reshuffled to other industry groups, like the embattled energy or financial sectors. To me, these rotational corrections are the best kind of corrections, so there is no need to panic.

June is historically a weak stock market month, but July is historically the best summer month, by far. According to Bespoke Investment Group's "July Seasonality" report (published June 28), the Dow Jones Industrials have risen an average 1.44%, 0.79%, and 1.08% in the past 100, 50, and 20 years, respectively. In the same report, they show that the performance of the S&P 500 tends to surge in mid-July as earnings announcement season heats up. Earnings help to fuel a lot of market excitement in the second half of July.

Last Tuesday, my favorite economist, Ed Yardeni, reported that the S&P 500 dividend payout ratio in the first quarter remained at about 50%. Dividends totaled $400 billion, while stock buy-backs added another $508.1 billion. The S&P 500's operating earnings were $958.1 billion in the first quarter, so 94.8% of these operating earnings were returned to shareholders via either dividends or stock buy-backs.

These totals are down from the record-setting first quarter of 2016, but reports that stock buy-back activity is faltering is "fake news," since Corporate America is still obsessed with maintaining high dividend payouts and strong stock buy-back activity. Furthermore, one of the reasons that the stock market seems to rebound quickly after any technology sell-offs is that dividend bargain hunters quickly appear and Corporate America likes to buy back more stock in the wake of any mechanical algorithmic sell-off.

In other words, the foundation under the market remains strong thanks to (1) the best operating earnings in over five years, (2) a 50% dividend payout ratio, and (3) continued strong stock buy-back activity.

Specifically, many dividend growth stocks have firmed up lately due the fact that the S&P 500 dividend yield remains very close to the 10-year Treasury yield. As I have repeatedly said, anytime the S&P 500 gets near the 10-year Treasury yield, it marks a screaming buy signal, just like happened last November. Since the 10-year Treasury yield declined in the second quarter, stocks are still bargains relative to bonds.

Banks may now be willing to become more share-friendly, too. Last Tuesday Fed Chairman Jane Yellen said in London that U.S. banks are "very much stronger." She also said that another financial crisis is not likely "in our lifetime," since the U.S. banking system has stabilized. Yellen stressed that the Fed learned lessons from the financial crisis: "I think the public can see the capital positions of the major banks are much stronger this year" since "all [major banks] passed the quantitative parts of the stress tests."

The next day, as if on cue, the Fed cleared 34 major banks, which account for 75% of the financial assets in the U.S. Those banks can now begin to return capital back to their shareholders, since they all passed the stress test and have sufficient capital. This is naturally good news and many major banks may choose to boost their dividends and/or redeem their preferred stock to return capital back to their shareholders.

The Dollar's Decline Also Helps Multinational Stocks

The other big development in the second quarter was that the U.S. dollar posted its biggest quarterly decline against rival currencies in nearly seven years. Hints that tighter monetary conditions might be forthcoming from some central banks around the world helped to cause the U.S dollar to decline 4.6% against a basket of major currencies in the second quarter. The euro was especially strong in the second quarter, surging 7% against the U.S. dollar, despite ultralow interest rates in the Eurozone.

Speaking of central banks, on Wednesday Bank of England Governor Mark Carney said that interest rates in Britain may have to rise to combat inflation caused largely by a weak British pound, which tends to raise the cost of imported goods. On Tuesday, the Bank of England tightened bank capital requirements, which is often a first step before the bank's Monetary Policy Committee (MPC) raises key interest rates.

Meanwhile, multiple Fed officials have recently questioned if the Fed should raise key interest rates any more, since Treasury bond yields are falling and the yield curve is flattening. These Fed officials are also talking about the lack of inflation in the U.S., implying that the Federal Market Open Market (FOMC) should be in no hurry to raise interest rates further, as the Fed has already "normalized" key interest rates.

A weak dollar helps multinational corporations, especially exporters, and helps boost GDP in the process. On Thursday, the Commerce Department revised first-quarter GDP growth up to a 1.4% annual pace, up from previous estimates of 0.7% and 1.2%. The primary reason for the upward GDP revision was that exports rose at a 7% annual pace (up from 5.8% previously estimated) and consumer spending rose at a 1.1% annual pace (up from 0.6% previously estimated). The optimism for second-quarter GDP growth remains high and most economists expect that GDP growth will at least double to a 2.8% annual pace.

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