Markets ended mixed over a month which witnessed a strong rotation out of tech stocks. In a widely anticipated move, the Fed hiked rates and provided details about how it intends to trim its balance sheet. The Trump administration introduced crucial legislations relating to health insurance and financial sector legislation which met with a limited amount of legislative success. Financials and healthcare stocks gained as a result of tighter rates and relaxation of regulations. Meanwhile, economic data continued to be worrying, particularly on the inflation front.

June’s Performance

For the month, the Dow and the S&P 500 registered gains of 1.6% and 0.5% respectively, while the Nasdaq declined 0.9%. Technology shares suffered several setbacks throughout the month on overvaluation concerns, dragging broader markets lower. The Fed hiked the key interest rate by 25 basis points on June 14, leading to gains for bank shares. Meanwhile, Senate released a new healthcare Bill on June 22 in an attempt to repeal key sections of Obama’s Affordable Care Act.

For the first half of the year, the Dow, the S&P 500 and the Nasdaq increased 8%, 8.2% and 14.1% respectively. The Dow and the S&P 500 posted their best performance for the first half since 2013, while the Nasdaq recorded its best performance for the same period since 2009. During the second quarter, the S&P 500 gained 2.6% while the Dow and Nasdaq increased by 3.3% and 3.9%, respectively.

Dismal Domestic Data

The majority of the data released in June led to heightened concerns about the state of the economy. The ISM Services Index declined to 56.9 in May while factory orders contracted by 0.2% in April. PPI remained flat during May even as CPI declined by 0.1%. Core CPI expanded by 0.1%, coming in below expectations. A 0.3% decline in May retail sales added to investor concerns. Industrial production remained flat in May while capacity utilization declined.

Durable orders dropped by 1.1% in May, declining for the second successive month. Worryingly, the PCE price index slipped 0.1% in May. Consumer expenditure increased by 0.1% in May, slower than the 0.4% pace of growth recorded in April.  

On the positive side, the ISM Manufacturing Index rebounded to hit 54.9 in May. More importantly, consumers remained upbeat with the Consumer Confidence Index rebounding to hit 118.9 in June after declining in May.

Q1 GDP Better than Anticipated

As per the third estimate released by the Bureau of Economic Analysis on Thursday, the real gross domestic product (GDP) increased at a 1.4% annual rate in the first quarter of 2017. It also beat analysts’ estimate of an increase of 1.2% and was a significant improvement over the second estimate of 1.2%.

The third estimate also showed that first quarter personal consumption expenditures and exports rose more than previous estimation. Consumer expenditure increased by 1.1%, exceeding the earlier estimate of a rise of 0.6%. Exports increased by 7%, improving over earlier estimate of a rise of 5.8%.

Housing Data Mixed

Overall, data on the housing sector was mixed in nature. Housing starts declined by 5.5% to a seasonally adjusted annual rate of 1.09 million in May, its lowest level in eight months while building permits moved 4.9% lower. The pending home sales index declined for the third successive month in May. The index was recorded at 108.5 in May compared to a revised value of 109.4 in April.

On the positive side, existing home sales increased by 1.1% to a seasonally adjusted annual rate of 5.62 million in May. New home sales increased by 2.9% to 610,000, higher than the consensus estimate of 596,000.

However, market watchers still think that though the recovery is weakening, it is likely to continue. Consequently, the NAHB Housing Market index lost 2 points to touch 67 in June, which remains a moderately strong reading.

Job Additions Fall, Unemployment Hits 16-Year Low

The U.S. economy added 138,000 jobs in April, significantly lower than the estimated level of 184,000. Job gains were primarily attributable to increase in jobs in health care and mining.Professional and business services led the way by adding 38,000 jobs whereas food services and drinking places added 30,000 jobs.

Meanwhile, unemployment rate declined marginally from 4.4% to 4.3% in May, marking its lowest level in sixteen years. Payrolls data also showed that the average hourly wages increased 0.2% to $26.22.

Tech Rout Weighs on Broader Markets.

For most of the month, tech stocks dominated the headlines as they have for most of the year, but for the wrong reasons. Stocks from the sector suffered grievous declines, dragging the broader markets lower. On Jun 9, The Goldman Sachs Group, Inc. (GS) issued a report regarding the top five performing tech majors of the year which triggered off several questions about the sector’s recent gains. The report raised concerns about the exorbitant valuations and low levels of volatility for this group. 

The group in question, comprising of Facebook, Inc. (FB - Free Report) , Amazon.com, Inc. (AMZN - Free Report) , Apple Inc. (AAPL - Free Report) , Microsoft Corporation (MSFT - Free Report) and Alphabet Inc. (GOOGL - Free Report) and had together added around $600 billion to overall market capitalization up to that point this year.Consequently, on Jun 12, the Nasdaq closed 1.8% lower, posting its worst weekly performance for the year.

Tech stocks staged a brief rebound thereafter, only to suffer another set of reverses. On Jun 16 the Nasdaq lost 0.2% and posted its second successive weekly decline. The Technology Select Sector SPDR (XLK) has declined by 3.4% over last month even though it remains up 13.2% year to date.

Biotech, Health Insurers Move Higher

Stocks from the healthcare sector, particularly biotech stocks experienced strong gains this month. One fear that has haunted this sector is the possibility of a crackdown on drug prices in Washington D.C. But, it is now widely believed that Washington will find it difficult to impose price controls with Tom Price as secretary of Health and Human Services since he has a history of rejecting such moves.

Regulatory changes relating to insurance coverage benefited insurers and ultimately the broader healthcare sector as a whole. After weeks of heated discussions and arguments, Senate Republicans unveiled the text of their new health care law on Jun 22. The new Bill won’t change Obamacare as drastically as the House legislation passed in May, but demands significant cuts that would likely benefit the uninsured. 

Financials moved north as Fed raised the key interest rate by 25 basis points after its widely anticipated policy meeting concluded on Jun 14. The benchmark federal funds rate has been hiked to 1.00–1.25%, from the 0.75–1.0% set in Mar 2017. Fed policymakers reiterated their projections of one more rate increase in 2017, followed by three hikes each in 2018 and 2019.  

Additionally, the central bank provided more details regarding the unwinding of its massive $4.5 trillion balance sheet. Coming to the details, the Fed aims to reduce fixed amount of assets on a monthly basis. Initially, the amount is expected to be $10 billion, including $6 billion from Treasuries and $4 billion from mortgage-backed securities (MBS).

In addition, the capped amount will increase once in three months by $6 billion for Treasuries and $4 billion for MBS to achieve the target of $30 billion and $20 billion, respectively.

Financials Gain from Rate Hike, Regulatory Changes

Earlier during the month, House lawmakers passed the GOP-led regulatory reform act, which effectively gutted the Dodd-Frank regulations of the Obama administration. The Financial Choice Act will allow the President to fire heads of the Consumer Financial Protection Bureau and the Federal Housing Finance Agency, which oversees the functioning of mortgage giants Fannie Mae and Freddie Mac.

It also gives Congress the authority to influence the Consumer Financial Protection Bureau’s (CFPB) budget, which means lawmakers could defund the agency entirely. The GOP proposal also restricts the Federal Deposit Insurance Corp from supervising the so-called living will process that requires banks to present plans on how safely they would unwind in the event of a collapse. The Bill still requires Senate approval to overhaul the Dodd-Frank regulations. 

Bank stocks gained traction after the bill to erase some Dodd-Frank banking rules was passed in the House. The broader SPDR KBW Bank has gained 4.7% over last month. The combination of a tighter rate environment and softer regulation led to gains for the financial sector as a whole with the Financial Select Sector SPDR (XLF) gaining 5.2% over the month of June.

5 Star Performers for June

I ran a screen on Research Wizard for companies with the following parameters:

1. Percentage price change over the last 4 weeks greater than or equal to 15%
2. 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
3. Expected earnings growth for the current financial year greater than or equal to 20%
4. Zacks Rank less than or equal to 2: This ascertains stocks that have shown above-average returns over the last 26 years.

Here are the top 5 stocks that made it through this screen each of which has a Zacks Rank #1 (Strong Buy):

Lakeland Industries, Inc. (LAKE - Free Report) is a manufacturer and seller of products for the industrial and public protective clothing segment.

Price gain over the last 4 weeks = 24.1%
Expected earnings growth for current year = 56.6%

Lakeland Industries’ forward price-to-earnings ratio (P/E) for the current financial year (F1) is 17.47x.

Schnitzer Steel Industries, Inc. (SCHN - Free Report) collects, processes and recycles metals by operating one of the largest metals recycling businesses in the U.S.

Price gain over the last 4 weeks = 22.7%
Expected earnings growth for current year = 88.4%

Schnitzer Steel Industries has a P/E (F1) of 19.38x.

Air France-KLM SA (AFLYY - Free Report) is an airline company. The Company's core businesses are related to passenger transport, cargo transport, and aircraft maintenance services.

Price gain over the last 4 weeks = 19.3%
Expected earnings growth for current year = 27.1%

Air France-KLM has a P/E (F1) of 7.88x.

Woori Bank Co., Ltd. (WF - Free Report) was established as Korea's first financial holding company in April 2001 to keep pace with the global trends and evolve as a global player with world-class competitiveness.

Price gain over the last 4 weeks = 16.5%
Expected earnings growth for current year = 29.8%

Woori Bank has a P/E (F1) of 8.87x.

CAI International, Inc. (CAI - Free Report) is one of the world's leading intermodal freight container leasing and management companies.

Price gain over the last 4 weeks = 15.4%

CAI International’s expected earnings for the current year is more than 100%. The stock has a P/E (F1) of 11.35x.

Can Markets Rebound in July?

At the end of the second quarter, a strong rotation away from tech stocks is still underway. Meanwhile, economic data continues to remain soft even though the latest GDP reading has been better than expected. The Fed remains determined to push ahead with monetary tightening despite little evidence of inflation picking up. Overall, stocks are likely to face a challenging environment in the weeks ahead

At this point it is unlikely whether other sectors will steps in to take the lead even as tech stocks continue to remain out of favor. Additionally, the Trump’s initiatives to execute policy changes have yet to make any significant headway. Despite the new administration’s best efforts, key legislations awaited the approval of the Senate. On the brighter side, financials and biotech stocks are notching up strong gains. If economic data undergoes an improvement, markets could return to their winning ways in the months ahead.