Markets notched up gains once again last month, with tech stocks leading the pack. Indications emerged that the Fed was going to trim its balance sheet even as investors prepared for rate hikes. Meanwhile, the Trump trade petered out even as the President dismissed the FBI director and released budget proposals which were mostly in line with expectations.

The OPEC-led output cut deal received an extension which failed to boost oil prices. At the same time, economic data remained mixed even as GDP figures experienced an upward revision.

May’s Performance

For the month, the Nasdaq, S&P 500 and Dow advanced 2.5%, 1.2% and 0.3%, respectively. During the month, the Federal Open Market Committee released minutes which indicated that Fed officials were in favor of trimming down the central bank’s $4.5 trillion balance sheet.

The Trump administration released its budget proposal which seeks to cut federal spending by $3.6 trillion with a focus on balancing the budget over the next decade. Moreover, Trump discharged Director of the Federal Bureau of Investigation (FBI), James Comey from office. Meanwhile, U.S. auto industry reported disappointing sales in April, with sales hitting 16.88 million, below an expected annual rate of 17.2 million.

Mixed Domestic Data

Economic reports released in May were mostly mixed in nature. The ISM manufacturing index experienced a decline in April Construction spending contracted while factory orders increased at a slower pace than in February. Additionally, consumer confidence declined from 119.4 in April to 117.9 in May. Retail sales increased at a faster pace in April, even though it came in under estimates. The ISM services index notched up gains for the 88th consecutive month.

In contrast, industrial production recorded a growth of 1% in April, marking its largest increase since February 2014. The leading indicators index increased by 0.3%. Consumer spending increased at its fastest pace since Dec 2016 in April even as incomes continued to rise. Both CPI and PPI moved higher. But even though PCE inflation increased by 0.2%, the annual rate slowed to a 1.7% gain, lower than the pace recorded in March and well below the Fed’s target of 2%.

Q1 GDP Revised Upward

As per the "second" estimate released by the Bureau of Economic Analysis, real gross domestic product (GDP) increased at an annual rate of 1.2% in the first quarter of 2017. It also beat analysts’ estimate of 0.9% and was an improvement over Q1’s gain of 0.8%. Moreover, corporate profits increased 3.7% year over year in the first three months of 2017, despite falling 1.9% from the fourth quarter of last year.

Additionally, after a temporary pullback, both consumer spending and business investment gained traction. Consumer spending, which accounts for a bulk of U.S. economic output, was revised upward from the preliminary reading of 0.3% to 0.6% in the second estimate. Also, business investment rose 11.9% in the first quarter, which is better than the previous estimate of 9.4%.

Housing Sector Recovery Stutters

The U.S. housing sector recovery remained on track despite the release of discouraging data on the sector. Housing starts declined 2.6% to an annual rate of 1.17 million while building permits also moved 2.5% lower. Existing-home sales declined 2.3% in April to a seasonally adjusted annual rate of 5.57 million, lagging the consensus estimate of 5.65 million.

New home sales declined by 11.4% to 569,000, in April 2017, also coming in below the consensus estimate of 610,000. The pending home sales index also suffering a similar fate, losing 1.3% to come in at 109.8 in April.

Shrinking supply has led to price levels increasing at the sharpest pace in almost three years. Consequently, the Case-Shiller 20-city home price index gained 5.9% on a yearly basis. However, market watchers still think that though the recovery is weakening, it is likely to continue. In keeping with such a view, the NAHB Housing Market index increased from 68 to 70 in May, marking its second highest reading since the recession of 2008.

Job Additions Rise, Unemployment Slips

The U.S. economy added 211,000 jobs in April, higher than the estimated level of 193,000. The strong payroll growth number was attributable to increase in jobs in leisure and hospitality, health care and social assistance, financial activities, and mining sectors.

Meanwhile, unemployment rate declined marginally from 4.5% to 4.4% in April, marking its lowest level since May 2007. The number of unemployed persons was 7.1 million, in April. The unemployment rate fell by 0.6% and the number of unemployed declined by 854,000 over the year. The "U-6," considered to be a broader measure of the unemployment as it includes those workers who are working part-time for purely economic reasons, declined to 8.6%.

Payrolls data also showed that the hourly pay rose 2.5% over the last twelve months. In April, average hourly wages for all employees on private nonfarm payrolls increased by 7 cents to $26.19. Additionally, the labor force participation rate for April changed little and held steady at 62.9%.

OPEC Output Cut Deal Extended

Oil prices recorded their third consecutive monthly loss in May even though the much awaited OPEC deal extension actually came through. Prospects that the deal would receive an extension buoyed oil prices over last month to a certain extent. Ultimately, on May 25, OPEC and 11 non-OPEC players decided to maintain to maintain existing production curbs for another nine months. 

Despite such a move, crude went south as the broader market was expecting deeper cut from the oil producers or at least an extension of the prevailing curb for another 12 months. (Read: 4 Big Winners from the OPEC Output-Cut Deal)

Market watchers now think that the output cut extension and the summer driving season will be unable to dent global supplies significantly. The latest EIA data, which depicts a 6.3% increase in production year-over-year, hasn’t helped matters. Over the month, prices declined by nearly 2.1% and West Texas Crude is currently languishing at a sub-$50 per barrel level.

Earnings Growth Hits Record Pace in Q1

The Q1 earnings season is effectively over now, with results from 492 S&P 500 members already out. Total earnings for these companies are up +13.5% from the same period last year on +7.2% higher revenues, with 72.6% beating EPS estimates and 65.2% beating revenue estimates.

These results represent a notable improvement over what we have been seeing from the same group of companies in other recent periods. While growth reached the highest level in more than 5 years, a bigger proportion of companies have been able to beat estimates, particularly revenue estimates.

 For the Retail sector, total Q1 earnings are up +1.7% from the same period last year on +3.1% higher revenues, with 60% beating EPS estimates and 50% beating revenue estimates. The sector’s Q1 results have been below other recent periods and are also among the weakest of all sectors this reporting cycle. 

Trump Trade Peters Out

By the second week of the month, U.S. stocks were hovering near fresh highs, with Apple Inc.’s market value breaking the $800 billion mark for the first time, as the earnings trade replaced the Trump trade. President Trump terminated and removed FBI Director Comey on May 9, a development that few saw coming. This decision made equity strategists emphasize that the days of the Trump trade were over. 

Earlier in May, Trump finally secured the necessary votes from House Republicans to pass the bill for repealing and replacing Obamacare with the revised American Health Care Act (AHCA). However, the fate of the bill is still uncertain, as it requires the Senate’s approval before it goes to Trump for his signature. 

The only White House-related development which left investors unperturbed was Trump’s budget proposal, which was more or less in line with expectations. Trump's budget seeks to reduce federal spending by $3.6 trillion through cuts in healthcare and food assistance programs. However, the budget assumes the Trump administration will lower tax rates for corporate and households.

Fed Minutes Hint at Balance Sheet Trim

As per minutes released from the Federal Reserve’s meeting held on 2-3 May, the central bank officials agreed to trim down its $4.5 trillion balance sheet. The Fed holds a massive portfolio of government debt, generated by purchasing treasury and mortgage-backed securities in the years after the financial crisis. According to the minutes, the central bank hinted that it may start unwinding the balance sheet later this year.

So far, the central bank has been reinvesting the proceeds it receives from maturing securities in more bonds. The central bank called for gradual reduction in the amount of bonds it would be purchasing each month. Fed is expected to set cap limits on the amount of securities it will agree to roll off each month without reinvesting. According to minutes, caps would be set at lower levels in an initial stage and then would be raised every three months.

In its minutes, the Fed indicated that it may raise interest rates in its next meeting in June. The minutes also revealed that most of the Fed policymakers agreed that it would “soon” be time to hike interest rates. Strong rate hike prospects and Fed’s proposal to unwind its balance sheet boosted investor sentiment.

5 Star Performers for May

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 20%
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:

SORL Auto Parts, Inc. (SORL - Free Report) specializes in the development, production and distribution of air brake valves and hydraulic brake valves.

Price gain over the last 4 weeks = 120.2%
Expected earnings growth for current year = 29%

SORL Auto Parts has a Zacks Rank #1 (Strong Buy). The stock’s forward price-to-earnings ratio (P/E) for the current financial year (F1) is 6.76x.

Camtek Ltd. (CAMT - Free Report) designs, develops, manufactures and markets automatic optical inspection systems and related products.

Price gain over the last 4 weeks = 65.7%

Camtek has a Zacks Rank #2 (Buy) and its expected earnings growth for the current year is more than 100%. The stock has a P/E (F1) of 17.58x.

Applied Optoelectronics, Inc. (AAOI - Free Report) designs, develops and manufactures advanced optical devices, packaged optical components, optical subsystems, laser transmitters and fiber optic transceivers. 

Price gain over the last 4 weeks = 50.3%

Applied Optoelectronics has a P/E (F1) of 16.15x and its expected earnings growth for the current year is more than 100%. The stock holds a Zacks Rank #1.

Flexible Solutions International Inc. (FSI - Free Report) is an environmental technology company focusing on the research, development and manufacturing of products that save water and energy.

Price gain over the last 4 weeks = 33.6%

Flexible Solutions holds a Zacks Rank #1 and its expected earnings growth for the current year is more than 100%. The stock has a P/E (F1) of 5.49x.

Nobilis Health Corp. (HLTH - Free Report) own and manage ambulatory and acute care facilities for healthcare services in the U.S.

Price gain over the last 4 weeks = 29.6%
Expected earnings growth for current year = 27.3%

Nobilis Health holds a Zacks Rank #1. The stock has a P/E (F1) of 12.50x.

Gains Likely to Continue in June

June typically marks the beginning of weak summer trade. Be it Lehman Bros’ collapse or the Fed's stimulus scale back or Greece's running out of money or the more recent “Brexit” -- investors have had to absorb all these shocks in the month of June. But, rather than markets dealing with such big setbacks, the most likely outcome this time around will be a gradual uptick since economic and earnings scenarios are reassuring. 

Investors will look toward encouraging economic data for support as the month progresses. If key indicators including GDP undergo upward improvements, gains are likely to continue for the bourses in the weeks ahead.

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