If investors have put their expectations for meaningful policy support from Washington on indefinite hold, it seems that it matters little, as stocks climbed to another new high last week. The S&P 500 closed at 2439, and is now higher on the year by 9 percent. The index itself was higher by 1 percent for the week, but of the nine sectors that were up, only one rose less than the overall index. That was real estate, which still added 0.8 percent as measured by the RWR ETF.

Otherwise, a wide range of sectors across the economy did even better than the index, led by telecom, healthcare, consumer stocks, materials and technology. The only groups that did not participate were the same that have lagged badly as the promise of stimulative policy has faded. Financials fell 0.7 percent last week, and have fallen for three straight months, leaving the XLF ETF just 0.9 percent higher on the year. The other group that was not invited to the party was energy, which fell 2.3 percent last week as measured by the XLE ETF. It has fallen each month this year and is lower by 13.6 percent. While these two sectors are dealing with their own headwinds, the rest of the market seems to keep climbing.

Economic Activity Remains a bit Disappointing

A solid manufacturing report for May from the ISM gave some support to the notion that economic activity was, indeed, picking up in the second quarter. That followed a report earlier in the week that showed personal spending rebounded in April from the pace of the first quarter. That same report, however, showed inflationary pressures that cooled from the prior month, at both the headline and core level. That was followed by a small decline in consumer confidence and a drop in pending home sales. And on Friday, the May jobs report came in well short of expectations, despite another drop in the unemployment rate. Hourly wages also remained stubbornly sluggish. All of which suggests that the economy does appear to be doing better than in the first quarter, but maybe not as well as hoped.

The lack of inflationary pressure has strained financials stocks, as the promise of an expanding net interest margin dissipates. The spread between the two and ten-year Treasury notes fell another 8 basis points to 87 last week, the lowest since last October, and down from 136 basis points when the reflation, post-election euphoria was at its peak in December. The yield on the ten-year note resides at just 2.16 percent, its lowest since the days immediately following the election in November.

The lack of inflation is also raising doubts about the pace of Federal Reserve rate hikes. Expectations for another rate hike on June 14 remain high, almost a lock. Beyond that, an already skeptical market lowered its expectations for a third rate hike before the end of the year. The dollar has also come under pressure. The DXY index slipped again last week, and is down 5.3 percent on the year.

Will the Fed be Forced to Lower Expectations?

The current response from equities is reminiscent of several episodes over the past couple of years when stocks would rally as the Fed was repeatedly forced to back off from its plans to hike rates in the face of slower than expected growth. If we are still in a slow growth environment, with little inflationary pressure, and the Fed is once again forced to lower its own expectations for the pace of policy normalization, then maybe liquidity will remain abundant for longer. And, as has been the case for much of this recovery, that may be enough to push both stocks and bonds higher. Inflation also slipped in the Eurozone in May, prompting European Central Bank (ECB) president Draghi to reiterate his commitment to stimulus. Perhaps not coincidentally, Eurozone equities rose for the first week in four. The ECB meets on Thursday.

The UK also goes to the polls on Thursday, and the outcome could make Brexit negotiations even more difficult than they are already likely to be if the Conservative Party suffers loses in parliament. Back home, Congress returns from recess, but whether it gets any real work done, given the distraction of various investigations into Russia’s involvement in the presidential election, remains to be seen.

Important Disclosures:   
The views expressed are as of the date given, may change as market or other conditions change, and may differ from views expressed by other Ameriprise Financial associates or affiliates. Actual investments or investment decisions made by Ameriprise Financial and its affiliates, whether for its own account or on behalf of clients, will not necessarily reflect the views expressed. This information is not intended to provide investment advice and does not account for individual investor circumstances.
Indexes are unmanaged and are not available for direct investment.
The S&P 500 is an index containing the stocks of 500 large-cap corporations, most of which are American. The index is the most notable of the many indices owned and maintained by Standard & Poor's, a division of McGraw-Hill.
The SPDR® Dow Jones® REIT ETF (RWR) seeks to provide investment results that, before fees and expenses, correspond generally to the total return performance of the Dow Jones® U.S. Select REIT Index.
 The Energy Select Sector SPDR® (XLE) Fund seeks to provide investment results that, before expenses, correspond generally to the price and yield performance of the Energy Select Sector Index.
The Financial Select Sector SPDR® Fund (XLF) seeks to provide investment results that, before expenses, correspond generally to the price and yield performance of the Financial Select Sector Index.
The ISM manufacturing index is a national manufacturing index based on a survey of purchasing executives at roughly 300 industrial companies.
The U.S. Dollar Index (DXY) measures the dollar's value against a trade-weighted basket of six major currencies.
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