June 12, 2018

Some of the “melt up” in the stock market this month continues to be related to index realignment in June. The MSCI index changes were effective on June 1st,so some big Chinese ADRs are now benefitting from persistent institutional buying pressure. Additionally, MSCI will announce its next index composition on August 13th and those changes will become effective on September 3rd.

Even more exciting is the annual Russell 1000, 2000, and 3000 index realignment this month. Russell’s add-and-delete lists should be finalized after the market close on the next two Fridays, June 15th and 22nd. The first day of trading for the new Russell indices should be June 25th. Historically, this annual Russell realignment and forced index buying has propelled many small-capitalization stocks dramatically higher.

In my opinion, the “melt up” in small-capitalization stocks is far from over. In the last week of June, I expect more gains due to (1) the annual Russell realignment and (2) normal quarter-end window dressing by institutional investors. As a result, I expect that many small-to-mid capitalization stocks will soar!

What to Expect from the Fed’s FOMC Statement Tomorrow

The Fed’s upcoming Federal Open Market Committee (FOMC) statement (to be released tomorrow) will provide more insight into the Fed’s outlook for inflation, which it implied was subdued in its most recent Beige Book survey. I expect we’ll see a relatively dovish FOMC statement that will continue to boost both the bond and stock markets, especially if there are any comments that inflation pressures are expected to ebb due to a surging U.S. dollar that drives crude oil and other commodity prices lower.

Overall, the U.S. economy remains in a “Goldilocks” environment with strong GDP growth and rising employment without excessive inflation, which should earn a dovish statement from the Fed tomorrow.

One piece of good news last week was that the Commerce Department announced that the U.S. trade deficit declined by 2.1% to $46.2 billion in April from a revised $47.2 billion in March. Economists had forecasted a $48.8 billion deficit in April, so this was a pleasant surprise and the lowest level in seven months. Exports rose 0.3% to a record of $211.2 billion led by petroleum, soybean, and corn exports. Imports declined by 0.2% to $257.4 billion as the imports of cell phones, consumer electronics, and vehicles declined. If the trade deficit keeps declining, economists will revise their GDP estimates higher.

On the same day (last Wednesday), the Labor Department reported that productivity rose by 0.4% in the first quarter, down from its previous estimate of a 0.7% increase. The Labor Department also reported that in the past four quarters unit labor costs only rose 1.3%, reflecting lower inflationary pressures. Put it all together and I don’t think the Fed need be concerned with inflation in tomorrow’s FOMC statement.

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Louis Navellier

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