The markets bounce back from this week’s selloff is an affirmation of strong underlying fundamentals and a solid economic backdrop. The consumer and manufacturing are two big drivers of the U.S. economy. Consumer spending has been steadily moving up (although maybe not as fast as some would like). The consumer is the game changer accounting for 70% of the U.S. economy and has undoubtedly been doing most of the heavy lifting since the recession but in the past year manufacturing has started to up its contribution. The 1% rise in industrial production in April was the third straight month of increases and the best jump in three years. This bodes well for second quarter GDP growth. However, bond yields are reserving judgement and the 10 year UST yield remains below 2.3%. Please follow industrial production on page 10 of the Global Perspectives™ book.
Last week investors were complaining that things were too quiet and volatility was almost non-existent. Well, be careful what you wish for, it may just bite you. Yesterday was a wake-up call for complacent investors as Wall Street decided that all of the Washington drama might delay the long awaited pro-growth policies. Today investors are taking a sensible second look at the market and coming to the realization that companies will continue to do business regardless of what happens in Washington. A blowout manufacturing Philly Fed Index of 38.8 and a 4K drop in initial jobless claims on the economic front also added some comfort. Please see page 4 of the Global Perspectives™ book for a look at an effectively diversified portfolio designed to help reduce volatility when wading into the market waters.
Paralysis may be too big a word for the progression of policy in Washington, but outside of deregulation things are grinding slowly if at all there. While the House passed the ACHA, the outlook for further progress in the Senate is quite cloudy. Tax reform – a difficult process in the best of times – looks increasingly like a 2018 story. Trump’s team is not fully staffed, making further economic progress both domestically and internationally problematic.
Understandably, the market remains in a ‘show me’ state over the outlook. At this point, the consensus is for a 2.1% GDP growth rate in 2017 followed by 2.4% in 2018. That’s strong enough for the Fed to slowly keep reducing the amount of accommodation, though still leaving monetary policy accommodative. It’s strong enough to keep the unemployment rate moving lower. However, in order to break the moderate growth log-jam, this will require progress not only on deregulation but also the promised tax reform of lower rates/wider base. Deregulation is a positive, and removing the threat of further regulation is a plus. But major Congressional-dependent policy changes appear to be on the slow track, and it is those policies that are the game changers to break from the sluggish growth of the past 15 years.
Having said that, expectations remain extremely positive in April. The University of Michigan Consumer Sentiment Index is at 98, up from 87 before the election. The NFIB Small Business Optimism Index remains around 105, up from 94 in 2016. Better animal spirits are important, but they must be validated by results. Please follow GDP on page 69 of the Global Perspectives™ Book.- Special Guest Blogger: Tim Kearney
There has been a lot of worry about the dichotomy between the hard data and the soft data. Sentiment data has been soaring but hard economic statistics don’t seem to jive. Or do they? Yes, some major retailers missed their mark but overall consumer discretionary earnings season was a blowout, retail sales are at an all-time high, and the overall earnings growth of the S&P 500 was the best since 3Q2011. Auto sales dialed back since also reaching an all-time high in December but rose last month to above the 17 million mark. Housing starts may fluctuate from month to month but year over year increases have been solidly high single digit increases. Personal incomes have been steadily moving up to all-time highs and wage increases are starting to take root. According to Yogi Berra, “It's tough to make predictions, especially about the future.” But forecasting gets even trickier when the economy keeps moving forward - expectations get rosier and the bar gets higher, setting the stage for potential disappointment if you don’t step back and take a broader view. Please see the Global Perspectives™ Investment Weekly for the latest economic data update.
Amid this week’s negative retail earnings news, a bright spot. Retail sales rose .4% in April to an all-time record high of $475 billion, bolstering the case for an economic GDP pickup in Q2. Non store retailers (internet merchants) and building materials and garden supply stores were the standouts while the brick and mortar vendors are still struggling. Consumer sentiment continues to be strong with the latest index reading of 97.7%. In addition, core inflation (CPI) which excludes food and energy was up, but only by .1%, lighter than expected. This muted inflation figure jives with the Fed’s plan for gradual rate increases. Investors may be distracted by all of the Washington tweets but the economic picture remains solid, #EconomicGrowth #DontTryToWashingtonProofPortfolio. Please watch retail sales and consumer spending on page 12 of the Global Perspectives™ book.
Oil prices have been robustly rebounding after a steep decline, but are still hovering in the high $40’s, a far cry from the $53 level achieved a month ago on 4/11/17. We know there is a supply glut of oil and we know that the most agile U.S. shale producers have been able to use technology to get the breakeven price of oil down to around $30/barrel. The EIA forecasts an increase in U.S. production in 2017 citing technological advances, which will increase U.S. drilling further, comparatively higher prices than in 2016 and Trump energy policies. However, global demand is increasing by an estimated 1.2 mb/d over the next five years and with the global economy surprising on the upside, it might be demand that is the wildcard not supply. Global Perspectives forecasts prices will hover in the $50’s. Meanwhile, the market is taking a breather today, digesting some particularly bad earnings data regarding some of the brick and mortar retailers in what has otherwise been a very bright Q1 earnings season. Please follow the price of oil on page 61 of the Global Perspectives™ Book
Last Wednesday, the Fed noted that the recent weakness was ‘transitory’. The NFP report underscored that their assessment seems about right, and so solidified a Fed rate hike at the June meeting. Given the problems with Q1 GDP seasonals for a decade, it’s a reasonable expectation that Q2 will be stronger. The NFP report was solid all around, though wage pressures remain muted. April payrolls rose by 211k vs 190k expected, although average hourly earnings rose 2.5% from a (revised lower) 2.6% in March and 2.9% at end-2016.
Understandably, the market remains in a ‘show me’ state over the outlook. As the Fed statement alluded, business investment has firmed and the FOMC expects the economy to grow at a moderate rate. That’s in line with the consensus for a 2.1% growth rate in 2017 followed by 2.4% in 2018. That’s strong enough for the Fed to slowly keep reducing the amount of accommodation, while still leaving monetary policy accommodative. It’s strong enough to keep the unemployment rate moving lower. However, in order to break the moderate growth log-jam will require progress not only on deregulation (a major plus already) but also the promised tax reform of lower rates/wider base.
Stronger growth will expand earnings through the top line, raise wages and raise the growth rate. And it’s a stronger growth rate that will ultimately move bond yields higher. The current low levels of bond yields appear to be the result of low real yields, as bonds have been following inflation higher. A productivity revival is part of the key to generating higher bond yields. Of course, higher growth will accompany higher productivity. Please review page 33 of the Global Perspectives™ Book. - Special Guest Blogger: Tim Kearney
The VIX measure of volatility dropped below 10 yesterday, the lowest level in 10 years. Meanwhile major stock indices are reaching record highs. Yes, earnings support this bull market and yes, the economic data is signaling better times ahead. Even the reluctant 10-year bond yield has moved up to over 2.4%. But risks are still present in the market. The French elections are behind us, but the European concerns regarding the execution of Brexit and the north/south growth divide are not. China has been stable lately, but April imports dropped 11% and worries about the property bubble and recent monetary tightening measures linger. In addition, there are still geopolitical hot spots looming in the background. Investors should be participating in this bull market but when markets are all going up it’s easy to forget about risk. Bonds can help balance risk. They will be there when you need them most, so don’t bail on bonds. Please follow the VIX, also known as the fear gauge, on page 24 of the Global Perspectives™ book.
In its latest meeting the Fed declared that the slowdown in activity seen in the first quarter is “transitory”. Indeed. The nonfarm payrolls report showed that a much higher than expected 211,000 jobs were added to the U.S. economy in April. The unemployment rate inched down to 4.4% and the comprehensive U-6 measure of all unemployed, discouraged and marginally attached workers moved down to 8.6%. This report almost guarantees an interest rate hike in June. In fact, the implied probability of a hike in June soared from 67.1% on Tuesday to 93.8% on Thursday to 100% today. However, all eyes will be on the French elections this weekend. Pro euro candidate Emmanuel Macron is significantly ahead in the polls but if Marine LePen, the anti-Eurozone or “Frexit” candidate, manages to win there will be rampant uncertainty. Markets will react accordingly with a selloff in Europe that will likely extend to U.S. investors running for the exit. This is not a likely occurrence but risk does not always make an appointment and show up when expected. As always, global diversification helps smooth the bumps along the way. Please see page 25 of the Global Perspectives™ book and note that missing just the 30 best days of the stock market over the last 50 years resulted in 40% less return.
Earnings season is 80% complete and in usual fashion, earnings have taken the focus off of geopolitical risks and put it back where it belongs – on the fundamentals. After a commodities bust and earnings recession in 2015/2016 corporate earnings are back on track. Q4 earnings growth was 5% and Q1 is shaping up to be about 13% growth over last year’s Q1. Accelerating earnings growth is the result of broadening manufacturing conditions global wide and consumers happily doing their share of spending, secure and confident in the strength of the housing and employment markets. President Trump’s pro-growth policies have yet to materialize, let alone filter down to corporate profits. So for now give credit where credit is due – the fundamental earnings. Please watch earnings and the S&P500 price on page 6 of the Global Perspectives™ book.