CPI met expectations for year over year growth through September at 1.7 percent. Increases in shelter and food inflation outweighed declines in energy. A big fear in the markets right now is any sign of deflation in the U.S. since Europe is currently at risk of deflation and recession. Third quarter corporate earnings are coming in better than expected and we are forecasting another 7 percent quarter for earnings growth. Fundamentals are sound but risks remain. Please see page 5 of the Voya Global Perspectives book for an "Effectively Diversified" portfolio.
So it is official that one of the biggest M&A deals of the year is a bust due to direct and intentional action from U.S. Treasury Secretary Jacob Lew. The Wall Street Journal reported "Mr. Lew reiterated that the Obama administration is weighing regulator action to limit the economic appeal of (tax) inversion." This cascaded to halt a number of M&A deals that were certainly in part attractive due to the tax advantages of the deal. Corporate M&A is a sign of market health and we have been calling 2014 "the year of the deal" since M&A has surged back to 2007 levels. This is a welcome return to normal and certainly has bolstered the markets this year. Government should heed the "law of unintended consequences" when deciding to interfere with markets and should instead examine the root cause of the rise of tax inversions which is the U.S.’s second highest corporate tax rate in the world. Recent volatility was in part coincident with this government threat of regulatory action. Meanwhile, the ECB has initiated bond buying stimulus rallying European markets and U.S. housing starts and existing homes continue their strength, jobless claims plummeted to the lowest level in 14 years and consumer sentiment rose to the highest level since July 2007. Please see page 63 of the Global Perspectives Book "Corporate Income Tax Rates" for insight into relative rates by countries.
Donald Rumsfeld gets credit for identifying "unknown unknowns -- the ones we don't know we don't know." We now know U.S. treasury ten year yields dropped below two percent for a time yesterday; we now know that global equity markets are getting hit relentlessly and that U.S. equity markets have all but given up gains for the year. Not good news but crystal clear and it may in fact be the “pullback” that many investors have been looking for along with being a test to separate the strong investor from the weak day trader. But I don’t know what to make of the unknown impact of Ebola. Why, as CNN reports, is the Chairman of the U.S. Joint Chiefs of Staff, General Martin Dempsey so worried about Ebola? His role is military not medical. CNN reports “The chairman said he has been concerned about Ebola as a global threat for at least 90 days." "I'm worried about it because we know so little about (Ebola)," he said, adding that his worry is stoked by seemingly conflicting information about how the virus can be spread.” Meanwhile, good news on initial employment claims and industrial production in the U.S. Please see page 57 of the Voya Global Perspectives book, “Unemployment Rate,” to see the strength of leading indicator claims data.
Perfect storm are two words that really don’t go well together. Perfect implies good and storm implies bad. But, the alternative can’t be used in polite company, so yes we are in a perfect storm. The surging dollar, plummeting oil prices and recessionary bond yields are creating havoc in the markets because they are signaling deflation. No, not just in Europe but globally as well. How did this happen so quickly? In a word - Russia. The impact of sanctions on Russia hit Germany more than we expected, which means Germany was weaker going into it than we thought. Now it looks like they are headed toward recession. Germany’s consistent strength was the bulwark against European recession and a key support for a strong Euro. The exit of the Euro was abrupt as money flows charged across the pond to the U.S strengthening the dollar. The U.S. dollar is the global reserve currency and its precipitous rise caught the markets by surprise and is negatively impacting global markets. A couple points, one, politicians should keep the “law of unintended consequences” in mind when making decisions and two, it is good to be effectively diversified prior to markets getting hit hard. Meanwhile, U.S. corporate earnings are off to a good start and Retail Sales was a disaster. Please see Voya Global Perspectives monthly article from 2013 “The Good, the Bad and the Ugly," which describes how seemingly small events can conspire to disrupt global markets.
Our contrarian $80 oil price target for 2014 West Texas crude oil is within a whisker of being achieved and global oil, brent crude, is dropping in concert. It is a pyrrhic victory though since it is creating shock waves around the globe. The U.S. in particular has been enjoying an energy renaissance in part due to high oil prices. High prices are a requirement to support the high cost of advanced drilling techniques such as horizontal hydraulic fracturing (fracking). The breakeven oil price is around $80, not only for U.S companies, but for many OPEC countries including emerging countries such as Mexico. Below this price is not only a revenue shortfall but it is unprofitable. Well, we have seen this before and it is not good, as in 1997 which culminated in a precipitous drop in oil. Yes, back then it dropped to $10 and crashed the Russian economy. This time is $80 the new $10? No, not likely, but unless prices stabilize requiring the global glut of oil to get worked off then “Houston we have a problem”. Meanwhile, S&P 500 earnings season is getting into full swing with Financials reporting, which are expected to have the highest contribution to earnings growth of any sector. Please follow “Oil Price and Intensity” on page 66 of the Global Perspectives book for insight into how the economy needs less oil to produce $1 of Economic Growth.
Bear markets are usually predicated by economic downturns. The U.S. economic data has not shown any signs of slowing. However, three of the other four largest economies in the world – the euro zone, China and Japan are struggling for growth. And recently the IMF has downgraded global projections, including growth in emerging markets which have been increasingly contributing more to expanding global GDP. Companies certainly have a challenging environment in which to advance their earnings, the fundamental driver of markets. This quarter (q32014) projections are for 4.5 percent growth in earnings over last year. According to Factest –“Over the past four years, 72 percent of companies in the S&P 500 have reported actual EPS above the mean EPS estimates on average. As a result, the earnings growth rate has increased by 2.3 percentage points on average from the end of the quarter through the end of the earnings season due to these upside earnings surprises.” Applying this average would result in almost 7 percent growth for this quarter, not too shabby. But keep your eye on global growth on page 4 of the Global Perspectives book.
Market volatility skyrocketed in the past few trading sessions all the way back to normal. Well, not quite, but close hitting a 19-handle. While the latest volatility is unsettling for investors, normal volatility for the market over the past 20 years has been a higher level at 20, measured by the VIX. We have pointed out numerous events that have conspired to raise volatility such as the Fed’s bond buying exodus, geopolitical risks and worries over the lack of global growth; but yesterday Mario Draghi, ECB President, committed the ultimate political blunder. He told the truth - that Europe needed more than just stimulus, it needs structural reforms or pro-growth economic policy. Europe is on a path to its third recession since the end of the Great Financial Crisis and the outlook for growth especially with Germany’s recent poor factory orders and exports is bleak. Policy leaders should therefore be looking within and preparing to take stronger action to inspire growth. In the meantime, broad global diversification helps investors ride the ups and downs of the market. Please follow the VIX measure of market volatility on page 36 of the Global Perspectives book.
Investors are anxious and confused. After several weeks of selloffs, yesterday was the best day of the year. The about face came on the heels of the release of the Fed minutes, which essentially indicated no policy change and the IMF’s downgraded expectations for global growth, leaving investors scratching their heads. The global economy is sending conflicting signals. The U.S. is doing just fine. The latest economic data point - initial unemployment claims - remained below 300,000 for the fourth week in a row. This is the first time that’s happened since early 2006. But developed economies particularly in Europe are struggling. Germany’s exports dropped by 5.8 percent in August, the strongest drop since January 2009. It is easy to get whipsawed. Keep your eye on the fundamentals – corporate earnings. U.S. companies are finding the global growth. The earnings forecasts as well as revenue expectations point to accelerating growth. Please see the latest perspective on the markets.
The rise of the U.S. dollar has some investors worrying about its effect on corporate profits. The dollar was up 7 percent in the third quarter. This is, for the most part, welcome as it helps U.S. domestic businesses with lower costs, but could put a damper on multinational companies doing business overseas. It’s very rapid ascent is also potentially disruptive to markets. On the other hand, companies that purchase raw materials overseas for manufacture in the U.S. will benefit and both consumers and companies are also benefitting from lower commodities prices because commodities such as oil are usually priced in dollars. Please read all about the state of the U.S. economy and what is worrying investor in "Europe the Fly in the Ointment as U.S. Economy Buzzes."
The U.S. economic picture looks solid. Earnings season starts this week and expectations are for robust growth. Additionally, falling gas prices will be a catalyst for holiday retail spending and a boost to GDP. Despite all of this good news the market and investors are uneasy, and not without reason; the global landscape is not without risks. The latest numbers for Europe, particularly Germany which has been an economic powerhouse until recently, looks grim. A recession in Europe could affect the U.S. rosy earnings outlook for Q4 and the beginning of 2015. That is exactly why investors should own bonds as part of a globally diversified portfolio.