Global Economic Conditions Should Improve from Here
May 4, 2015
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U.S. economic growth stalled in the first quarter, but should regain traction in the coming months.
We expect the Fed will press ahead with rate increases later this year.
On balance, we believe the macro backdrop argues for overweight positions to equities in investors’ portfolios.
The major events last week included a weak first quarter gross domestic
product report, a Federal Reserve policy meeting and indications toward a
compromise over Greece’s debt issues. For the week, U.S. stocks declined,
with the S&P 500 Index falling 0.4%.1 Oil prices continued to recover, which
helped energy stocks, while biotechnology and small cap stocks sold off. In
other asset classes, European bond yields rose noticeably, which put upward
pressure on U.S. Treasury yields.1 The euro also rallied strongly.1
Weekly Top Themes
- Economic growth slowed significantly in the first quarter. The first quarter
GDP report showed the U.S. economy expanded at only 0.2%.2 Exports fell by
0.7%, reflecting overseas weakness and the stronger U.S. dollar.2 Investment in
nonresidential structures fell 23% as a result of the harsh winter.2
- In our view, at least some of this weakness should be temporary. We expect
the effects of the winter weather and West Coast port strikes will fade. We also
believe that the benefits of lower energy prices will provide a boost to growth
via an increase in consumer spending. Decent employment growth and still-low
interest rates should also help the economy regain traction.
- On balance, last week’s Fed meeting was a non-event. There was no change to
the Fed’s forward guidance or to the outlook for moderate growth. The central
bank did acknowledge weaker growth, but attributed it to “transitory” factors. We
continue to believe September remains the most likely timeframe for the start of
a rate increase cycle.
- Corporate earnings are beating lowered expectations. With over 70% of
companies reporting first quarter earnings, results have surpassed expectations by
an average of 7%.3 At this point, earnings are up 3% for the quarter, with strength
coming from the technology and health care sectors.3 Were it not for the energy
sector, earnings would be up 9%.3
- Wages appear to be accelerating. Monthly jobs reports had been pointing to
upward wage pressures, and the first quarter Employment Cost Index that was
released last week confirmed it. The Index was up 0.7% for the quarter and rose
2.6% year over year,4 indicating that reduced slack in the labor market has been
putting upward pressure on compensation.
Volatility May Remain Elevated, but Conditions Favor Equities
U.S. growth slowed and basically stalled during the first quarter as exports
contracted and as consumer and business spending weakened. Looking ahead,
we think growth will rebound, with the consumer sector in particular gaining
strength. Solid income and employment growth, lower energy prices and improved
confidence should all provide a boost to consumer spending. The Fed should start
increasing rates later this year, but should do so gradually and modestly, meaning
rate increases shouldn’t undercut economic growth. Outside of the United States,
conditions also appear to be improving. We believe the odds are growing that a deal
will be struck to help keep Greece in the eurozone. While Chinese growth looks to
be slowing, other regions (Europe in particular) should strengthen.
So far this year, equities have held their ground in the face of softer growth and
declining earnings expectations. Volatility levels have risen a bit in recent months
and we think volatility will remain moderately elevated. The extreme rally in the
dollar and the precipitous decline in oil prices that began in mid-2014 appear to
have been overdone and are starting to reverse. This is causing investors to scramble
to reposition their portfolios. The pending shift in Fed policy is also causing some
measure of market turbulence.
We expect both economic and earnings growth to improve in the coming months,
which should result in a strengthening tailwind for equities. We also expect these
same factors to put increased pressure on government bonds, especially since
inflation levels are starting to rebound. As such, we continue to favor equities within
multi-asset-class portfolios, believe government bonds will be pressured by rising
rates and would suggest underweight positions in commodities.
1 Source: Morningstar Direct and Bloomberg, as of 5/1/15
2 Source: Bureau of Economic Analysis
3 Source: J.P. Morgan
4 Source: Bureau of Labor Statistics
Last Week's Commentary
Equities Should Push Higher Along a Bumpy Road
April 27, 2015
Earnings have been beating expectations, but those expectations have been lowered.
Both global growth and corporate earnings should slowly improve over the coming months and quarters.
Equities face several risks, which should cause volatility to advance, but we expect prices to continue to rise.
Investors mostly focused on the positives last week. Corporate earnings
generally beat expectations and merger and acquisition activity remained
solid. Despite disappointing economic data, this trend reinforced the
perception that the Federal Reserve would hold off on rate hikes for the time
being. The turmoil in Greece rattled investors, but remains relatively contained.
For the week, the S&P 500 Index rose 1.8%, with the technology and
telecommunications sectors leading the way.1 Energy and consumer staples
were the chief laggards.1
Weekly Top Themes
- Earnings are exceeding lowered expectations, but the energy sector remains a
drag. With about 40% of the S&P 500 companies reporting results, earnings are
beating expectations by 5.5%, while revenues are missing by around 1%.2 Were it
not for the energy sector, earnings would be up close to 8%.2
- We are not expecting significant changes from this week’s Fed meeting and
believe rate hikes will begin in September. The Fed will likely acknowledge a
first-quarter slowdown in economic growth and the labor market. However, with
core inflation starting to creep higher and financial conditions looking good,
the Fed should still be on track to raise rates later this year. When it does so, we
think the central bank will be slow and deliberative, as the fed funds rate climbs
gradually to 1% or slightly higher.
- Global monetary policy remains in an easing mode. Outside of the United
States, policy easing continues with the impact varying by country. In China, for
example, we do not believe policy support will accelerate growth, but it should
moderate the slowdown. In Europe, the massive quantitative easing program
should boost growth.
- Equities have accelerated since the end of the global financial crisis despite
disappointing global economic growth. A combination of significant
deleveraging and a global collapse in productivity has limited economic growth
over the past several years despite unprecedented stimulus. Nevertheless, equities
have enjoyed an extended bull market mainly because slow wage growth pushed
earnings higher and an abundance of liquidity propelled investors into higherrisk
- The bull market in U.S. stocks recently celebrated its sixth birthday, but age
alone will not derail the advance. There is no magic number of years at which
bull markets end. Fundamentals, the economic backdrop and investor sentiment
all matter far more than an arbitrary age. We believe these factors point to more
time and more price advances for this bull market.
Economic Growth and Earnings Should Regain Traction
The first few months of the year were marked by disappointing economic data and
deteriorating earnings expectations that put U.S. equities into a choppy holding
pattern. We expect economic growth to improve from here as the temporary effects
of a harsh winter fade and consumer spending gradually accelerates. Earnings have
been hit by the precipitous drop in oil prices and pressure from the rising U.S. dollar.
In our view, profit growth should begin to improve as stabilizing oil prices settle the
energy sector and non-energy earnings reflect the delayed benefit of cheaper oil.
Assuming the advance in the dollar levels off and global growth continues to firm,
we forecast a brighter environment for earnings in the coming months.
Such a backdrop should allow equity prices to advance, but the road ahead will
be rocky and not without risks. The threat of a Greek debt default and a messy
exit from the eurozone is much in the minds of investors right now. The ongoing
negotiations may cause market turmoil, but we believe the most likely outcome
is some sort of compromise that leaves the eurozone intact. The pending start of
the Fed’s rate hike cycle is likely to result in increased bond yields and heightened
volatility in the equity market. But we don’t believe this shift will derail the bull
market given a healing economy and an accommodative global monetary policy
environment. We think the balance of risks remain favorable for equities and
continue to advocate a pro-equity, pro-growth investment stance.
1 Source: Morningstar Direct, as of 4/24/15
2 Source: RBC Capital Markets