The Back-and-Forth Continues as Equities Gain Ground
November 23, 2015
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Equities recovered what they lost in the prior week as investors focused on the positives.
Global growth must improve for stock prices to experience a sustained increase.
Ultimately, we think that will happen, although the path will be a bumpy one.
U.S. equities climbed sharply last week, with the S&P 500 Index advancing
3.3%, essentially erasing losses from the prior week.1 Somewhat surprisingly,
investors did not focus on the terrorist attacks in Paris, paying more attention
to the positives. The October Federal Reserve minutes seemed to strike the
right balance between raising expectations for a December rate liftoff and
maintaining a measured pace. Merger and acquisition headlines were also in
the news and there were some bright spots on the corporate earnings calendar.
For the week, the consumer discretionary and technology sectors led the way
while energy and utilities underperformed.1
Despite Some Worries, Consumer Spending Is Strong
Several prominent retailers posted disappointing third quarter earnings results,
which have caused some observers to opine that consumer spending levels are
weakening. We disagree. Spending levels remain strong in areas such as housing,
autos, "experiences" and e-commerce, which may be diverting spending from
traditional brick-and-mortar companies. The tailwinds for spending outweigh the
headwinds, and include an improving labor market, wage gains, low core inflation,
low energy prices, rising consumer net worth and rising real income expectations.2
Weekly Top Themes
- Lower energy prices have historically led to periods of improved economic
growth. As happened in such times as 1981 - 1982, 1986, 2008 and 2011,
declining energy prices may help real gross domestic product growth, payrolls,
capital expenditures, manufacturing and industrial production in 2016.2
- Rising inflation may become an important story in 2016. In particular, we
expect to see modest upward pressure on wages and core inflation.
- Since the market low in August, equities have been doing relatively well, with cyclical
sectors outperforming.1 We expect this trend will persist and expect global
manufacturing levels to improve.
- The Paris attacks could act as a drag to European growth. Specifically, trade,
travel and consumption could take a hit. For the United States, the main effect
would likely emerge as shifts in export and import levels due to a stronger dollar
and a potentially weaker European economy.
Better Global Growth Should Eventually Help Risk Assets
Although volatility has increased over the last several months, fundamental
conditions continue to be steady. The global economy remains uneven and somewhat
weak as one or more major economies have suffered periodic setbacks at various
points. As a result, investors have relied on easy monetary policy rather than on
improving growth to power risk assets higher.
Markets now sit at a crossroads. Monetary policy should remain an important
consideration, but for risk assets (including equities) to achieve a sustained uptrend,
we believe better global economic growth will be needed. And we expect global
conditions to gradually improve. China is stabilizing and policymakers are keenly
attuned to promoting continued growth. The U.S. remains in decent shape, as the
improving job market should drive consumer spending levels higher. Additionally,
after years of acting as a drag, government spending should serve as a positive force.
Global manufacturing has been weak, but we think this area is starting to turn.
While there are a number of risks, most should remain relatively contained.
Terrorism and geopolitical instability are again driving a number of financial
conversations. But while the human costs of the tragic events we have seen in
France, Mali and elsewhere are staggering, geopolitical issues are unlikely to
significantly affect financial markets unless they undermine broader economic
growth. Many are also concerned about a shift in Fed policy, but we believe the
Fed will move cautiously. And while a stronger dollar has some downside, we don’t
expect the sort of sharp surge we witnessed in late 2014 into 2015.
Ultimately, we think evidence of better global economic growth will cause investors
to move out of safe-haven assets such as Treasuries and cash and into equities. The
path ahead will likely be bumpy, but we do expect equity prices to grind higher over
the long term.
1 Source: Morningstar Direct, as of 11/20/15
2 Source: Cornerstone Macro
Last Week's Commentary
Equities Decline, But Long-Term Trends Look Positive
November 16, 2015
The multi-week equity rally paused, as investor sentiment turned negative.
To see a sustained uptrend in prices, we will need more evidence that global growth is accelerating.
Such evidence should materialize, but it may take some time, suggesting markets may remain choppy for now.
U.S. equities came under pressure last week, with the S&P 500 Index falling
3.6%, its largest pullback since late August.1 A number of issues contributed to
the decline, including valuation concerns driven by the recent price rally and
struggling earnings. Some negative earnings results from department stores
and ongoing unease over Fed policy also contributed to souring sentiment.
For the week, utilities was the only sector to advance, while energy, technology
and consumer discretionary led the way lower.1
Weekly Top Themes
- Despite fears to the contrary, consumer spending remains strong. Since the
end of the Great Recession, consumers appear to be saving more. At the same
time, many brick-and-mortar stores have been struggling and offering poor
forecasts for future growth. This has led some to believe that consumer spending
levels are weakening. Despite these trends, however, we are seeing strong
spending in such areas as housing, housing-related sectors and e-commerce.
Additionally, for the first time in 20 years, consumer real income expectations are
rising.2 To us, this suggests spending is stronger than many believe.
- Corporate earnings continue to struggle. A combination of lower oil prices,
poor productivity, pricing power issues, higher net interest expenses and the start
of wage acceleration has pressured U.S. companies. At this point, it looks like
earnings-per-share growth will be flat in 2015, although earnings should trend
higher to the 4% to 5% range next year.3
- We expect the Federal Reserve will raise rates next month, but the subsequent
pace will be slow and deliberate. The Fed should remain focused on promoting
economic growth, and the strong dollar will likely limit the Fed’s pace for raising
rates in 2016.
- U.S. inflation appears to be in a bottoming process. We are not expecting
significant inflationary pressures any time soon, but stabilizing commodity prices,
wage pressures, a tight housing market and rising health care costs are putting
upward pressure on inflation.
- Equity market leadership is narrow, which is a concerning technical signal.
The S&P 500 Index has rebounded notably from its summer lows, but leadership
has been concentrated in a small group of mega-cap stocks, showing that market
breadth remains limited.1
Equities May Remain Range-Bound, Pending More Clarity
The global growth scare earlier this year notably reduced investors' risk appetites.
Many investors fled equity markets and moved into the perceived safety of
government bonds, and thus missed out on the rally from the end of September
through early November. Many are now wondering if equity prices will be able to
continue to rally. In our view, in order to see a sustained uptrend in prices, we will
need to see more evidence that the global economy is gaining momentum.
Such evidence should eventually materialize, but it may take some time. The United
States appears to be on solid footing, and a modest rate increase campaign should
not derail the expansion, especially if spending levels pick up as we expect.
Outside of the U.S., the Chinese economy faces serious structural issues, but
conditions do not appear as dire as many believed a few months ago. Other regions
are mixed, but we think growth in Europe should improve. At the same time, we
think we’ll see improvements in global manufacturing and trade levels in the coming
Investors have reasons to be concerned, including signs of wage pressures, earnings
difficulties, rising valuations, narrowing market breadth and uncertainty over Fed
policy. In contrast, there are positive signs as well, such as still-accommodative global
monetary policy, healthy corporate balance sheets, improving U.S. economic growth
and better signs from elsewhere around the globe.
On balance, we think the positives outweigh the negatives, but markets are likely
to remain choppy for some time. Over the long-term, equity prices should advance.
But for now, we expect markets will remain in their current trading range.
1 Source: Morningstar Direct, as of 11/13/15
2 Source: Cornerstone Macro
3 Source: FactSet