Global Economic Growth Should
Gradually Begin to Improve
January 26, 2015
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- The ECB easing program should help stave
off deflation and improve investor sentiment.
- We expect U.S. and global economic growth
will improve this year.
- Market volatility is likely to persist, but
equities appear set to advance over the
course of 2015.
Equity markets reacted to both positive and negative forces last week, but
the positive factors won out in the end. Corporate earnings sentiment was
lackluster and investors continued to focus on the negative effects of falling
oil prices. However, markets experienced a significant tailwind from a more aggressive-than-expected quantitative easing announcement from the
European Central Bank (ECB). For the week, the S&P 500 Index climbed 1.6%,
snapping a three week losing streak.1
There is More to Be Done, but ECB Easing Should Help
We expect the ECB’s new easing program will be moderately effective in helping
to stave off deflation and boost growth. There is still more work to be done in
Europe, however, and the dangers are far from over. We believe the eurozone needs
significant structural reforms, which do not appear to be on the horizon. In any
case, the new program should be a positive, and the weaker euro, the fall in oil prices
and some healing in the banking sector should also help the eurozone. Looking
ahead, we believe eurozone growth is more likely to surprise to the upside than the
downside. We also believe the move should improve investor sentiment and put
some much-needed upward pressure on global inflation expectations.
Weekly Top Themes
- Economic weakness outside of the United States is helping U.S. growth.
Slower growth in China is one factor putting downward pressure on oil prices
and European deflation threats are keeping global interest rates depressed. Both
of these trends are contributing to the consumer and business sectors of the U.S.
- U.S. earnings trends appear to be following the pattern of global divergence.
At this point, fourth quarter estimates are that U.S.-oriented companies will see
earnings growth of 11%, while globally-oriented companies will experience a
drop of 1%.2
- Although a number of factors are keeping interest rates low, we expect yields
to rise in 2015. Our list of reasons includes a solid U.S. economy, a possible
stabilization in oil prices, the likelihood of the Federal Reserve increasing rates
and some healing in the eurozone.
- In an unusual confluence, both the federal budget deficit and trade deficit are
falling simultaneously.3 These trends are putting upward pressure on the dollar
and should help support U.S. equities.
- The creditworthiness of oil-producing companies and countries appears to be
deteriorating. Credit spreads for both have been widening in recent weeks.1
- Chinese economic growth slowed to 7.4% last year,4 and we believe weakness
will persist. We expect Chinese corporate earnings, consumer spending and
investment growth will all decline in 2015.
- Relative equity and bond market yields suggest the outlook for stocks could
be strong. For just the fourth time in the last 50 years, the dividend yield on
the S&P 500 has moved above that of the 10-year Treasury. In the other three
instances, equities advanced 25%, 35%, and 33% over the following twelve
The Outlook for Equities Remains Solid
Financial markets have been experiencing a pocket of volatility, which has
undermined investor confidence. We do expect that oil prices will stabilize and
experience a moderate bounce from oversold levels, which should help calm the
markets. Over the next twelve months, we have a constructive view toward risk
assets. U.S. economic growth is improving, corporate earnings should be decent
(outside of commodity-related sectors) and the fiscal drag is fading. The Fed is likely
to raise rates, but will do so carefully and modestly. Outside of the U.S., reflationary
support in Europe and Japan should help global growth. Investors should remain
prepared for a bumpy ride in 2015, but by the end of the year, we expect equity
prices will be higher than where they began.
1 Source: Morningstar Direct and Bloomberg, as of 1/23/15
2 Source: RBC Capital Markets
3 Source: U.S. Treasury Department and the Bureau of Economic Analysis
4 Source: China’s National Bureau of Statistics
5 Source: Bespoke Investment Group
Last Week's Commentary
Despite Escalating Volatility,
U.S. Fundamentals Remain Sound
January 20, 2015
- Equity markets are likely to remain
vulnerable until oil prices stabilize.
- Investor sentiment has become depressed,
but we think it is out of sync with increasing
evidence of an improving global economy.
- Fundamentals suggest that 2015 should be a
positive year for global equities.
U.S. equities declined for a third straight week, with the S&P 500 Index
dropping 1.2%.1 Defensive areas such as utilities and telecommunications
were the best-performing sectors, while the financial sector was hit the
hardest.1 Notwithstanding last week’s decision by the Swiss National Bank to
remove its currency peg, the fundamental backdrop has not changed much in
recent weeks. We attribute the fall in equity prices to ongoing worries about
the collapse in oil prices and the ripple effect on the global financial system.
Weekly Top Themes
- Retail sales levels fell in December, but longer-term trends remain positive.
Sales excluding gasoline dropped 0.4% last month,2 but we think it would be an
overreaction to suggest that the retail sector is in trouble. Over the past six and
twelve months, sales ex-gas were up 4.4% and 5.3%, respectively.2
- Inflation looks steady, but may be due to fall. The headline Consumer Price
Index (CPI) fell 0.4% in December and core CPI was unchanged.3 Core CPI
was up 0.8% year-over-year.3 Given the sharp decline in energy prices, we expect
core CPI may turn negative in February or March.
- We believe lower oil prices produce a net benefit to the U.S. economy.
Declining oil prices help consumers and users of energy. Oil producers are hurt
by this trend, but this group is relatively small. Nonfarm payrolls show 140
million people are employed in the United States, with 931,000 working in the
oil and gas industry.4 In other words, less than 1% of total U.S. employment is
based in the energy sector.
- Near-term earnings trends may be disappointing, but we remain optimistic
about the coming year. As the fourth quarter earnings season begins, current
S&P 500 estimates are for a paltry 1% year-over-year gain, with weakness
centered in the energy sector.5 Looking ahead, we believe an improving economy
and healthy profit margins should help corporate earnings to rebound.
- The U.S. dollar may be overdue for a pullback. The dollar has rallied
substantially over the past few months, due to falling oil prices plus diverging
economic growth and monetary policies between the United States and other
countries. We think these long-term trends will persist, but some sort of near-term
consolidation or counter-rally in the dollar may occur.
- European growth remains under pressure. We expect the eurozone to continue
to struggle as long as bank lending remains depressed, inflation remains close
to zero and governments remain unwilling to increase spending. The growing
possibility of additional easing action by the European Central Bank (ECB) will
help, but likely won’t be enough to pull Europe out of its doldrums.
- Investors have a long list of events and data to react to this week. Earnings
results will get their share of attention, and this week also features a rash of
Chinese economic data, the President’s State of the Union address, an ECB
meeting and elections in Greece.
Sentiment Falters, Yet Equities Still Look Attractive
The sharp decline in oil has contributed to a fall in equity prices and in bond yields,
as it has sparked global deflation fears and undermined confidence in the global
economy. The fundamental supply and demand factors behind falling prices are real,
but we believe prices may have overshot and the current turmoil should diminish.
The souring of investment sentiment seems out of sync with increasing evidence of
The pickup in volatility is unnerving, but we encourage investors to ride out the
equity market turbulence. Those with longer-term horizons may want to consider
using periods of weakness to add to positions as well. We expect the coming year to
be a positive one for global equities in both absolute terms and relative to Treasuries.
We think both the economy and corporate earnings are strengthening, and global
monetary policy remains supportive. Commodity price volatility remains a risk, and
equities are likely to remain vulnerable until oil prices stabilize. We think equities
will be able to overcome this risk.
1 Source: Morningstar Direct, as of 1/16/15
2 Source: U.S. Department of Commerce
3 Source: Bureau of Labor Statistics
4 Source: Deutsche Bank Research
4 Source: MRB Partners