The Slowly-Growing Economy Should Persist for Some Time
May 26, 2015
Download & Print:
U.S. and global economic growth remain uneven, but should accelerate over the coming quarters.
The Fed is likely to raise rates later this year, which may cause volatility to pick up.
As long as bond yields don’t rise dramatically, the equity bull market should persist.
There was little meaningful direction in equity markets last week. Global
bond yields generally rose and economic data was mixed. U.S. equities
posted modest gains, with the S&P 500 Index rising 0.2%.1 The consumer
staples sector was the worst-performing area of the market, while health care,
financials and technology led the way higher.1
Weekly Top Themes
- A noticeable economic acceleration has failed to materialize. We continue to
believe that the weakness in first quarter growth was due to temporary factors,
but so far, the data from the second quarter has failed to show much additional
traction. Overall, we think the preponderance of important data (including jobs
growth, housing and retail sales) suggest slow but sustained economic progress.
- Housing is an area that may be improving. One strong reading certainly doesn’t
make a trend, but the 20% jump in U.S. housing starts in April was impressive.2
At an annual rate of 1.135 million, housing starts reached their highest level
since November 2007.2 We believe the increase provides further evidence that
the earlier-year slowdown was weather-related, and we expect the housing
market will continue to improve, albeit at a more modest pace.
- Inflation is slowly but surely rising. The headline Consumer Price Index
climbed 0.1% in April, in line with expectations.3 Core inflation, however, was up
0.3%, its highest reading since August 2011.3 As a result, the annualized three-month
rate of core inflation has climbed from 1.3% in January to 2.6% in April.3
- Janet Yellen’s remarks suggest the Federal Reserve is on track to raise rates
later this year. In her speech to the Greater Providence Chamber of Commerce,
the Fed Chair indicated that the recent slowing in economic growth has been
due to transitory factors. Nothing she said indicated that the Fed is shifting its
stance, and we believe September remains the most likely time frame for the first
- Global growth remains uneven. U.S. growth has downshifted, but we expect the
U.S. economy will gain some strength in the coming quarters. Europe appears
to finally be recovering from recession and we believe this region will provide
more of a tailwind for world growth. China, in contrast, appears to be continuing
to experience a slowdown in growth and we do not believe this will change any
Yields May Rise, but Equities Should Survive
Financial market volatility has eased as the recent rise in bond yields and the
advance in oil and commodity prices appears to be leveling off. We believe this is a
temporary calming and expect we’ll see more volatility when the Fed finally decides
to lift rates. Most of the pain will probably be felt in government bonds, but equities
and other areas of the fixed income market are likely to face higher volatility as well.
Given our outlook that U.S. growth will improve, the global economy is firming,
inflation is starting to pick up and the Fed is set to move rates higher, we think it is
all but inevitable that we will also see a rise in bond yields. The pace and magnitude
of the increase will be critical in determining how equity markets respond. If the
rise in yields is gradual, there is a good chance that the bull market can continue and
that valuations can become more stretched before the current cycle of rising stock
prices comes to an end. In contrast, if yields rise quickly or dramatically, there would
be a much greater chance of a significant downturn for equities.
The Fed is highly attuned to the state of financial markets and wants to help allow
the current economic expansion to continue. The Fed is obviously aware that
economic data remains mixed and has emphasized clearly the importance of key
data when considering rate increases. As such, the Fed should move slowly and
deliberately when it does act. A cautious Fed, combined with the fact that monetary
policy easing continues in many parts of the world, should prevent yields from rising
in a manner that would disrupt the equity bull market.
So we do not believe that rising rates will end this bull market, but we also believe a
rebound in corporate earnings would be required for equities to make further gains.
The good news is that it looks to us like earnings momentum has been picking up
over the last month. As such, the balance of evidence suggests that stock prices can
still rise from here.
1 Source: Morningstar Direct, as of 5/22/15
2 Source: Commerce Department
3 Source: Labor Department
Last Week's Commentary
Equities Push Ahead Despite Softening Economic Growth
May 18, 2015
U.S. and global economic growth should improve in the coming months, but areas of the world are still in need of policy support.
The advance in global bond yields should persist, but rates will likely move slowly and unevenly higher.
These factors suggest tailwinds for the equity market may strengthen later this year.
The continued advance in global bond yields dominated the financial story
again last week, although this trend eased slightly by the end of the week.
Economic data featured a relatively weak retail sales report. Notwithstanding
these factors, U.S. equities advanced, with the S&P 500 Index hitting another
record high as it gained 0.4%.1 The consumer staples, health care, industrials
and technology sectors led the way, while energy was the worst-performing
area of the market.1
Weekly Top Themes
- Retail sales figures are not climbing as anticipated. Despite solid employment
gains, retail sales were flat for April, suggesting that consumers are continuing to
save rather than spend.2 We expect spending levels to rise in the coming months,
but the consumer sector is not currently helping growth as much as many
- U.S. economic growth is not yet accelerating. Following a weak first quarter,
most economic data suggest that the second quarter has not yet picked up
noticeably. We would not be surprised to see first quarter gross domestic product
growth revised lower. While the second quarter should be better than the first,
those numbers may also be disappointing.
- It will be difficult for the "Goldilocks" investing backdrop to persist. For the
past six years, investors enjoyed an economic backdrop strong enough to push
most asset classes higher but not so strong that inflation or tightening monetary
policy emerged as threats. With uneven economic growth and emerging signs of
wage inflation, we believe the investing environment is becoming more difficult
and that selectivity is growing in importance.
- Global growth prospects appear mixed. We expect Europe to become a stronger
tailwind for the world economy thanks to low commodity prices, a cheaper euro
and an accommodative central bank. In contrast, it looks to us like Chinese
growth will continue to decelerate.
- Overall, we believe the global economy will improve in the coming months.
The "stronger dollar/weaker commodities" trade that emerged in the middle of
last year indicated investors were expecting global growth to be soft as deflation
fears were rising. We have begun to see the strength of that trade diminish with
deflation risks fading and growth prospects improving.
Investor Confidence Should Pick Up in the Coming Months
Concerns over deflation are fading as it becomes increasingly clear that global
growth is recovering. Economic conditions around the world and in the United
States remain uneven, but we still believe that Federal Reserve rate hikes are
inevitable. As we approach the first rate increases, investor anxiety will likely increase
as worries mount that the Fed will become too aggressive and act in a manner that is
detrimental to economic growth. It may seem odd that this would become a concern
considering how dovish the Fed has been and how much central bankers have
focused on transparency. But the 2013 "taper tantrum" taught us that investors are
prone to overreaction and that once yields start rising, many will become concerned
about the possibility of deflation and economic stagnation.
Because of these concerns, one of the prominent near-term risks for equities is that
bond yields will advance too quickly, which could trip up the stock market. We think
such a scenario is unlikely. Improving global growth and a pending shift in Federal
Reserve policy will put upward pressure on bond yields. But many regions of the
world are still in an easing cycle, which should prevent yields from advancing too
dramatically. For its part, the Fed should proceed cautiously so as not to risk slowing
U.S. growth. Once the Fed starts to act, we believe investor confidence will rise. As
such, we expect any setbacks in equities that result from rising rates to be temporary.
Likewise, we believe the dramatic volatility in currency and commodity markets is
starting to fade. These markets remain unsettled and may continue to be choppy for
some time, but should calm somewhat. Increased stability should provide a further
boost to investor confidence. Overall, we acknowledge clear risks to the global
economy, but we continue to advocate a pro-growth investment stance and favor
overweight positions for equities.
1 Source: Morningstar Direct, as of 6/20/14
2 Source: Department of Commerce