U.S. equities finished modestly lower last week with the S&P 500 nearly unchanged.1 Most of the damage occurred on Friday when escalating tensions surrounding Ukraine weighed on sentiment. Positive dynamics included an improvement in first quarter earnings metrics, a notable pickup in M&A activity and deal speculation. A broader macro narrative reflects better traction for the recovery and gradual policy normalization. With momentum plays under renewed scrutiny, several internet, software and biotech companies sold off despite an expected cushion from solid first quarter results.
Nearing an Inflection Point
Nearly 50% of S&P 500 companies have reported earnings, and 73% have beaten consensus earnings per share expectations, slightly above the recent trend.2 Companies are beating estimates by almost 5% in aggregate, above the one-year average of approximately 3%.2 A notable positive change occurred from the slightly negative surprise rate earlier in the quarter.
U.S. economic data seems to be at an inflection point. Most of the Purchasing Managers Index (PMI™) monthly data have shown an uptick, and anticipatory measures argue this is the beginning of a new trend. An uptrend in leading economic indicators is usually synonymous with risk-on markets. Generally cyclical sectors such as industrials and technology lead equities, bond yields begin to drift higher and eventually earnings start to improve. Markets will likely abandon their obsession with counter-cyclicals and start to bid up investments with U.S. economic leverage. If we are correct, April will be viewed as the month when economic conditions and markets changed.
Weekly Top Themes
1.The leading economic index jumped more than expected in March. Th drop in unemployment claims and the rise in manufacturing work week accounts for much of the gain.3 Robust readings for the last two months suggest U.S. economic growth is rebounding after dampened activity during the severe winter.
2.Capex grew 10.9% quarter-over-quarter (annual rate) for fourth quarter 2013.4 Capital expenditures are part of GDP and may finally see a long-awaited bounce.
3.Why are interest rates staying so low? Our thoughts on why rates have remained low include: weak first quarter growth, concerns about an emerging market crisis spurring a flight to quality, or the Ukraine crisis causing a flight to quality to persist, the potential for European Central Bank quantitative easing and a Fed tone that briefly seemed more hawkish. But nominal growth and wage rates are accelerating, which should ultimately cause bond yields to rise.
4.We continue to believe growth in dividends — rather than yield itself — will provide alpha for income-oriented investors.
5.Momentum seems to be lacking in the current rally.
The Big Picture
Equity markets have been on the brink of a correction several times this year yet have proven resilient. The macro backdrop is supportive in terms of the economic landscape, current policy settings and likely path of interest rates over the next year. Risk factors hang over the equity market, however, especially geopolitical developments that could trigger a setback considering the undercurrent of investor cautiousness. We would describe equity market action so far this year as a rotation rather than a correction.
After a soft patch during the unusually harsh winter, U.S. economic data has recently improved. The rebound in growth should support U.S. equities, trigger another rise in government bond yields and induce investors to rotate out of cash and fixed income into equities. Despite geopolitical tensions and lingering uncertainties about growth in China and Japan, the U.S. stock market has endured. Measures of breadth have stayed reasonably healthy, and leadership has started transitioning away from secular growth toward cyclical value, which reinforces a positive outlook for the economy and earnings. As a result, we maintain a moderately pro-growth posture.
1 Source: Morningstar Direct, as of 4/25/14. 2 Source: FactSet, “Earnings Insight,” April 25, 2014. http://www.factset.com/websitefiles/PDFs/earningsinsight/earningsinsight_4.25.14. 3 Source: The Conference Board, “The Conference Board Leading Economic Index® (LEI) for the United States,” April 21, 2014, https://www.conference-board.org/pdf_free/press/TechnicalPDF_5161_1398068405. pdf. 4 Source: Strategas Research Partners, “Capex Acceleration Finaly Happening, More to Go,” April 16, 2014, http://www.strategasrp.com.
The S&P 500 Index is a capitalization-weighted index of 500 stocks designed to measure the performance of the broad domestic economy. Euro STOXX 50 Index is Europe’s leading Blue-chip index for the Eurozone and covers 50 stocks from 12 Eurozone countries. FTSE 100 Index is a capitalization-weighted index of the 100 most highly capitalized companies traded on the London Stock Exchange. Deutsche Borse AG German Stock Index (DAX Index) is a total return index of 30 selected German blue chip stocks traded on the Frankfurt Stock Exchange. FTSE MIB Index is an index of the 40 most liquid and capitalized stocks listed on the Borsa Italiana. Nikkei 225 Index is a price-weighted average of 225 top-rated Japanese companies listed in the First Section of the Tokyo Stock Exchange. Hong Kong Hang Seng Index is a free-float capitalization-weighted index of selection of companies from the Stock Exchange of Hong Kong. Shanghai Stock Exchange Composite is a capitalization-weighted index that tracks the daily price performance of all A-shares and B-shares listed on the Shanghai Stock Exchange. The MSCI World Index ex-U.S. is a free float-adjusted market capitalization weighted index that is designed to measure the equity market performance of developed markets minus the United States. The MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance of emerging markets.
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The views and opinions expressed are for informational and educational purposes only as of the date of writing and may change at any time based on market or other conditions and may not come to pass. This material is not intended to be relied upon as investment advice or recommendations, does not constitute a solicitation to buy or sell securities and should not be considered specific legal, investment or tax advice. The information provided does not take into account the specific objectives, financial situation, or particular needs of any specific person. All investments carry a certain degree of risk and there is no assurance that an investment will provide positive performance over any period of time. Equity investments are subject to market risk or the risk that stocks will decline in response to such factors as adverse company news or industry developments or a general economic decline. Debt or fixed income securities are subject to market risk, credit risk, interest rate risk, call risk, tax risk, political and economic risk, and income risk. As interest rates rise, bond prices fall. Non- investment-grade bonds involve heightened credit risk, liquidity risk, and potential for default. Foreign investing involves additional risks, including currency fluctuation political and economic instability, lack of liquidity and differing legal and accounting standards. These risks are magnified in emerging markets. Past performance is no guarantee of future results.
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