Economy, Earnings and Policy Push Equities to New Heights
A combination of receding global growth fears, strong corporate earnings results and continued monetary policy support helped U.S. equities rise for a second week, with the S&P 500 Index climbing 2.7%.1 The week ended with stock prices again hitting record highs and the S&P 500 closing nearly 11% higher than its low on October 15.1 The technology and health care sectors outperformed last week, while oil, gold and most other commodities continued to demonstrate weakness.1
Weekly Top Themes
1. The Federal Reserve held course, while adopting a slightly more hawkish stance. As expected, the central bank announced it was ending its bond purchase programs last week and continued to indicate that it would keep rates at nearzero for a “considerable time.” The Fed also acknowledged improvements in the labor market, signaling it recognizes the U.S. economy is strengthening.
2. The Bank of Japan (BOJ) surprised markets with additional easing. Friday’s action contributed to last week’s market rally and was an important reminder that monetary policy around the world is not moving in lockstep.
3. U.S. economic growth continues to accelerate. Following a strong second quarter of 4.6% growth, third quarter gross domestic product growth rose 3.5%, marking the strongest back-to-back readings in ten years.2 Excluding the first quarter’s weather-related downturn, U.S. GDP growth has averaged 4% in four of the last five quarters.2
4. Corporate earnings show ongoing strength. With 80% of the S&P 500 companies reporting results, earnings are exceeding expectations by close to 5%.3 We expect third quarter revenues to grow 5%, earnings by 8% and earnings per share by 10%, all good numbers.
5. The odds of Republicans capturing the Senate appear to be increasing. Pundits appear to be suggesting that there is a two out of three chance the GOP will take the Senate while extending gains in the House. If this does occur, we expect the amount of legislation passed by Congress and that lands on President Obama’s desk to rise.
6. With the labor market improving, we are starting to see upward pressure on wages. The employment cost index advanced 0.7% in the third quarter and is now up 2.3% for the year.4 We expect to see wage growth continue to pick up in the coming months, which is typical as economic expansions mature.
7. Technical factors and historic trends suggest equity prices may continue to rise. Equity price gains have become broader (last Wednesday, for example, 90% of issues on the New York Stock Exchange closed higher)1, a sign that the recent correction may be behind us. Additionally, we are about to enter the post midterm-elections season, a period that has historically been strong for equities.
Deflation Fears Are Unlikely to Depress U.S. Growth
It has become increasingly clear that economic growth and policy around the world have been diverging. The Fed sent a clear message last week that it is on track to begin increasing rates next year as the U.S. economy accelerates. In contrast, the BOJ’s actions came in response to weak Japanese growth and European policymakers are debating how to respond to recession and deflation fears. This divergence has been pushing the U.S. dollar higher and commodity prices lower, trends we expect will continue over the coming months (although in the near term, commodities may be due for a bounce and the dollar may be overbought).
The combination of deflation fears and low bond yields have reinforced a sense that the global economy remains troubled. Although there are pockets of weakness, we remain convinced that U.S. growth remains solid and that risks of deflation creeping into the United States are extremely low. If anything, we would expect U.S. strength to contribute to growth in the rest of the world.
Looking ahead, we think investors should expect to see equity prices rise more modestly and experience more volatility than in recent years. This should still produce better results than what can be found in other asset classes, which is why we suggest maintaining an overweight position in equities.
1 Source: Morningstar Direct and Bloomberg, as of 10/31/14 2 Source: Bureau of Economic Analysis 3 Source: FactSet and Bloomberg 4 Source: Bureau of Labor Statistics
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.
RISKS AND OTHER IMPORTANT CONSIDERATIONS
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. Noninvestment-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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