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
1. 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.
2. 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.
3. 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 threemonth rate of core inflation has climbed from 1.3% in January to 2.6% in April.3
4. 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 rate hike.
5. 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 time soon.
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
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. 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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