Key Points
▪ The multi-week equity rally paused, as investor sentiment turned negative.
▪ To see a sustained uptrend in prices, we will need more evidence that global growth is accelerating.
▪ Such evidence should materialize, but it may take some time, suggesting markets may remain choppy for now.
U.S. equities came under pressure last week, with the S&P 500 Index falling 3.6%, its largest pullback since late August.1 A number of issues contributed to the decline, including valuation concerns driven by the recent price rally and struggling earnings. Some negative earnings results from department stores and ongoing unease over Fed policy also contributed to souring sentiment. For the week, utilities was the only sector to advance, while energy, technology and consumer discretionary led the way lower.1
Weekly Top Themes
1. Despite fears to the contrary, consumer spending remains strong. Since the end of the Great Recession, consumers appear to be saving more. At the same time, many brick-and-mortar stores have been struggling and offering poor forecasts for future growth. This has led some to believe that consumer spending levels are weakening. Despite these trends, however, we are seeing strong spending in such areas as housing, housing-related sectors and e-commerce. Additionally, for the first time in 20 years, consumer real income expectations are rising.2 To us, this suggests spending is stronger than many believe.
2. Corporate earnings continue to struggle. A combination of lower oil prices, poor productivity, pricing power issues, higher net interest expenses and the start of wage acceleration has pressured U.S. companies. At this point, it looks like earnings-per-share growth will be flat in 2015, although earnings should trend higher to the 4% to 5% range next year.3
3. We expect the Federal Reserve will raise rates next month, but the subsequent pace will be slow and deliberate. The Fed should remain focused on promoting economic growth, and the strong dollar will likely limit the Fed’s pace for raising rates in 2016.
4. U.S. inflation appears to be in a bottoming process. We are not expecting significant inflationary pressures any time soon, but stabilizing commodity prices, wage pressures, a tight housing market and rising health care costs are putting upward pressure on inflation.
5. Equity market leadership is narrow, which is a concerning technical signal. The S&P 500 Index has rebounded notably from its summer lows, but leadership has been concentrated in a small group of mega-cap stocks, showing that market breadth remains limited.1
Equities May Remain Range-Bound, Pending More Clarity
The global growth scare earlier this year notably reduced investors’ risk appetites. Many investors fled equity markets and moved into the perceived safety of government bonds, and thus missed out on the rally from the end of September through early November. Many are now wondering if equity prices will be able to continue to rally. In our view, in order to see a sustained uptrend in prices, we will need to see more evidence that the global economy is gaining momentum.
Such evidence should eventually materialize, but it may take some time. The United States appears to be on solid footing, and a modest interest rate increase campaign should not derail the expansion, especially if spending levels pick up as we expect.
Outside of the U.S., the Chinese economy faces serious structural issues, but conditions do not appear as dire as many believed a few months ago. Other regions are mixed, but we think growth in Europe should improve. At the same time, we think we’ll see improvements in global manufacturing and trade levels in the coming months.
Investors have reasons to be concerned, including signs of wage pressures, earnings difficulties, rising valuations, narrowing market breadth and uncertainty over Fed policy. In contrast, there are positive signs as well, such as still-accommodative global monetary policy, healthy corporate balance sheets, improving U.S. economic growth and better signs from elsewhere around the globe.
On balance, we think the positives outweigh the negatives, but markets are likely to remain choppy for some time. Over the long-term, equity prices should advance. But for now, we expect markets will remain in their current trading range.
“Equity prices should advance over time, but for now, markets appear stuck in a trading range.”
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1 Source: Morningstar Direct, as of 11/13/15
2 Source: Cornerstone Macro
3 Source: FactSet
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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