Key Points
▪ Equity prices rose for the third consecutive week as the news and economic data have turned less negative.
▪ We expect volatility will remain high and believe we need to see additional improvements before a sustained equity advance.
The “risk-on” trend continued last week, helped mainly by stronger U.S. economic data, heightened expectations for more European Central Bank stimulus and additional stabilization in oil prices. High yield spreads fell and equities rose, with the S&P 500 Index climbing 2.7%.1 Over the past three weeks, U.S. stocks have nearly recovered all of the ground they lost earlier in the year.1
Evidence Does Not Point to a U.S. Recession
The bearish case for the U.S. economy and equities is that the Federal Reserve inflated risk asset prices and did little to stave off an inevitable recession by keeping rates at artificially low levels for seven years. In contrast, the bulls would argue that the long period of zero rates created a robust economy and allowed unemployment to fall to below 5%. We lean more toward the positive case. Despite still-weak global manufacturing, the weakness in the energy sector and ongoing global financial market turbulence, consumer spending is rising, inflation is slowly ticking higher and economic growth is accelerating. In our view, there is almost no evidence of a pending slowdown in growth, let alone signs of a recession.
Weekly Top Themes
1. U.S. jobs growth once again experienced a solid month. February’s labor market report showed a surprisingly strong 242,000 new jobs were created.2 The data showed some negatives as well, including a slight downtick in wage growth and smaller number of hours worked.2
2. Manufacturing activity showed a slight improvement. February’s Institute of Supply Management’s manufacturing index increased, likely due to increased consumer spending.3 The index remains below 50, however, and a relatively weak international backdrop remains a headwind.3
3. We believe oil prices are bottoming. Over the next few months, U.S. oil production is forecasted to drop from roughly 9 million barrels per day to closer to 8.5 million.4 This should help prices continue to advance.
4. We expect the Fed to raise rates two or three times in 2016. This could change if economic growth weakens and/or global financial conditions deteriorate.
5. Global policymakers remain biased toward policy easing. The G20 meeting demonstrated that government officials believe the world economy remains sound, but they will engage in aggressive fiscal or monetary policy actions to promote growth if conditions worsen.
It May Take Better News for the Rally to Continue
Financial markets appear to be normalizing in recent weeks after the risk asset rout that started the year. We would caution, however, that market improvements have come about because the news has become less bad, not because it has turned good. Investor sentiment is fragile and will likely remain so for some time. One of the key variables remains oil prices. Oil markets have stabilized in recent weeks, but volatility and a renewed downturn could occur anytime. We also believe we need a sustained improvement in U.S. and Chinese economic data before investors grow more confident. Finally, the global political system remains a wildcard. The current focus is on the possibility of the United Kingdom leaving the European Union. The odds favor the status quo, but a potential “brexit” would be destabilizing for the U.K., and the uncertainty is fueling downward pressure on risk assets.
All of this suggests that markets may remain volatile in the near term. A longer-term rally in equity prices is possible, but it would require continued improvements of the factors mentioned above. A renewed softening in economic data or an additional downturn in oil prices could easily spook investors and trigger another risk-off move. Additionally, the bond market is not signaling an all-clear sign. U.S. Treasury yields remain quite low and have been slower to advance than equity prices. High yield spreads have declined, but also signal signs of risk.
Nevertheless, as we stated earlier, we do not expect the U.S. economy to weaken and think the odds of a recession are low. A slow (if uneven) improvement in economic growth should boost corporate earnings. That, in turn, should help pave the way for equity prices to move higher.
1 Source: Morningstar Direct & Bloomberg, as of 3/4/16
2 Source Labor Department
3 Source: Institute of Supply Management
4 Source: Dudack Research
The S&P 500 Index is a capitalization-weighted index of 500 stocks designed to measure the performance of the broad domestic economy. The Dow Jones Industrial Average is a price-weighted average of 30 significant stocks traded on the New York Stock Exchange and the Nasdaq. The Nasdaq Composite is a stock market index of the common stocks and similar securities listed on the NASDAQ stock market. 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. 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. MSCI EAFE Index is a free float-adjusted market capitalization weighted index designed to measure developed market equity performance, excluding the U.S. and Canada. The MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance of emerging markets. Barclays U.S. Aggregate Bond Index covers the U.S. investment grade fixed rate bond market. The BofA Merrill Lynch 3-Month U.S. Treasury Bill Index is an unmanaged market index of U.S. Treasury securities maturing in 90 days that assumes reinvestment of all income.
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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