The Positives Outweigh the Negatives for the U.S. Economy
Key Points
▪ Dovish comments from Janet Yellen suggested a slow pace of interest rate increases and helped push stock prices higher.▪ We expect relatively weak first quarter corporate earnings results, but believe conditions should improve later this year.
▪ Despite some near-term risks, we have a positive long-term view toward equities.
The U.S. equity rally resumed last week with the S&P 500 Index climbing 1.8%.1 Although expectations for the upcoming corporate earnings season are low, investors chose to focus on the positives. Specifically, investors reacted to dovish comments made by Federal Reserve Chair Janet Yellen in her speech at the Economics Club of New York, which counteracted some more hawkish comments made by Fed officials the previous week. Other asset classes came under pressure, including commodities and oil, causing some skepticism about the recent rebound. The oil sell-off was due to heightened doubts about the ability of major producers to formalize a production freeze agreement.
Weekly Top Themes
1. Strength in the labor market reinforces our view that the economy remains in solid shape. The March jobs report was mostly good news. Payrolls increased by 215,000 last month, and the unemployment rate ticked up to 5.0%.2 The data suggest more Americans are entering the labor force.2 Average hourly earnings were better than expected, climbing 0.3%, although they are only up 2.3% for the quarter on an annualized rate.2 Overall, the data suggest that while the economy may not be accelerating rapidly, it is growing.
2. Manufacturing may be finally shifting into a higher gear. The March ISM Manufacturing Index beat expectations by rising from 49.5 in February to 51.8 in March (any number above 50 indicates growth).3 This was the highest level since last July.3 The details within the report were strong, with new orders showing a particularly large increase.3 It appears to us that the recent stabilization in oil prices and the decline in the dollar are improving prospects for the manufacturing sector.
3. The Fed is likely to remain cautious in its rate increase efforts. Janet Yellen’s comments indicated that while she acknowledges improvements in the economy, she is also focused on weaker international growth. The Fed is clearly in no hurry to raise rates again. We expect to see one increase this summer and probably one additional increase later in the year.
4. We expect first quarter real gross domestic product to be about 2.0%. The economy is enjoying a number of tailwinds, including low mortgage rates, healthy consumer income growth and low energy prices. Weak growth overseas is a drag, however. Although we have a positive view toward the consumer sector, real consumer spending levels have sagged a bit in recent months.4
5. Near-term weakness in corporate earnings may persist, but results should improve later this year. First quarter earnings results will be released soon, and we anticipate the numbers will show a year-over-year decline. We believe corporate profits are bottoming, and expect to see better results in the second half of 2016 as headwinds fade from the “oil down/dollar up” dynamic.
Despite Risks, Our Constructive Long-Term Outlook Persists
U.S. equities have rebounded sharply over the past couple of months, with the S&P 500 rising by an impressive double-digit rate.1 The gains are partly due to investors covering short positions as they have apparently recognized that the economy is in better shape than was feared in January. The rebound in oil prices has also reduced worries over deflation and provided support to risk assets, including equities and high yield bonds.
In our view, the global economy remains rocky and is still dependent on supportive monetary policy in some regions. In the near term, equities may experience some consolidation given the extreme pace of recent gains. We don’t expect to see a sustained uptrend in equity prices until investors grow more confident in the global economy and become convinced that oil prices won’t experience a renewed rout.
Nevertheless, we believe global growth conditions will improve as the year progresses, which should provide more support for corporate earnings and allow equity prices to rise. As such, we continue to have a moderately constructive outlook and a favorable view toward risk assets on a six- to twelve-month basis.
1 Source: Morningstar Direct, as of 4/1/16
2 Source: Bureau of Labor Statistics
3 Source: Institute of Supply Management
4 Source: Commerce Department
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. 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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