The Slow Growth Race Seems Undeterred for Now

Key Points

▪ The Federal Reserve continues to prepare markets for a rate hike later this year.

▪ U.S. equity markets seemed to take a break in recent weeks, possibly awaiting catalysts for growth, including corporate earnings. Expect volatility and low, positive returns.

▪ The global economy has been relatively resilient but risks should not be overlooked.

U.S. equities were primarily unchanged last week and have moved mostly sideways for the last few weeks.1 The positive surprise in the July jobs report had sparked discussion that the Federal Reserve would raise interest rates in the near-term, but softer-than-expected U.S. economic data somewhat dampened expectations. Global monetary policy continues to attract attention over concerns about its effectiveness. The rally in oil, based on hopes of a renewed production freeze, didn’t affect the broader environment. Although retail sales were disappointing, department store quarterly results were well received.2 The energy and consumer sectors led the way, while materials, health care and financials lagged.1

Weekly Top Themes

1. We maintain a constructive outlook for corporate profits. Yet we anticipate growth will stay muted by historical standards. Aggregate profits could return to growth in the third or fourth quarter, largely driven by how quickly oil prices rebound. Non-U.S. profits represent approximately one half of all earnings and continue to be the primary weak spot.

2. Economic data from China was weaker because the government has reduced stimulus, particularly credit growth. The economy has stumbled historically once stimulus is removed.

3. It appears the equity bull market is not over yet. We anticipate a more volatile phase with low, positive returns. Equities do not usually peak until after the Fed begins tightening monetary policy. After the presidential election, we expect that increased fiscal spending, gradually tightening monetary policy and a modestly rising dollar will provide a level of support for equities.

Global Growth Stays Modest but Also Resilient
The global economy and financial markets have demonstrated remarkable resilience since the shock of the U.K. referendum vote in June. Global policymakers provided additional monetary stimulus, which helped support economies and markets. The Bank of England and European Central Bank increased stimulus, while the Fed and Chinese leaders have delayed further tightening, and Japan and Canada provided fiscal support. In turn, this has helped bolster economic confidence and allowed the positive trends in the global economy to remain mostly intact with the exception of the U.K.

Current momentum should carry the global economy and equities in the second half of 2016, which is positive for pro-growth and pro-risk asset stances. However, caution and selectivity are warranted because the investment cycle is maturing, and notable economic and political risks must be monitored in major economies.

The state of U.K. politics has improved somewhat in a matter of weeks as Brexit negotiations pushed out and the Bank of England stepped up reflationary efforts. Confidence measures are deteriorating, however, and the economy seems headed toward recession. Euro area economic confidence has held up in the face of Brexit, which is encouraging since this is an important factor for the progress of the global economy. Pockets of the euro area banking system are still undercapitalized, posing a threat that governments would need to curtail if the regional economy stumbles.

The U.S. economy is solid and deleveraging pressures are fading, making emergency policy settings no longer necessary. The Fed will likely resume its tightening campaign following the presidential election but will move slowly to avoid disrupting U.S. growth. The only noticeable threat appears to be political, with uncertainty during the build up to the election, although the political environment does not generally have a major impact on the economy.

Economic growth in China has been propped up by another round of stimulus and a cyclical rebound in the property market. Structural reforms have largely retreated into smaller scale experiments at a local level.

The balance of global growth appears to be shifting in a mildly favorable way. This trend gives credence to pro-growth positioning and creates the potential for higher equity prices yet this year.

1 Source: Morningstar Direct and Bloomberg, as of 8/12/16

2 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.


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