Economic Outlook: No Place Like Home
- We’ve commented in recent weeks about housing prices and noted that they have been moderating. However Housing Starts picked up at the end of the year, reaching their highest level in almost seven years. The December single family home starts were at an annual pace of 728,000. This is a 7.0% increase over November. Including apartments, total starts surpassed an annualized rate of 1 million.
- Existing Home Sales increased 2.4% in December according to the National Association of Realtors. This reverses the decline recorded in November. Additionally, the November decline number was also revised to a final number that showed a smaller decline.
- The strong single family home number is an important signal of strength among first-time home buyers, an important segment. This says a lot about confidence in the job environment in the U.S. economy.
- The PMI Manufacturing Index “Flash” number came in at 53.7, moderating from earlier months. The manufacturing survey data has been a touch weaker the past few months (Markit). This likely reflects the reality that capital projects in the energy sector are ratcheting down in response to the lower price environment.
- Nonetheless, the Conference Board’s Leading Indicators rose 0.5% in December, suggesting further growth ahead for the U.S. economy.
- China posted a GDP growth rate of 7.4% in their most recent report. This comes amidst a number of reports of efforts to deal with credit imbalances in the Chinese economy.
- The European Union Consumer Confidence “Flash” Index came in better than expected. According to the most recent EU Commission survey, Eurozone consumer confidence was up 2.4 points versus its final December level, thereby posting its largest rise since March of last year and its highest level since July.
- This confidence reading may reflect a boost from lower energy costs and anticipation of the ECB announcement of QE measures last week. We will see in coming weeks and months if this translates into actual increased Consumer Spending.
- The European Union PMI Composite “Flash” Index also showed some decent strength, coming in at 52.6, reflecting gains in both manufacturing and service components (Markit). While these manufacturing surveys have been slowing somewhat in the U.S., they have picked up slightly overseas, an interesting reversal of fortune. The pick-up in the Euro-zone is one we’ve been anticipating.
Equities Outlook: A Wall of Worries
- January has been a month evidencing big swings in investor sentiment. There’s a wall of worry that investors will need to get over in the equity markets. Overhanging all of the headlines is the ongoing attention taken by ISIS, and is it morphing into a cyber-form of terrorism? How will the uncertainties in Greece be resolved? Will the Fed start hiking rates, and if so, how soon and how fast? Will the low oil prices sink Russia? Can China get through their credit problems and get the Chinese economy re-started and headed toward double-digit growth once again?
- The market has climbed these sorts of walls before; will it happen again in 2015? Last week was a strong week for U.S. stocks with the S&P 500 advancing more than 1.0% on the week.
- Forward earnings forecasts for U.S. S&P 500 companies reached a high early in the fourth quarter (October). Since that time, forecasts have been moderating downward, principally reflecting reduced forecasts for the Energy sector. Excluding Energy, the forward earnings forecasts for S&P 500 companies are essentially unchanged as of January 2015.
- Clearly, earnings will be a bit harder to come by in 2015 compared to last year. Energy companies will certainly produce lower earnings. In addition, the very strong U.S. dollar will depress foreign earnings by S&P 500 companies when translated back into dollars. S&P 500 companies obtain roughly half of their revenues and earnings from overseas, so this is no small factor.
- Some of the energy earnings weakness could potentially spill over to the Financials sector if banks create larger reserves against their energy loan portfolios. This will be something to watch.
- We certainly can expect volatility to pick up in 2015, particularly if the Fed starts raising short-term rates. However, volatility does not equate to a Bear Market. History says that bull markets do not end because of heightened volatility, stretched valuations or outright age, but rather when money begins to get tight enough that the yield curve becomes inverted. We are a ways off from that at this point.
- The ECB’s QE announcement last week which we discuss below is likely to prove a near-term trigger improving the relative attractiveness of foreign equities in coming months. This was at least validated by the initial response of markets to the announcement.
Fixed Income Markets: The “Really Really Big News”
- The “really big news” last week was the ECB’s announcement of a QE-like bond buying plan. At the equivalent of just over 10% of Euro-zone GDP, it is similar in size to the initial bouts of QE undertaken by the U.S. Federal Reserve Bank.
- There are some reservations in the financial markets about the details, particularly regarding risk-sharing among the various member countries. Overall, however, the fact that bond yields in the peripheral Euro-zone economies have fallen in response to the announcement suggests that the markets are generally endorsing the actions.
- As we’ve emphasized in conversations with clients, even sizeable amounts of QE are unlikely to transform the outlook for absolute levels of growth in the Euro-zone economy. Without significant structural reform, these measures will close some of the growth gap between the Euro-zone and the U.S., but will not eliminate the differential entirely.
- That said, this is likely to prove an important inflection point in terms of relative momentum between the financial markets in Europe and the U.S.
- Core bond returns have started off 2015 extremely well. The 30-year U.S. government bond has seen a pretty steep decline in yield (and conversely, a rise in price), possibly reflecting lower oil prices and diminished inflation expectations
- The interest rate on the ten-year U.S. Treasury Note ended last week slightly lower at 1.80% on Friday. This is a further decline from where it closed the previous week at a yield of 1.84%, and follows the trend that has been in place since early December.
The Week Ahead
- U.S., New Home Sales (Census)
- U.S., Conference Board Consumer Confidence
- U.S., FOMC Meeting Announcement
- U.S., GDP (BEA)