Market Insights: January 27, 2014
Economic Outlook: The data continues to be good…
- Initial Jobless Claims have been volatile the past couple months, but seem to have resumed a downward trend coming in a 326,000 this week [U.S. Dept of Labor].
- PMI Manufacturing Index Flash reads 53.7, a slight decrease from last month, but still pointing to expansion [Markit Economics].
- Conference Board’s Index of Leading Indicators increases 0.1% in December, following a strong November reading of +1.0%.
- The IMF released its report on the global economy last week. They are predicting global economic growth of 3.7% in 2014. Notably, their estimate for the Euro-zone is 1.4% growth, an improvement over 2013. The IMF predicts inflation in the developed economies of 1.7%.
- The Euro-zone budding recovery is weak. However, industrial production in November grew faster than consensus estimate, almost 2.0% month over month.
- European Union PMI Composite Flash continues to expand with a 53.2 reading. In core Europe, the discrepancy between Germany (55.9 composite reading) and France (48.5 composite reading) continues to widen [Markit].
- We’ve written about slack capacity and demand in emerging economies and the constraint this creates on inflationary break-outs around the globe. The growth rate in China is a key metric we watch to gauge the rate of change.
- The China Beige Book is an independent research group that does independent “on the ground” accounting of the growth rate in China. It is an excellent check against the official data released on Chinese growth, since official releases by the Communist government can be suspect. China Beige Book’s latest numbers on 2013 Q3 growth data show deceleration in every economic sector except manufacturing. If this metric of slowing growth is accurate, a pickup in inflationary pressures for raw materials and commodities may still be some months and even several years into the future.
- Interesting to note that the IMF Global Outlook (mentioned above) predicts a slightly slowing Chinese growth rate over the next three years.
Equities Outlook: What inning are we in?
- We continue in client meetings to get the same question: How can the market follow through on a 30% return in 2013? While we have acknowledged the ever-present possibility of a correction, this question suggests to us that investors may be under-estimating the potential for continued attractive stock returns.
- In the past 7-10 days, the unsettled emerging markets have been weighing on investors’ minds. The prospect of easy money being tapered by Central Banks has a risk-off mindset controlling these markets and the spillover effect has reached developed markets, including the U.S. We might be getting this correction we’ve spoken about. The question – is it likely to be something more?
- For the market to peak here and start a sustained slide, we need an economic recession. We have not had a recession in the U.S. since World War II that did not start with an inversion in the yield curve (short rates higher than long rates). The yield curve is far from inverted today. Based on economic data, a recession appears very unlikely to us at this juncture or in the near future. We could still be 3-4 years from an inverted curve, recession onset, and a peak in the equity market.
- What could speed up the timetable for recession? Increasing inflation expectations might cause the Fed to move faster in raising rates. So keep a close eye on inflation signs as a canary from the mine. Conversely, more talk by central bankers about any deflationary concerns will initially be bullish for equities, as they suggest continuation of easy monetary policy.
- The Ten-year Treasury currently offers a 2.75% return. Over a decade, that is not likely a return which will out-pace inflation sufficiently to meet investors’ needs. Absent any “canaries”, it is probable that as investors become more confident about the reliability of corporate earnings in an improving economy, the price they are willing to pay for those earnings will edge higher. Stocks will do well.
- On a valuation basis, most would argue that stocks are either over-valued or fairly valued. At a P/E multiple on 15.4 times forward earnings, we are more in the “fair” camp based on the view that the earnings will be there in a better economy. Analysts’ consensus earnings forecasts for the S&P 500 companies in 2014 are for earnings growth of more than 10.0%.
- There has been only a single 10-year rolling period in U.S. history before the Millenium where equities delivered a negative return (1930s). Stocks out-performed bonds for many years following that. The decade of the 2000’s was a second such period of negative returns for stocks. We are very possibly in the fourth or fifth inning of the market recovery game. We may well have some ups and downs in such a medium-term bull market, but that is normal.
- As we have noted, in a recovering global economy, foreign equities look even more attractive on a valuation basis. The P/E multiple for the MSCI EAFE Index is 13.9, significantly lower than the comparable measure for the S&P 500.
The Fed and Fixed Income Markets: Not a lot going on right now…
- The Ten-Year Treasury drifted lower last week. At week’s end, it closed at a yield of 2.72%.
- Minneapolis Fed President Narayana Kocherlakota said he favors even easier monetary policy because inflation is too low, “We’re running the risk of being content with inflation running consistently below our target. That’s inappropriate.”
- There has been little upward pressure on interest rates in the past several months, after much concern in the third quarter of last year. That concern last year, following Bernanke’s comments on tapering, precipitated the first negative calendar year return for bonds in a decade. At the moment, the bond market is quite stable.
The Week Ahead: A Quiet One…
Monday: New Home Sales [U.S.]
Tuesday: Consumer Confidence [U.S.]
Wednesday: PMI Manufacturing [China]
Thursday: Jobless Claims [U.S.]
Friday: Consumer Sentiment [U.S.]