Market Insights

Market Insights: June 15, 2015

Economic Outlook:  How Much Unemployment is Acceptable?

  • You may have heard this quip before: An “acceptable” level of unemployment means that the government statistician who finds it “acceptable” still has a job. While that may be true on an individual basis, the collective statistics have probably arrived at a point that is “acceptable”.
  • Despite the slow start in the first quarter, job gains in the U.S. have averaged over 200,000 per month for this year. The May number was 280,000, confirming that progress on the employment front is continuing.
  • The Job Openings (JOLTS) Survey showed 5.4 million job openings in the U.S. We have never seen the survey at this level since they started the measurement.
  • Average hourly earnings have moved up 2.3%, and while it’s not a rapid pace it’s nonetheless an increase over the past few years. Maybe we are coming to the end of the soft patch that everyone has been talking about.
  • These stronger employment numbers are definitely a source of comfort in regards to a possible slowdown in the U.S. These employment numbers do not suggest an economy that is rolling over towards recession.
  • The latest surveys from the National Federation of Independent Businesses (NFIB) make it probable that continued growth in payrolls will come from small and medium size companies that employ 50-500 people. If you dig into the detail of the surveys, the picture is one of a pretty tight job market for these companies – a dearth of qualified applicants for the number of openings. The highest in 40 years!
  • May’s Flash CPI measure for the Euro-zone surprised on the high side as prices moved up 0.3% over year ago levels. This reverses the pattern we’ve noted in recent months where the annual comparisons have been posting with negative signs in front of the numbers. This probably explains the turnaround in Euro-Zone bond yields.
  • German Factory orders showed another strong rise in April, +1.4%, even stronger than the March results. Most interesting was the strong reading on Foreign Orders, where the strongest numbers were for orders related to other countries in the Euro-Zone, confirming the increasing strength in the entire region.

Equities Outlook:  Large Caps – Happy as a Gopher in Soft Dirt?

  • The U.S. equity market has been in a soft patch so far in 2015. Though the S&P 500 Index has been up and down several times since the first of the year, we stand currently only about +1.0% on a year-to-date basis.
  • Small and mid-cap stocks have out-performed and are up in a range of 3.0% – 4.0% year-to-date. So these smaller stocks have been where the action is thus far in 2015.
  • From a valuation standpoint, however, the large cap stocks now stand at around 16.5 P/E Ratio, measured on forward earnings. The small caps and mid caps are at higher multiples, 19X and 18X, respectively. So comparatively speaking, large cap stocks may be deserving of Jed Clampitt’s memorable appraisal on The Beverly Hillbillies: “Happy as a gopher in soft dirt…” Relative valuation seems to favor the Blue Chips in the near term.
  • As we discuss below, the Fed is likely to finally move on the Fed funds rate before the end of 2015. Assuming they do, there is undoubtedly some effect in the form of increased market volatility around the shift in policy.
  • However, historical perspective is important. Well known is that history strongly suggests that equities move higher in the 12 months preceding the first Fed rate hike in a cycle. What is less well known is that this same pattern holds true for the 12 months following the initiation of a rate hike cycle. Is there a fundamental explanation for this pattern?
  • It is not hard to explain. Stronger job growth should lead at some point to stronger consumer spending. This stronger spending leads to demand that influences the capital goods sectors of the economy, creating revenue growth there as well. Against this is a background of a global economy that appears to be emerging into the growth camp as well.
  • In stock and sector selection, emphasizing businesses with very favorable cash flow metrics is important. If interest rates start to rise, and bonds begin to provide meaningful competition for stocks, one should own companies who are themselves increasing their distributable cash flow to the shareholders.

Fixed Income Markets:  One and Done – Are We Almost There?

  • There was a slight drop-off in yield on the 10-year Treasury note at the end of last week, as the yield on the 10-year closed at 2.39%, down 2 basis points from where it finished the previous week.
  • Rising interest rates may have more to do with diminishing fears about deflation than actual fears of rising inflation. A contrarian view would call for quickly rising inflation. We do not foresee much likelihood of this contrarian view, but we acknowledge that it represents a risk in the bond market.
  • The U.S. economy is at a place of extremely low inflation, transitioning to low inflation. Interest rates are at zero, but should probably be transitioning to just low. These two factors confirm that it is time for the Fed to make a move on rates.
  • Our best guess at this point is that the Federal Reserve will make a single move of 25 basis points in the Fed Funds rate this year, and that could well be it. While it would be justifiable for them to move at the upcoming June meeting, it is more likely they will take a more conservative pace and wait for the September meeting.
  • There is likely to be at least some market turbulence in connection with such an increase. However, the important perspective is to realize that the move is really a step to normalization of rates, and not necessarily a pattern of increasing rates.

The Week Ahead


  • U.S., Industrial Production (Federal Reserve)


  • U.S., Housing Starts (Census, Dept of Commerce, HUD)


  • U.S., FOMC Meeting/Press Conference


  • U.S., CPI (BLS)
  • U.S., Conference Board Leading Indicators