Market Insights: June 30, 2014
Economic Outlook: Outliers and the Weight of the Evidence
- First quarter U.S. GDP was revised down to a -2.90% annual rate in the final revised measurement [BEA].
- There were, however, a number of one-time anomalies that likely explain this and suggest to us that this negative reading is unlikely to represent a real interruption of the fairly steady 2.0% annual growth we’ve witnessed over the past two years. A number of later data releases and coincident indicators suggest to us that the trend line continues unchanged.
- BEA’s own final estimate for Corporate Profits in the first quarter was in fact revised up to 6.80% year-over-year growth.
- Markit’s “Flash” readings for June are coming in strong. The PMI Manufacturing Index “Flash” came in at a strong 57.5 reading. The PMI Services Index “Flash” also finished strong at 61.2.
- The data for New Home Sales rebounded, by increasing 18.6% in May to an annual rate back above 500,000 [Dept. of Commerce].
- The Conference Board’s Consumer Confidence measure moved upwards also, to new recovery high, and stands now at 85.2.
- Initial Jobless Claims continue hovering at lower levels (312,000) this past week [Dept. of Labor].
- The important metric of Personal Income continues to grow steadily, up 0.4% month-to-month in May. This metric combined with all of the others just mentioned is not sending any messages warning of an onset of recession. Based on the weight of the evidence, we regard the negative first quarter GDP number as a one-off outlier.
- The numbers out of Europe also continue to signal transition from recession to growth, though not as strong as domestically, as we near the one-year mark from the inflection point. Markit’s European Union PMI Composite Flash remains in growth territory at a reading 52.8. There are some deviations within the detail however as there are gaps between core countries like Germany (in growth at 54.2) and France (at 48, signaling contraction).
- The Economic Sentiment Index for the European Union has remained stable lately, hovering around 102 to 103. It posted at 102 for the month of June [European Commission].
- Japan’s CPI appears to be responding to “Abenomics”. The inflation measurement in Japan increased 0.4% in May and is now running at a 3.7% year-over-year rate, the highest level in quite a few years for a country that has been sweating out deflationary threats [Japanese Ministry of Internal Affairs and Communications].
Equities Outlook: Reviewing the Math
- There was some bond market reaction to the weak GDP report last week, but equity markets seemed to pretty much ignore the news, probably because of more positive and coincident data that has been released lately and which we discussed above.
- We described the math in several of our weekly comments during September of 2013 that suggested the S&P 500 average could easily reach a range of 1850 to 2000 by the end of 2014, based on further increases in corporate earnings.
- We are at the half-way mark for 2014 and the S&P 500 is trading just below 2000, the high end of the range. The S&P 500 remains the top performing major market index so far this year, though almost all of the equity indices are in positive territory on a year-to-date basis.
- From a sector perspective, Utilities are still the best performer by a pretty wide margin thanks to declining interest rates since late last year, followed by Energy (recipient of a recent boost from the uptick in oil prices), and then Healthcare. All sectors, even Consumer Discretionary, now, are showing positive returns for 2014.
Fixed Income Markets: The Benchmark Yield and Inflation
- The Ten-Year Treasury declined in yield last week. It had closed the previous week at a yield of 2.62%, and ended lower this past week at the 2.53% level.
- This decline in interest rates was reflected mainly in trading on Wednesday, possibly in response to the much weaker than expected first quarter GDP report. As we commented above, first quarter’s GDP number was revised downwards to a greater negative than had been anticipated by most observers, creating some doubt about the persistence of the recovery.
- Meanwhile, the PCE, the Fed’s preferred measure of inflation, has been edging higher along with the CPI; it is now up 1.80% year-over-year, closer to the Fed’s 2.0% target. Core PCE, however, is up somewhat less at 1.50% year-over-year.
- Historically, the 10 year Treasury yield has typically sustained a somewhat higher premium above CPI inflation than the current 50 basis points.
- Speaking last week, Philadelphia Fed President Charles Plosser sounded somewhat hawkish. He characterized the current economy as close to the Fed’s dual mandate of low unemployment and 2.0% inflation. Plosser predicted an unemployment rate down to 5.80% by the end of 2014.
The Week Ahead
- U.S., Motor Vehicle Sales [BEA]
- U.S., PMI Manufacturing [Markit]
- U.S., ISM Manufacturing Index [ISM]
- U.S., Construction Spending [Dept. of Commerce]
- U.S., ADP Employment Report
- U.S., ISM Non-Manufacturing Index