Market Insights: May 13, 2014
Economic Outlook: Housing, and everything else…
- We’ve noted in the past month or so that the housing data has hit a definite “pause”. This is likely due to the change in affordability factor for buyers, due to rising prices and higher mortgage rates.
- Clients have asked if a pause in housing is troubling to our thesis of a continuing somewhat tame economic recovery. The answer is “No”. Housing has not made a major contribution to this recovery since 2009, and if anything, has been a drag. A pause here does not really disrupt any of the factors that were contributing to growth momentum.
- The April report for same-store retail sales came out last week and we saw an increase of more than 6% from the year-ago levels. That is a lot more than what economists were expecting and suggests the consumer is definitely not hunkered down at this point.
- April’s auto sales came in at 16 million, a little above the average since August of 2013.
- Otherwise, it was a quiet week for U.S. data, but notably both of the metrics for the non-manufacturing portion of the U.S. economy were strong. Markit’s number (PMI Services Index) came in at 55.0 and the ISM Non-Manufacturing Index came in at 55.2.
- China’s export numbers improved markedly in April, enough that year-over-year comparisons are once again positive. Most of the increase reported were exports to Europe, which tends to support our thesis that demand is picking up in Europe and contributing to firming growth.
- Growth metrics in the U.K. continue to come in strong. The consensus forecast for GDP growth in 2014 is now north of 3.0%, lending further support to a strong U.K. stock market.
- European Union PMI Composite increased to 54.0 in April, up from 53.1 last month. This represents a continuation of the expansion story.
- We continue to believe that some modest exposure to Emerging Markets makes sense for most equity investors. The forward P/E Ratio for these markets has recently been in the 10-11 range, compared to about 15 for the S&P 500 stocks. While the risk associated with these is clearly higher, this P/E level represents a significant valuation differential.
Equities Outlook: Earnings and margins…
- The first quarter earnings reporting is now more than 75.0% done. Most of the numbers reported by U.S. companies are positive.
- It appears the over-all reporting will show a 4.0% earnings gain compared to a year ago. The total earnings for the combined S&P 500 companies will probably end up around $120 per share.
- Many who have been negative on equities have predicted that operating margins for U.S. companies, which have persisted at above-average levels for several years, will revert to the mean and profit growth will come under pressure at some point.
- Using consensus expectations for revenue and earnings growth, however, suggests that the current 10.2% average margin will actually increase to as much as 10.9% over the next year. This will be good for equities.
The Fed and Fixed Income Markets: Bonds, yields & inflation expectations…
- The Ten-Year Treasury gained a bit in yield during the week; opening the current week at a yield of 2.58%, and closing at 2.62%.
- The bidding level in the latest U.S. Treasury auction for new bonds and notes was significantly weaker last week. This suggests that the rally in Treasuries since the first of the year may have peaked and that the current low yields will present some difficulty attracting buyers. We have been purposely slow in putting some of our clients’ fixed income money to work at these rates.
- In the bond market, inflationary expectations are probably more important than the actual reported inflation results. Here’s an interesting factoid buried in the Michigan Consumer Sentiment survey during April. The percent of consumers who expect prices to be falling in the next 5 years has dropped to 1.0%. This reading has not been at this low level since before 2006 and has typically been running at more like 5.0% to 8.0% during most of the past 5 years.
- So there is almost consensus among consumers that we will see inflation rather than deflation over the coming 5 years. These expectations are likely at some point to reflect themselves in how fixed income investors price bond yields.
- Janet Yellen spoke to the Joint Economic Committee last week. She sees continued accommodative policy with slack in the economy and low inflation. She calls labor market conditions “far from satisfactory”. Unemployment is still seen as elevated while inflation is still quite low. Yellen foresees monetary policy as still loose even with the QE taper.
The Week Ahead
- US, Retail Sales (Census, Dept of Commerce)
- US, Housing Market Index (NAHB)
- US, CPI (BLS)
- EU, GDP (Eurostat)
- EU, Inflation (Eurostat)
- US, Housing Starts (Census, Dept of Commerce, HUD)
- US, Consumer Sentiment (Univ of Michigan)