Market Insights

Market Insights: May 28, 2015

Economic Outlook:  The News – How Good is Good Enough?

  • We’ve been anticipating that there might be a rebound in housing to sustain the economy’s growth. We got some good news in the April numbers as Housing Starts surged ahead at a 20%+ pace from the previous month. A strong housing market will be key to economic growth holding steady for the balance of the year.
  • The various Regional Business Surveys conducted by the Federal Reserve have generally been strong. Remarkably, tax collections by the U.S. Treasury are running more than $40 billion of the government’s own forecast.
  • We’ve noted the slow growth rate in first quarter U.S. GDP, and it was indeed soft. These strong tax collections may be providing an insight, as an interesting explanation for this was offered by David Rosenberg of Gluskin Shelf last week. Rosenberg pointed out that government revenues (read “taxes”) are increased 14% from last year, while government spending, which contributes to the GDP data is only +2.5%.
  • The result of this swing is that the deficit has declined more than 10% in the past year. That may be something to cheer about; however, this disparity between taxes and spending represents a fiscal drag on GDP. Rosenberg estimates that this has taken a full percentage point off GDP in the past 12 months. Another way to look at this (the silver lining, perhaps): without this drag from the public sector, GDP growth could be in the high 3.0% range.
  • With the private sector performing like it is, a recessionary downturn for the U.S. is unlikely at this point, in our opinion. The most recent Federal Reserve minutes summarize the favorable factors for the U.S. economy: low interest rates, rising household income, and consumer confidence (though the most recent post on this last metric was a pullback from earlier highs).
  • Japan reported their final Q1 GDP number and the Japanese economy is growing at a 2.4% annual rate. This looks strong as a headline, but we must remember that they are making up from some negative readings in previous quarters. We will need to see if this rate can hold up.

Equities Outlook:  At First Glance – More Than Meets The Eye on Earnings?

  • S&P 500 Earnings are up only about 1.5% over the year ago results. At first glance, this looks like a deceleration of earnings growth, but can you stop there? Maybe not. It is important to recognize that the S&P 500 companies, excluding Energy, actually have sustained double-digit earnings gains compared to a year ago.
  • Energy companies make up about 8.0% of the S&P 500 companies. Earnings forecasts have been in a free-fall. Only within the last week or two have the industry analysts stopped cutting their earnings estimate.
  • The major U.S. equity indices moved ahead to new highs last week, but finished relatively flat. There is some divergence, however, worth keeping an eye on. The Small Cap Russell 2000 did not confirm last week’s new highs, and the Transport Average likewise has been diverging from the Large Cap Indexes. Persistent divergence in these metrics would be a weak technical underpinning for the markets.
  • Valuations, on a forward earnings basis, are indeed now stretched a little above long-term averages. The Forward P/E of the S&P 500 is now at 17.0. The Small Cap S&P 600 Index is at a multiple of 19.3. However, acknowledging the unusually low interest rates and low inflation, it is somewhat logical that earnings multiples would trend a bit higher than normal as a consequence of low rates. In fact, it is perfectly logical that yield-hungry investors would be bid up equities that in many cases, yield dividend returns around 3.0%, and which represents a yield that is growing in many cases by 7.0% or more annually. That investment opportunity frankly looks attractive compared to a 10-Year Treasury Note with a yield so low that the market value of the bond will drop about 13% if interest rates move up 200 basis points.
  • This may explain why the much more modestly valued foreign equity markets have started to out-perform U.S. equities. Quantitative Easing ended in the U.S. late last year and began in Europe about the same time. Market performance momentum has shifted in the same direction. Here’s a simple illustration: Vanguard’s Total International Stock ETF is up 11.11% year-to-date. Vanguard’s S&P 500 U.S. Stock Index fund is up 4.05% over the same period. We would not be surprised to see foreign equities continue to hold this momentum advantage for a while.

Fixed Income Markets:  Here and There

  • There was further advance in yield on the 10-Year Treasury note last week, as the yield on the 10-Year closed at 2.21%.
  • Janet Yellen’s speech last week was not surprising. She reiterated the Fed’s view that the weak numbers in Q1 were mostly attributable to one-time temporary factors and that the stage may continue to be set for tightening of the funds rate later in 2015. Most analysts seem to believe the September Fed meeting is the most likely timeframe. Employment growth and related data is the most important data source to watch for clues.
  • Some of the surprisingly good economic indicators in the Eurozone compared to relatively soft data in the U.S., has resulted in the Euro rebounding to $1.14, though it dropped back below $1.12 last week on comments by an ECB policymaker, suggesting that the ECB is preparing to ramp up its bond-buying program before the summer.

The Week Ahead


  • U.S. Durable Goods Orders (Department of Commerce)
  • U.S. New Home Sales (Department of Commerce)


  • U.S. GDP Q1 Release – Second Estimate (BEA)