Market Insights: September 2, 2014
Economic Outlook: Less Can Be More
- The U.S. economy seems to be moving completely independent of the Eurozone economy which shows signs of slowing significantly. In light of global interdependence, is there an explanation for this decoupling?
- A couple of items come to mind. Comparatively speaking, the U.S. economy is much less regulated than that of its European counterparts. In many key aspects – starting a small business, leasing facilities, building factories, hiring and discharging workers – it is simply much simpler to conduct business in the U.S. compared to Europe. Despite our extended unemployment benefits and various government income support mechanisms, the incentives to work are greater here.
- It shows up in the numbers. Last week’s consumer confidence number from the Conference Board reached a new high for the current economic recovery and posted at 92.4 for August.
- The initial jobless claims for last week remained below the key 300,000 level. Last week’s number held steady at 298,000 first-time jobless claims.
- The GDP number for the second quarter has been revised upward from 4.0% to 4.2%. This is the second revision to the estimate before we will ascertain a final number for the second quarter. This adjustment trend, however, is positive.
- Personal income statistics for the month of July showed an increase of 0.20%.
- Japan is struggling by contrast. Household spending data for Japan declined for the fourth consecutive month. Spending is now down 5.9% from the year ago numbers.
- The overhang of Ukraine tensions are not helping in Europe either. Retail sales in Germany showed a surprising decline of 1.4% in July. Inflation numbers in the region remain low, posting only a 0.30% increase over the 12 months numbers from last August.
- The L&W Investment Committee is focused upon this dichotomy of statistics. Market valuation differences, however, already price in to a certain degree these differences in the economic outlooks of Europe compared to the U.S. and in fact, may actually create opportunities.
Equities Outlook: Returning to the “Why?” Question
- There was much concern during July and early August that the U.S. Equity Market might finally be experiencing a correction (it has been 36 months since the last 10.0% drop). However, the market attained a new record high last week. It appears that the upward trend remains intact.
- U.S. Blue Chip stocks have shown the best gains. The Russell 1000 Large Cap Equity Index is back in record high territory. However, the Russell 2000 Small Cap Equity Index is essentially treading water at about the same place it began the year.
- With the negative headlines coming from the Middle East and Ukraine, clients continue to ask “Why is the market continuing to do well, when there is so much bad news in the world?”
- As we have discussed in recent weeks, the forward estimates for revenues, earnings, and profit margins for S&P 500 companies remain strong. As we described earlier, the U.S. economy is to some degree decoupled from the problems infecting Europe.
- The significant evolution of the North American energy story is perhaps another explanation for this dichotomy between the U.S. and Europe. Note that the price for a barrel of Brent Crude has dropped $15 since June 19th despite the worsening headlines from the Middle East. Perhaps this also shows the increasing independence of the U.S. economy from Middle East oil developments, something that would not have likely happened 5 years ago.
- A very bullish development for the United States is the fact that oil field production is up to more than 8.5 million barrels per day as of July, 2014. We are increasingly becoming less dependent upon the unstable parts of the world for our energy and to some extent the underlying resiliency of our equity market reflects this foundational change.
- Europe’s contrasting difficulties may actually create opportunities in the long run. In an interview on Bloomberg Radio this past week, Robert Doll, Nuveen’s Chief Equity Strategist pointed to the French Oil giant, Total S.A., as an example to illustrate this point. “When you can buy Total for less than 12 times what they earn and get paid a dividend that is more than 5.0%, it might be worth waiting a bit for things to turn around.”
Fixed Income Markets: Competition from Abroad
- The Ten-Year U.S. Treasury yield held eased lower to close the week at 2.34%, back where it resided two weeks previous. The yield had rebounded a bit last week to 2.4%.
- With a strengthening U.S. economy and the increased likelihood that 2015 will be the year of the Fed returning to a more normal policy, only the gloomy picture in Europe creating competition in the form of low rates can seem to explain the constrained interest rates in the U.S.
- Alternative fixed income areas like high yield and convertibles have continued to out-perform the more traditional core bond areas. We are watching those closely, however, as the upside can become limited.
The Week Ahead
- PMI Manufacturing (Markit)
- ISM Manufacturing Index (ISM)
- ADP Employment (ADP)
- ISM Services (ISM)
- PMI Services (Markit)
- Employment Situation Report (BLS)