Economic Outlook: The Forest and the Trees
- It is always important to avoid being overly optimistic about the economy. However, step back and look at just a few key data points.
- Despite short-term shifts in the figures for starts and permits, the NAHB Homebuilder Index is at a 10 year high, beyond where it was in 2006, when it had the help from all the lubrication of sub-prime mortgages (if you’ve applied for a mortgage recently, you are aware that there is no such debt around today). There is real housing demand out there.
- The growth in retail sales (the core number) for July and August are showing 6.0% gains on an annualized basis.
- We have a 5.1% unemployment rate and initial jobless claims have been below 300,000 for virtually all of 2015. As we described last week the Job Openings numbers are at record levels in the U.S.
- Some of the core measurements are very encouraging. U.S. railcar loadings for containers hit a record high in early September, up more than 5.0% from a year ago. Truck tonnage is also showing good numbers in terms of growth. Gasoline usage is up significantly on lower prices. These all associate with positive economic activity.
- If you ask people what worries them, most people talk about China. China’s problems have been well publicized in the financial press. Clearly, growth there and in emerging markets is slowing.
- Even Janet Yellen’s comments about China and its effect on the global economy last Friday were all the market needed to sell off and pretty much reverse the pre-Fed meeting rally that had developed over the preceding week.
- In thinking about China, it is important, however, to realize that the main impact of a China slowdown is limited to the U.S. S&P 500 companies.
- This puts some pressure on S&P 500 profits in certain sectors, but employment by S&P 500 companies is limited to only about 17.0% of total U.S. employment. Therefore, the spillover effect to the U.S. consumer, the main driver of the U.S. economy, is not likely to have broad economic impact in the U.S.
Equity Markets: Is Now the Time?
- Many conversations with clients in the past 4-6 weeks have revolved around a question something like this: “I’ve got cash I’ve been waiting to deploy. Now that we’ve seen a market correction of 10.0%, should I put my cash in or is there more downside ahead?”
- The market-timer’s challenge is a lot like the dilemma faced by avocado-lovers: Not yet. Not yet. Not yet. Not Yet. Eat me now! Too late…
- In a deeper sense, this market timing question reflects a continuing emotional mindset. Investors have been on edge since 2008 and still are not over it. So while U.S. economic fundamentals are solid, we may continue to see some stormy conditions in terms of investor sentiment and therefore volatility. That’s not a reason to avoid equities.
- Longer term, we need to not lose sight of what is a pretty favorable back drop for equities for any investor whose time horizon is not shorter than a year or two.
- Valuations for U.S. equities have adjusted as a result of the August correction. What could have been characterized as a marginal condition of over-valuation has been eliminated. Equities are not priced at “blood in the streets” bargain prices, but they certainly look reasonable.
- Most important, revenues and earnings remain in uptrend. The rate of growth for both revenues and earnings fluctuates regularly as one would expect. But the general trend line remains moving North, not South.
- As we described above, the U.S. economy is showing solid fundamentals in terms of numbers. It is very difficult to find data to support a thesis of an imminent recession.
- As we describe below in our comments on fixed income and the Fed, inflation and interest rates remain low and there is no solid case yet for any sustained upturn for either number. This is precisely the kind of environment in which equities typically out-perform other asset classes.
Fixed Income Markets & the Fed: “None. But What About Done?”
- There was much debate heading into the Fed meeting last Thursday. Economists were split about half and half between those anticipating a Fed move and those expecting no change. The market was uncertain as the front page headline in the Wall Street Journal read, “Wall Street Has Doubts About Fed Lifting Rates”. At least the uncertainty is removed – for now.
- By now, everyone is aware that the Fed left the Funds rate unchanged at last week’s meeting. While there was a lot of uncertainty, this was in line with the market’s prediction for less than a 30.0% chance for an upward move at the time of the Fed meeting.
- In thinking about what lies ahead, a large majority of economists and prognosticators predict the Fed will indeed implement a rate increase, but that it has simply been deferred for the October or December meeting.
- The one difficulty with that thesis is that there is not a press conference scheduled in connection with the October meeting (although obviously that could be changed) and the Fed has historically avoided implementing the start of any tightening at the December meeting since it could create liquidity issues during the heavy holiday demand period.
- Increasingly, we may need to consider the possibility that no move may be seen until 2016. We are now more than 12 months beyond the end of Quantitative Easing. At some point, avoiding the risk of raising rates prematurely can shift and become a risk of waiting too long and unleashing some inflationary pressure.
- If we could eavesdrop on the deliberations of the Fed governors, it might remind us of Stan Laurel’s comment to his ever-present sidekick Oliver Hardy before walking into a gas-filled kitchen with a lighted match: “You know, there’s a right and wrong way to do everything.” (Unaccustomed As We Are – 1929 – MGM)
- In any case, the possibility of an extended delay in a rate increase is not a prediction. But its possibility is something we discuss frequently among ourselves in the L&W Investment Committee.
- Last week, the yield on the 10 Year Treasury note fluctuated as investors positioned themselves for the Federal Reserve meeting. However, at the end of the week, the yield on the 10 Year closed at 2.13%. It closed the previous week at 2.19%.
The Week Ahead
- U.S., Existing Home Sales
- U.S., Durable Goods Orders
- U.S., Initial Jobless Claims
- U.S., New Homes Sales
- GDP Third Quarter Estimate
- GDP Price Deflator Estimate
- Michigan Consumer Sentiment Survey