Economic Outlook: Better read between the lines
- As you know, we review what seems to be a mind-numbing supply of economic data releases in the Investment Committee meetings. The challenge is definitely NOT availability of data. The challenge is making sense of the data we have.
- Interpretation is key when evaluating this never-ending stream of economic statistics. A case in point is January Retail Sales, which showed a decline of 0.8% in January, on the heels of a similar decline in December. Are things really slowing at the retail level? Maybe not.
- Given the strength in the payroll numbers and the inflation-adjusted wage numbers, it seems inconsistent to be seeing a simultaneous decline in retail sales numbers. There IS an explanation. If the effect of reduced gasoline prices is removed from the numbers, inflation-adjusted retail sales numbers for the last 3 months have actually been rising at an annual rate of around 8.0%. That is a quite different conclusion in interpreting the data that puts the Retail Sales number in concert with the Payroll and Wage data.
- We are not expecting a strong pickup in GDP growth for the first quarter. The extremely cold weather on the east coast and the port lockdown on the west coast will likely conspire to make Q1 GDP growth look like a reprise of the Q1 data from 2014.
- OK, so is there something to worry about? Perhaps the generally weak level for overall commodity prices in the world could be one thing. The CRB Index of these prices is certainly down from the middle of 2014. Of course oil prices have been a big part of this. The key to interpreting this data – is the weakness a case of over-supply or is it more a reflection of weak demand? We do not have this answer, but this interpretation is our focus.
- Speaking of oil, here’s an understatement: Oil prices have been volatile. We were over $115 last year. Prices for Brent Crude declined over 50% to the mid $40s. Now, we’ve rebounded back north of $60. This clearly seems to be supply-related, not demand related.
- The supply of oil in the U.S. is more elastic than people may have believed. The market responds very quickly to lower prices. As amazing as it might sound, the U.S. crude oil rig count was over 1600 in the fall of last year. It is now already down to just over 1000. By the end of this year, this decline could mean a decline in domestic oil output of more than 1 million barrels per day.
- Maybe they are starting to “get it” in Europe. Last week, French President Francois Hollande used a somewhat risky and rarely used constitutional strategy to implement a deregulation package that he was unable to get through Parliament on a normal vote. He implemented a range of measures that will extend Sunday trading hours, shorten labor arbitration procedures and deregulate notary and legal professions, among other reforms. This comes on the heels of some much needed tax reform.
- As we’ve written about, the French economy has been notoriously stagnant and economists have judged it to be weighed down by regulation that makes it incredibly difficult to simply “do business”. Hollande has apparently seen the light to a degree and took this fairly bold political step to see if he can jump start a stagnant economy. It will be interesting to see if other countries in the Euro-zone with similar problems choose to follow suit.
- Growth rates in GDP for Germany and Spain are now running above 2-1/2% on an annualized rate. Even secondary countries like Portugal and Ireland are growing.
Equities Outlook: 17 Is Not a “Bubble”!
- The S&P 500 closed last week at a record high of 2110. The Nasdaq rose to the highest level since the heyday of March 2000. In just 2 weeks, we will reach the sixth anniversary of this bull market. Is the party coming to an end?
- Though we had several scares to start the year in January (Greek concerns, Ukraine, low oil prices, etc.), the dominating upward trend of the market has reasserted itself and the S&P 500 is now positive on a year-to-date basis, after being down for the first month of the year.
- The market is trading at a multiple of about 17 times earnings. That is fully priced in light of expected growth in corporate earnings, but not a bubble by any stretch.
- Oil stocks have rebounded on greater stability in oil prices. If prices continue to stabilize in the low 60’s, or even edge higher, we are likely to see further strength in this sector. Investors who found those 4.0%+ dividend yields attractive a couple of months ago when oil prices appeared to be in a free fall are smiling now.
- An interesting fact from overseas: 55% of the European STOXX 600 companies have beaten analysts’ EPS estimates for Q4, a higher rate of out-performance than is typical. And perhaps more of note: 58% beat top-line revenue estimates. Europe might have been pronounced to be dead, but the data clearly suggest that there is a pulse and it may be rising.
Fixed Income Markets: 2 Factors Waning
- The interest rate on the 10-year U.S. Treasury Note ended last week at 2.11%. This is a further rise that continues a trend of the past 4 weeks. Last week’s closing yield was 2.05%.
- The exceedingly low interest rates we’ve seen over the past 3-4 months have been influenced heavily by 2 factors – declining oil prices and the slow economic growth emanating from Europe with consequent low rates there.
- As we’ve discussed in comments above, the recent reversal in oil prices may mitigate this influence on rates. In addition, the signs of nascent strength in the Euro-zone may at least check further downward pressure from the second factor.
- In short, we may have seen the bottom of rates for now. Certainly the signals coming out of the Federal Reserve are that the Governors may be ready to make the first increase in short term rates by mid-year. Nonetheless, they have also seemed to signal that the pace of increases is likely to be very patient and perhaps extended over time.
- Deflation fears seem to be abating in the market and you can see it in the bond market. TIPs break even yields are supporting that thesis. The January U.S. wage data also supports that thesis.
The Week Ahead
- U.S., Existing Home Sales (National Association of Realtors)
- U.S., Conference Board Consumer Confidence
- U.S., New Home Sales (Dept of Commerce, HUD)
- U.S., CPI (BLS)
- U.S., 2nd GDP Estimate (BEA)