Mon, JUL 27th, 2015
“Neither comprehension nor learning can take place in an atmosphere of anxiety.” – Rose Kennedy
In my last blog post we examined the growth hiccup in the first quarter for the US economy, which we believed to be transitory due to certain short-term factors (e.g., adverse weather, port slowdown, etc.). We explained that despite these problems the American economy remained supported by steady job growth, recovering confidence, improved private sector balance sheets, and stable household consumption. Indeed, these fundamentals remain the cornerstone of the low to mid 2% GDP growth path.
As we review second quarter data, with the first quarter’s fleeting shackles removed, the economy appears to have responded in the way we anticipated with underlying fundamentals and GDP tracking closer to trend. Job growth during the second quarter was solid, confidence was steady, and consumption experienced a resilient bounce back. A continuation of these fundamentals coupled with a general state of low inflation (including still-lower energy prices), strong corporate earnings, some early signs of rising wages, and accommodative monetary policy augurs well for general economic activity over the near-term.
In international economies there remain pockets of good and bad. Growth’s green-shoots continue to emerge in Europe despite the Greek morass. European policymakers are throwing everything they can at the drama that is evermore unfolding like a Greek tragedy. While the risk of a “Grexit” (Greek-exit) from the Eurozone project has gone up since the referendum we continue to believe that cooler, rational heads will ultimately prevail resulting in the euro remaining intact (at least for now). And even if this view proves to be a misjudgment, Europe has spent the better part of the past three years putting into place a policy-driven firewall to stem grave economic and market contagion from a Greek debt default. Either way, we do not believe that this situation is a reason not to own stocks.
Over in Asia, the last month of the quarter ushered in a bear market for Chinese stocks after a dizzying twelve-month surge. While this rapid decline is a bit troubling, at present we do not expect this to be a major adversarial event for US stocks. Meanwhile, Russia and the Middle East remain hot zones of headline-grabbing anxiety as these regimes continue to kick sand in the eyes of those they disagree with or who are oppositional to their quest for power. And while developments here can often create volatility in financial markets, we do not foresee them cracking any of the four pillars that buttress US stock prices: the economy & earnings; inflation; interest rates; and valuation.
Broad-based US stock indices were once again essentially flat during the second quarter. While the bedrock of the economy & earnings remain steady and inflation is low, our view is that there are two key factors that have restrained the stock market so far in 2015. First, investors are wringing their hands over when the first Fed rate hike will be. Second, many continue to believe that valuations for stocks remain elevated. The confluence of these two concerns has provided enough motive to pause the bull rally. We trust however that looking out longer-term what matters more is not the timing of the first rate hike but the path to rate normalization. Equally as important (and as we have discussed in prior letters), despite the verbosity to the contrary, stock market valuations by our assessment are not exuberant when viewed through the lens of corporate earnings, low inflation and interest rates. In spite of the narrow, sideways trading range for US stocks year-to-date, we believe that the fundamental underpinnings of the bull market remain in tact.
Jason L. Ware, MBA / Chief Investment Officer
Albion Financial Group