Fri, OCT 16th, 2015
“It’s not what you look at that matters, it’s what you see.” – Henry David Thoreau
After a hiccup in Q1 followed by a strong snap-back in Q2, blended US GDP growth in the first half of 2015 expanded at a pace just below this recovery’s six-year average of approximately 2.25% per anum. Recent economic indicators suggest that a similar speed is plausible for Q3. Steady job gains, rising consumption, stable confidence, and flush corporate profitability – all bedrocks to economic activity – are supportive of continued growth.
As we anticipated, zero-bound monetary policy remains intact as the Federal Reserve chose not to raise rates at both their July and September FOMC meetings. Indeed many years of interest rates near zero have helped resuscitate a weak economy and prompt a modest level of risk taking (a vital ingredient to a healthy economy), which has proven to be a good cocktail for stocks.
Going forward we think that the US economy likely continues along its modest path higher and the Fed continues with easy monetary policy. On the latter, there is a growing parlor game among investors and economists alike as to when the Fed will begin to raise interest rates. While we understand the intense focus surrounding this question, our position has been and continues to be that the timing of the first rate hike is of little importance to investors. Rather, what matters more is the pace, magnitude, and duration of interest rate increases once commenced. We think that the Yellen Fed will be slow, steady, and pragmatic in “normalizing” rates. This “lower for longer” narrative should be supportive to both the US economy and the stock market.
Outside of the US, the third quarter ushered in growing anxiety as China – in tandem with a summer stock market swoon – showed further evidence of a slowing economy. This, along with several other countries showing signs of a slowdown, plus signals from soft commodity prices, prompted financial markets to modestly recast their world macro views. Countering this are the stabilizing effects of Europe’s young QE program and the cooling of the Greek debt crisis, as well as Japan’s continuous attempts to reignite economic growth. These global cross-currents have increased market volatility, and, if stubbornly persistent or ill-managed, could begin to affect US growth. Despite this possibility we believe the probability is that easy global monetary policy (on the whole) and steady economic trajectories in most developed countries will ultimately have the largest impact on aggregate world output. If correct, this implies that world economic growth should continue to expand.
As a consequence of the tense environment, US equity returns in Q3 as measured by the S&P 500 were down nearly -7%. Yet when we distill all of this information down into our near- and longer-term outlook we remain constructive on US equities despite recent volatility and growing pessimism. Not only has the quarter’s selloff refreshed valuations, but history shows that bear markets are typically caused by recession and the depressed corporate profits that result. Though select economic figures might have slowed recently, there’s no evidence in the preponderance of data to suggest a looming recession.
At the corporate profits level the past couple of quarters have undeniably experienced sluggish growth in aggregate. However this pause is mainly due to much lower energy prices and a strong US dollar. As these year-over-year declines run off, mid-single digit profit growth should return. Meanwhile, inflation is tame and interest rates remain at historically low levels.
All told we reason that the underlying fundamentals of the bull market are unbroken and we remain cautiously optimistic.
Jason L. Ware, MBA / Chief Investment Officer
Albion Financial Group