At quarter’s end, the equity market had recovered all that it had lost between 12/31 and 2/11, plus about 1%. Apparently, this was the swiftest recovery in any quarter since 1933. While we were fairly certain that the downdraft was just a much needed correction, like you, we don’t care too much for the uncertainty that such markets bring, especially when the business media was practically cheerleading for a recession. We would actually prefer to be on any of the roller coasters at America’s theme parks, because, while we don’t like that ride either, there is a near certainty that it will end in a minute or two and that we will end up almost exactly where we started.
But, as we stand at quarter’s end, we see markets torn between the Bulls and Bears, and, as we see it, very data dependent going forward. On the one hand, GDP appears to be growing at stall speed, just a couple of slips away from recession. While Q4 growth was recently upgraded from 1% growth (originally .7%) to 1.4%, that rate is still anemic. And readings from various reliable GDP models put Q1 growth below 1%. On the other hand, the labor market appears to be tight as a drum, now beginning to draw from those who had dropped out and, until recently, had stopped looking for work altogether. How else do you get month after month of 200,000+ job growth, but a rising unemployment rate (from 4.9% in February to 5.0% in March)?
Let’s look at the U.S. data:
- Business capital spending saw negative growth in Q4, and from January and February data, it appears that it will be negative again in Q1.
- Q1 profits (S&P 500) are estimated to have fallen 6.9% over the past year and they have fallen even if we exclude the energy sector. Analysts expect Q2 to show a year over year contractions too, (-1.9%); thus, we are, at the least, in a profits recession.
- S&P 500 earnings are estimated to be $120 for 2016. So, at 2060, the S&P 500 level at quarter’s end, the forward P/E ratio is a rich 17.2x. If 15x is “normal,” then the S&P 500 should be closer to 1800. Of course, with monetary policy still at or near ZIRP (zero interest rates), nothing about the markets look “normal.”
- The consumer sentiment indexes for March are once again split with the University of Michigan’s Consumer Sentiment index falling (to 91.0 from 91.7) while the Conference Board’s measure is on the rise (to 96.2 from 94.0). Historically, Michigan’s index has been influenced by the goings on in the equity markets, so we expect a reversal in that measure at the next reading.
- Employment remains strong. March’s net job growth (Establishment Survey) was 215,000, and now we expect to see the long awaited wage growth advance at a 3%+ rate.
- The consumer is in good shape: the debt service ratio is at a generational low, home values are now higher, on average, than they were in ’08, and energy costs (gasoline) at its lowest level in 14 years.
- Underwater mortgages have receded back to more normal levels, and new home sales have turned up. Existing home sales, on the other hand have not, but not due to a lack of demand. The issue here is lack of supply, mainly due to 7 years of little new development. As a result, in many markets, home prices have risen above their pre-crisis peaks. The average price of a home in America’s 20 largest markets (Case Shiller Index – January (latest data)) stood 5.75% above year earlier levels.
- Retail sales appear to be slow, but it appears to us that much of this is a measurement issue. First, the traditional “retail sales” data point is a measure of “hard goods.” Also, recognize that falling gasoline prices have a dramatic impact on this measure. Not only have the traditional sights for the sale of such goods changed (think internet vs. department stores), but the younger generations now spend on “experiences” rather than on “possessions,” which aren’t generally in the monthly retail measurement. Thus, the rise of the “sharing” economy. Because sales at restaurants (“experiences”) are up double digits no matter what time period you use to measure, we believe this is a sign that consumers are spending.
- After 5 consecutive months showing contraction, the ISM Manufacturing Index turned positive in March, standing at 51.8 (was 49.5 in February and 48.2 in January); 50 is the demarcation line between contraction and expansion. And the Non-Manufacturing Index rose too, to 54.5 in March from 53.4 in February.
- Also, for the first time in 8 months, China’s equivalent Manufacturing Index also rose above 50 (50.2). So, this too is good news.
- But the bad news once again revolved around oil, where the price had risen to over $40/bbl from the $26/bbl low in early February based on the belief that OPEC would limit supply. But, now, Saudi Arabia is backing away from output limits because Iran is refusing to participate and the price has fallen back to $35/bbl. So, recession in the oil industry is likely to continue – but, on the other hand, cheap gas will also linger.
Outside of America, there are very few economic bright spots. Only Canada immediately comes to mind. Europe is mired in a near zero growth mode with recent terrorism likely to have a negative impact. Then there are the “Brexit” (Britain’s potential exit from the European Union which will be decided by a referendum on June 23rd), and refugee issues. Japan cannot figure out how to pull itself out of its quagmire, now apparently in yet another recession with absolutely no one except the Bank of Japan (Japan’s central bank) willing to purchase the government’s debt at negative interest rates (proving that such a policy is simply insane). China has its own debt issues that are now constraining its ability to grow, and it looks to be several more years before that economy will have the potential to grow faster than mid-single digits.
Over the last couple of years, the U.S. has been the victim of mercantilistic policies of other countries; this is also known as “currency wars.” The result has been a strengthening dollar which reduces U.S. exports (higher prices) and increases imports (the dollar buys more). This crimps the profits of multinational corporations. That is why the markets reacted positively when Fed Chair Yellen, in her speech to the Economic Club of New York on March 29th, let it be known that the next rate hike was still far off as she voiced her concern about slow economic growth abroad. The dollar’s value immediately retreated, and stock prices rose. Nevertheless, if the Fed eventually moves interest rates up toward something more “normal,” the dollar will, once again strengthen, especially if the world’s other major central banks continue to pursue Quantitative Easing (QE) and Negative Interest Rate Policies (NIRP).
A strong dollar also impacts emerging market debt, as such debt is most often denominated in dollars and must be paid back in dollars. A strong dollar has a negative impact on the budgets of emerging market nations.
In the post-WWII period, there have been 11 official recessions, one occurring about every 7 years. So, let’s consider that the anemic economic growth we’ve seen this past year is the equivalent of that recession. We certainly know that we are in a profits recession. Deeper and longer term questions all revolve around the massive debt buildup in the world since the financial crisis, and the continuation of money printing by major central banks, by continued fiscal deficits, and by zero interest rate policies. We don’t know what the final impact of these will be, and we certainly don’t know the timing of any such fallout. So, let’s stick to what we do know, and what we have experience in analyzing. There are two possible scenarios that we see unfolding. The first scenario is the continuation of anemic growth in the U.S.; and the second one is the return to more normal growth levels.
Scenario 1: If the economy’s growth remains anemic, as Fed Chair Yellen appears to believe, and that corporate profit growth will be anemic going forward, then the equity market will remain range bound, with the top being near 2100 for the S&P 500, and the lower bound at about 1800.
Scenario 2: If the sudden renaissance in manufacturing is a clue to what could transpire, and that is combined with some stability in oil prices, and job creation continues, and together, they lead to rising consumer sentiment and spending, then economic growth and corporate profits will rise. It is likely that the equity markets would follow suit.
Currently, we think that we are in Scenario 1. But recent data, like the ISM Manufacturing and Non-Manufacturing Indexes for the U.S. and China, along with continued job growth, may be the first signs that anemic economic growth and the profits recession may be ending. We are watching the data closely for more clues.
Robert Barone, Ph.D.
Joshua Barone, Robert Barone, and Andrea Knapp Nolan are advisor representatives of Concert Wealth Management. Joshua and Robert are Principals of Universal Value Advisors (UVA),Reno, NV, a business entity. Nicoleta Tulai is an analyst with UVA. Advisory services are offered through Concert Wealth Management, a Registered Investment Advisor. Joshua, Robert and Andrea are available to discuss client investment needs. Call them at (775) 284-7778.
Statistics and other information have been compiled from various sources. Universal Value Advisors believes the facts and information to be accurate and credible but makes no guarantee to the complete accuracy of this information. A more detailed description of Concert Wealth Management, its management and practices is contained in its “Firm Brochure” (Form ADV, Part 2A) which may be obtained by contacting UVA at:9222 Prototype Dr., Reno, NV 89521. Ph: (775) 284-7778.