INSIGHTS

On May 18, 2016

No Time to Be Complacent

Global equity markets[1] posted mixed results in April with the S&P 500 index flat for the month, MSCI EAFE Index returning 2.5% (excluding emerging markets) and the MSCI Emerging Market Index returning 0.4%. The S&P 500 remains in positive territory year to date 2016 up 1.0%, developed non-U.S. equities (MSCI EAFE) are down 1.3% over the same period. Oil[2] prices have rebounded strongly as WTI (West Texas Intermediate) crude prices rose 15.5% in April.

The first-quarter 2016 GDP[3] of 0.5% was modestly below already lowered expectations, as the hard data was flashing weakness well ahead of its release. While strong second quarters have followed weak first quarters in the past few years, we believe there is reason to be a bit skeptical that this will happen again. Weakness here does not come from the overly harsh winter environment, but rather is a continuation of trends, such as weak consumption and business investment, which started in the second-half 2015. Plus, inventory levels were already high and the correction did not come through as expected in the first quarter, so this will likely continue into the second quarter.

The details of the GDP report⁴ are worth digging into, as well. Two-of-the-three broad business investment categories turned negative in the quarter. Part of the issue is the decline in oil & gas drilling investment, despite oil rallying in the quarter; oil remains too low to stimulate much investment yet in our view. However, oil & gas was not the only category of weak equipment spending, which in our view does not bode well for the second quarter. One sign that corporate spending could improve is that consensus expectations for the S&P 500 earnings ex-energy5 will by positive for the full-year 2016. If correct, it implies the worst of the profit declines may have occurred in the first quarter.

The Federal Reserve (Fed) kept its dovish stance in its April press release⁶, but remained data dependent. The Fed also noted the current economic backdrop was weakening, which is similar to the GDP report in tone. On balance, the Fed has kept the possibility of a June rate hike open, but we believe it has significant work in adjusting market sentiment should conditions warrant a rate hike.

Businesses investment in physical assets may be weak, but the market for talent remains at the other extreme. Job additions and the unemployment rate are both strong and initial claims of unemployment insurance is at all-time lows⁷, reflecting the unwillingness of companies to let workers go. Despite the breadth of positive labor data points, wage growth remains weaker than these metrics would imply, suggesting the tightness in the labor market may be somewhat less than perceived.

For now, concerns about the fragile growth environment around the world appear to have been offset by some optimism from the positive impact of China stimulus programs and a reprieve for U.S. multi-nationals in the form of the U.S. dollar’s recent weakness. While this benign environment may last in the short run and risk assets may have some more room to run, we believe it is no time for investors to be complacent. This positive environment could be upset by risks like the U.K. referendum on Euro-zone membership, economic outcomes widening in an aging business cycle, and concerns about global monetary policy choices. In addition, the strong showing of anti-establishment U.S. presidential candidates continues to oscillate, and could spill over into markets as attention turns toward the respective candidate’s potential policies and their economic implications.

 CRN: 2016-0517-5360R

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