by Jason Norris, CFA
Senior Vice President of Research
The Wealth Effect Rearing Its Head
Shrugging off higher taxes and politics in Washington, consumer sentiment reached levels not seen since 2007. The gains, however, were focused primarily among the higher income earners. The broad University of Michigan Index gained seven points from last month, however, those families earning over $75,000 posted a gain of over 17 points, while those making less rose only two points. Higher home prices and a strong stock market has a significant wealth effect on higher earners, thus instilling higher confidence.
This strength in data fueled Friday’s equity markets to record highs. Specifically, the S&P 500 is up over 17 percent for the first five-and-a-half months of 2013. Robust economic growth has not been the catalyst. While the U.S. economy should continue to grow in the 2 to 3 percent range and corporate earnings are expected to show growth of around 7 percent, a 17 percent move in equities may seem a little frothy. We believe that equities still offer a better risk/reward relative to bonds. With the price-to-earnings multiple on stocks is currently at 15 times the earnings in 2013, this is still below multiples seen in 2007 when the equity markets were last at these levels. Also, with interest rates remaining below 2 percent on the 10-year Treasury, we would not be surprised if price-to-earnings multiples continue to expand into the upper-teens.
Japan Joins the Printing Party
That leads us to that elusive question of when will interest rates start rising in a meaningful way. Central banks around the world continue to flood their economies will currency in order to stimulate growth. The four major central banks (U.S., EU, UK and Japan) have increased their balance sheets by over $5.0 trillion to $9.1 trillion since 2008. Japan has been the most recent country to aggressively purchase securities to increase its money supply. This has resulted in a meaningful depreciation of the Japanese Yen relative to the U.S. dollar. However, the ECB has been shrinking its balance sheet and the Federal Reserve has been giving signals that it may be closer to unwinding its QE program. San Francisco Federal Reserve President John Williams stated earlier this week that the pace of securities purchases could slow as soon as this summer. This will have to be balancing act so rates do not spike. Commenting on how the Fed might end the monthly purchase of $85 billion in fixed income securities, this week the Dallas Fed President stated that, “I don’t want to go from wild turkey to cold turkey,” and “I think we ought to dial it back.” We believe the end game will be the Fed eventually stopping all purchases. However, they will not actively sell bonds to the open market, but rather just let them mature.
Has Gold Lost it Luster?
Collectively, the aforementioned events have resulted in relative strength in the U.S. dollar, which in turn, has led to a major sell off in gold. Friday’s close of $1,364 for an ounce of gold is the lowest level since early 2011. With inflation benign and the dollar holding firm, there may be more downside to gold in 2013.
Our Takeaway from the Week
- Even with stocks at historic highs, valuations are still reasonable