George Hosfield, CFA, discusses Ferguson Wellman's quarterly strategy titled, "Inflation's Flame Flickers," which addresses the narrow market leadership, the impact of higher interest rates on inflation and how assets are priced at this stage of the economic cycle.
George Hosfield, CFA, discusses the firm's quarterly strategy titled "Stalemate," which highlights the Fed's ongoing battle to tame inflation along with our views on the health of the banking industry and capital market expectations for the balance of the year.
Director and Chief Investment Officer George Hosfield, CFA, discusses the Fed raising interest rates, peaking inflation and our view on equities and volatility across all asset classes in our Investment Strategy titled, “Balancing Act.”
Gracing the cover of Time Magazine in 2017, famed political author and Eurasia Group founder, Ian Bremmer claimed “China Won.” This statement was not necessarily controversial, as economists and political pundits all but guaranteed a new age of geopolitical and economic dominance led by the fast-growing nation.
The resilience of the equity markets has been quite impressive. At the time of the February lows, pessimism was rampant. Faith in the Chinese economy was shaken, gold was on the rise and there were faint whispers of imminent recession. Fast forward six weeks and the S&P 500 has rallied
With change at the economic margin beginning to improve (e.g. recent U.S. payrolls, durable goods orders and manufacturing PMI), investors are beginning to see cyclical elements of the equity market improve. Oil prices are now up year-to-date, energy and industrials are all of a sudden outperforming the broader market, and financials, which so far this year have pulled up the rear, are starting to get a bid.
That’s the message we heard loud and clear from the markets this week. As economies and markets around the world wobble to start the new year, they were looking to central banks to bail them out. Mario Draghi gave markets around the world some solace with his dovish news conference yesterday.
The slowing Chinese economy is ripping through markets, but Ferguson Wellman Capital Management is telling clients not to worry too much because the U.S. economy remains strong.
by Jason Norris, CFAExecutive Vice President of Research
A Light in the Black
What a week! With concerns about growth in China, continued deterioration of the Chinese equity market and U.S. investors rushed to the sidelines by redeeming over $17 billion in equity mutual funds and ETFs. This, coupled with concern over when the Fed will raise rates, led U.S. equities to experience a 12 percent correction from recent highs on Tuesday (see last week’s blog for more detail). This was long overdue as it had been almost four years since the S&P 500 had corrected by at least 10 percent, which was the third longest period in history. However, after six consecutive days of selling, on Wednesday the near-term bottom was reached on the S&P at 1867, down from its all-time high of 2130 which was reached on May 21, 2015.
Understandably, rapid downward moves in equities can be disconcerting. We don’t know if we’ve seen the bottom; however, we believe there is a light at the end of this tunnel in the form of domestic market fundamentals. For example, U.S. GDP was revised higher on Thursday from 2.3 percent q/q annualized to 3.7 percent. This was driven by several factors - primarily capital spending and consumer spending. Earlier this month we also saw retail sales numbers revised higher. When this data was originally reported, we did view it with some skepticism since our bottoms-up analysis did show better strength than the broad government reports.
After analysis of the earnings reports for the companies we own, it revealed annual growth in earnings of 2 percent; however, excluding Energy, growth was close to 13 percent. Even when looking at the broad market, earnings growth (excluding Energy) was around 5 percent. This growth was driven by the U.S. consumer and healthcare. These fundamentals signal to us that the U.S. economy is healthy and improving.
Earnings Growth for the 10 Economic Sectors of the S&P 500
| Q2 y-o-y growth | 2015e | |
| Consumer Discretionary | 9.2% | 11.3% |
| Consumer Staples | 2.5% | 1.7% |
| Financials | 6.8% | 15.9% |
| Healthcare | 14.4% | 12.7% |
| Industrials | -4.5% | -1.0% |
| Info Tech | 4.5% | 4.9% |
| Basic Materials | 6.0% | -1.0% |
| Telecom | 8.5% | 8.3% |
| Utilities | 6.5% | 1.6% |
| Total (ex. Energy) | 5.3% | 7.0% |
| Energy | -55.7% | -56.3% |
| Total | -0.7% | 1.0% |
Source: FactSet
The table above highlights the underlying sectors of the U.S. market, showing both the actual growth rate for the second quarter and an estimate for 2015. The key to focus on is that commodity prices are bringing down Energy and Basic Materials, and the strong U.S. dollar and China is hurting Industrials. However, when you lift up the hood of the market, corporate America is still exhibiting solid growth.
Our Takeaways for the Week
by Brad Houle, CFA
Executive Vice President
Currency markets are extremely difficult to grasp and most people’s experience with foreign currency is limited to travel. These experiences generally involve moments where someone realizes they just paid roughly six dollars for a Diet Coke at the Eiffel Tower or that they can buy a substantial amount of beer for the equivalent of a dollar in China. This week the news that China had devalued its currency the renminbi or (RMB) by two percent was headline financial news and drove market volatility around the world. Two percent is not a lot of anything so why does this matter so much? On the surface, having a strong economy and a strong currency should be the goal of every country. However, in times of economic weakness central governments only have a few leavers to pull to stimulate economic growth.
One of the obvious and favorite methods is to stimulate economic growth to lower interest rates. This has been done in the United States since the financial crisis and numerous other governments around the world have used this play from the economic rescue playbook. One of the other techniques is to have a weak currency. Having a weaker currency gives a country a potentially large economic tailwind because it makes goods that are exported from the country with a weak currency relatively less expensive when exported to a country with a stronger country. To use a beer analogy, Tsingtao beer from China is normally 8 dollars a six pack at the supermarket and Stella Artois from Belgium is also around the same price. If China devalues its currency, the beer distributor can then buy Tsingtao for a discount because the U.S. dollar buys more Chinese RMB and therefore more Tsingtao. The relative price of the Tsingtao is now less than the Stella Artois and consumers will substitute the less expensive good for the more expensive good. It can be broken down to an ECON 101 scenario of supply and demand and consumer preference. If you then multiply this effect by a billions of dollars of exports from China or another country devaluing its currency it becomes impactful.
Officially, most countries profess to maintain a strong currency policy as that is often associated with a strong economy. Zhang Xiaohui, an assistant governor of the central bank of China, was quoted in The New York Times stating that the RMB is a strong currency and there was "no basis for the continued depreciation of the renminbi." The decision to depreciate the RMB was characterized by the Chinese government as a move to make the currency more market-oriented.
The fear by investors is that this is a sign that China is struggling to keep its economy growing. While China's last GDP growth number was 7 percent year-over-year, there have been worries about the Chinese economy slowing and that the actual growth rate was materially lower than what was “officially” reported. Data has been mixed relative to economic growth in China with worries about a property market bubble and economic indicators such as auto sales being very weak.
Our Takeaways for the Week
by Brad Houle, CFA
Executive Vice President
Gyrations in the Chinese A-share stock market have been a big topic in the financial press recently. The questions that we are getting from clients all center on what the broader implications might be for the Chinese economy and the impact on Western economies. Bottom line, the Chinese A-share market gyrations are a circus side show that will not have real impact on the actual economy of China or the economies of the U.S. or Western Europe.
In fact, the recent events in the Chinese stock market are an excellent primer on what NOT to do while trying to develop free price capital markets. Currently, the A-share market is more rigged than a game of Three-card Monte and the government in Beijing is determined to build the world’s biggest casino. There has been a dizzying array of strategies employed by the Chinese government to first inflate the value of the market and then attempt to control its inevitable decline. Most investors in the A-share markets are Chinese retail investors. The use of borrowed money or margin was encouraged and the A-share market became the most levered financial market of all time for a short while. Since the market started its downward slide, margin debt has now been restricted. In addition, if you are a greater than 5 percent holder of a stock, you are now not allowed to sell for six months. In addition, 200 companies listed on the Shanghai exchange have suspended trading. This is only a partial list of the heavy handed tactics utilized by the government in an attempt to control the stock market. Capital markets that are free from unnecessary regulation and are as transparent as possible are vital to build trust with global investors. While China has gotten it wrong in the short-term, eventually they will get it right as the country transforms to more of a free market economy.
The Chinese A-share market is a rounding error in international equity indexes and Chinese exposure for our clients is accomplished via exposure to Hong Kong and its stock market’s H-shares, as well as Chinese companies that trade on American exchanges. Unless you are a retail investor in China who is invested in the Chinese A-share market, it is not impactful. What is important, however, is what happens in the Chinese economy.
Chinese GDP was released this week at a 7 percent year-over-year growth rate. It is an old story that global investors look at Chinese economic data with skepticism. If you look deeper at other economic indicators in China, the data suggests that a number much lower than 7 percent GDP is probably closer to the truth. One of our research partners, Cornerstone Macro, points out that as business confidence is at the lowest level in 16 years, electricity consumption is up just 1.8 percent, auto sales are down 40 percent and bank loan demand is lower. As such, Cornerstone theorizes that actual GDP growth is likely closer to 5 percent. China is the number two economy in the world, and what happens with the trajectory of the Chinese economy is impactful to the world economy. Currently, the U.S. and European economies appear to be decoupled from the Chinese economy and are benefiting from lower commodity costs and strong domestic economies.
Our Takeaways for the Week
