The current economic expansion has been punctuated by record profits for large corporations, and slow job and wage growth for U.S. consumers.
Main Street Over Wall Street?
Stuck With You
by Ralph Cole, CFA
Executive Vice President of Research
Stuck With You
We all know too much of a good thing is no longer a good thing: that has been the case with interest rates in recent years. Coming out of the financial crisis, banks needed lower interest rates so they could repair their battered balance sheets. Short-term rates came down even faster than long-term rates and allowed banks to pay virtually nothing on deposits and make loans at a substantial profit. As long-term rates have come down, banks have had to lower what they charge for loans, thus reducing their profit margins (otherwise known as net interest margins). For the last couple of years, banks have been hoping for higher rates. Thus far this quarter they have received their wish and we can see that regional bank stock prices have responded well.
Source: FactSet
The correlation between U.S. 10-year Treasury yields and the regional bank index has been remarkable. The theory is that as long-term rates rise banks will be able to charge more for the loans than they make. They will also get higher returns on bond investments that they offer. These improved profit margins will help bank earnings. Much like the relationship between oil and gasoline prices at the pump, banks will be slow to raise interest on deposits and much quicker to increase what they charge on loans. We expect rates to continue to move higher throughout the rest of the year.
Every Little Thing Is Going to be Alright
In a year when the Fed is expected to raise interest rates every piece of economic data is parsed and picked apart. This week it was retail sales and consumer comfort. Retail sales were strong, whereas consumer comfort came in weaker than expected … So let’s just step back for a moment.
Employment gains have resumed their 200,000+ trajectory from 2014. Wage growth is finally starting to flow through the economy. Consumers and corporations continue to benefit from generationally low interest rates. We believe the consumer and the economy are on solid footing and that bodes well for whenever the Fed starts raising rates - be it June, September or December. We caution all not to worry too much about the daily economic numbers or the daily movements in the stock market.
Takeaways for the week:
- Banks are a beneficiary of higher long-term interest rates
- "Main Street" is finally feeling the positive effects of this economic expansion
Liquid Courage
by Jason Norris, CFA
Executive Vice President of Research
Volatility increased this past week in most asset classes with oil being in focus. In the last two weeks, crude oil is up roughly 20 percent, its best two-week move in 17 years. While the demand picture has not changed, we have seen U.S. oil and gas companies announce major employment cuts and capital expenditure reductions for 2015. We believe that there has been some “short covering” in the market which has led to recent strength. Our belief is that by year-end, oil prices will be between to $60-$70/barrel, due to reduced supply in the U.S. In the face of this, we do believe we see some opportunity in energy stocks. While earnings continue to come down, we think we can find value in select names with strong balance sheets.
All Over the Road
As mentioned earlier, the energy complex was not the only asset class exhibiting volatility. In the first five weeks of 2015, the S&P 500 has been either up or down more than 1 percent 11 times, which is 44 percent of the trading days. To put it in perspective, last year the S&P 500 moved this much only 15 percent of the time. The chart below highlights the last five years.
Days the S&P 500 Was Up or Down More Than 1 Percent
| 2011 | 2012 | 2013 | 2014 | 2015 | |
| Number of Days | 96 | 50 | 38 | 38 | 11 |
| Percent of total trading days | 38% | 20% | 15% | 15% | 44% |
Source: FactSet
This year is setting up to be similar to 2011, a year that saw a lot of uncertainty due to surprisingly poor U.S. GDP growth, a U.S. debt downgrade and the European crisis coming to the forefront. All this uncertainty resulted in a flat market for 2011, but it was a rollercoaster ride. We believe the fundamentals of the U.S. economy and the recent actions of the European Central Bank leave the foundation of the global economy a little firmer. We don’t think the volatility mitigates itself; however, we do believe that equity returns will be better than 2011.
Working for the Weekend
Heading into a wet weekend on the west coast, the monthly jobs report this morning was very strong with the U.S. economy adding 257,000 jobs in January. The unemployment rate ticked up to 5.7 percent due to an increase in people looking for jobs, which is a positive for the economy. This is only a small part of the story. Job gains for December and November were revised higher by 147,000. The third leg of the stool of the January jobs report was an uptick in wages. Wages bounced back after a disappointing December, rising 0.5 percent month-over-month. With a strong labor market and unemployment close to the Fed’s target, we believe this wage growth will persist throughout 2015. This further reinforces our view that 2015 will be a good year for “Main Street.”
Our Takeaways for the Week:
- Main Street will fare better than Wall Street in 2015
- Adding to high quality energy names at this time could pay dividends in 2015