The U.S. economy continues to defy one of the most anticipated recessions. Since January, investors and economists have been on edge as economic indicators started flashing red, particularly the purchasing managers index (PMI) and the leading economic indicators (LEI). Both metrics are closely watched as they have been reliable in foretelling downturns.
Good News First
Friday’s jobs numbers propelled stocks to roughly break even on the week. While the gain of 227,000 jobs in January was meaningfully above the estimate of 175,000, the unemployment rate ticked up and wage growth ticked down. The increase from 4.7 percent to 4.8 percent in the unemployment rate was due to more people entering the labor force, thus not much of a negative.
Spring is Finally Here
by Shawn Narancich, CFA
Executive Vice President of Research
Spring is Finally Here
True to our outlook for the quarter and in-line with anecdotes from the mass of companies reporting first quarter earnings, the U.S. economy appears to be gaining speed after a weather-induced slowdown earlier in the year. While investors were disappointed to learn that first quarter GDP barely budged in the U.S., their disappointment was short-lived, as the blue-chip Dow Jones Industrial Average traded to new highs this week, with the benchmark S&P 500 not far off its best-ever levels. Merger and acquisition deal flow has picked up markedly, signaling greater confidence in corporate America to deploy near-record levels of idle cash. To our surprise, benchmark 10-year Treasury bonds remain remarkably well bid, with yields that held stable after a bullish jobs report likely reflecting continued geopolitical risk in Eastern Europe.
Green Shoots
Investors were encouraged to see that the U.S. jobs market kicked into a higher gear, producing substantially better than expected growth of 288,000 net new jobs in April. Previously reported jobs numbers were revised higher and the unemployment rate fell to a 5-and-one-half-year low of 6.3 percent. Bears will argue that a drop in the labor force participation rate to 36-year lows was responsible for the falling jobless rate, as discouraged workers gave up the hunt for jobs. We would argue that an accelerating economy will produce more job opportunities for disaffected workers, pulling them off the sidelines and tempering the decrease in unemployment. Average hourly earnings remain subdued, rising at the slowest pace of the year, and likely heartening the Fed, which earlier in the week left its QE3 tapering on course for conclusion by year-end. In addition to healthier labor markets, equities are responding favorably to further strengthening of the U.S. Purchasing Managers Index, a benchmark gauge of manufacturing health; it rose for the fourth consecutive month in April and dovetails with the rising levels of manufacturing and construction employment seen in the payroll report. U.S. auto production in March rising at the fastest pace since 2007 is another data point confirming for us the renaissance in domestic manufacturing. Finally, we were encouraged to see March consumption spending increase by nearly 1 percent sequentially, indicating that shoppers are beginning to spend at healthier rates following a brutal winter.
The Urge to Merge
All of a sudden, deal-making abounds: the planned combination of orthopedic device makers Zimmer and Biomet, Comcast’s proposed acquisition of Time Warner Cable, GE’s bid for Europe’s Alstom, Exelon’s planned acquisition of fellow utility Pepco Holdings, and Pfizer’s $106 billion bid for British drug maker AstraZeneca. This sample of proposed combinations highlights companies attempting to grow their bottom lines through sales and cost synergies at a point later in the economic cycle, when organic growth is harder to come by.
Only time will tell whether these deals actually get consummated as antitrust issues and nationalistic sentiment could foil at least a couple of them. For investors, the bidding activity shines a positive light on the economy and corporate valuations that we believe will continue to expand.
Late Innings of Earnings Season
Nearly 75 percent of the S&P 500 Index has now reported first quarter earnings. With forecasts that initially called for a decline in earnings now morphing into the reality of low single-digit growth, we observe that corporate America is once again proving its ability to under-promise and over-deliver.
Our Takeaways from the Week
- Evidence of an accelerating economy continues to mount as weather-induced weakness fades
- Heightened deal activity and better-than-expected corporate earnings leave stocks well bid, trading at near-record highs
Time of the Season
by Jason Norris, CFA
Executive Vice President of Research
Here Comes the Sun
The polar vortex of 2014 seems to have finally thawed and we believe this change in the weather will bring some warmth to the U.S. economy. Economic growth hit a speed bump in the first quarter as much of the U.S. experienced severe winter conditions. This resulted in lower-than-expected economic activity, which in turn led investors to reduce risk in their portfolios and bid up bonds, leading to a decline in interest rates. We believe the “soft patch” is a short-term phenomenon and we have already started to see a pick-up in retail sales and industrial production, as seen in the Purchasing Managers Index (PMI).
While stock market volatility hasn’t hurt consumer confidence, the price of gas may do so in the near future. We have seen a 10 percent increase in gas prices over the last two months. Commodity prices can be volatile, but if this is a persistent trend higher, it will present an impediment to our bullish view of the U.S. consumer.
Send Me Your Money
April 15 has come and gone, bringing increased revenues to the Treasury. 2013 showed high single digit “revenue” growth for the Treasury. On the expenditure side of the ledger we are seeing lower-than-anticipated spending on healthcare and defense. Both of these instances should lead to lower deficits. While the U.S. is still spending more than it takes in, we are pleased that difference is declining. For those tax payers who have a big heart and want to make a difference, the IRS includes a box on tax forms for filers to check if they want to make a donation to the Treasury. Remember that tax rates are just a minimum requirement – you may always pay more. Over the last 15 years the average annual donation has been around $2 million; however, 2014 has already eclipsed this amount with $2.7 million in donations. Considering the strength in equity markets the last few years, will there be more “giving” to the U.S. government… or will increased capital gains taxes eat into this potential philanthropy?
Back in Business
April kicks off the first quarter earnings season for 2014 and this week we saw two bellwether semiconductor companies report, Intel and Linear Technology. The results were mixed, with Intel citing a pick-up in the P.C. space and Linear seeing strength in automobile and industrial markets. Both companies showed average revenue growth but profit margins continue to remain high.
Overall, expectations for the first quarter are for an earnings growth of three percent (year-over-year). This is down from expectations of 10 percent growth three months ago. We believe this negative revision is a result of the inclement weather in the first quarter. We expect second quarter growth to reaccelerate to nine percent. That may prove to be somewhat optimistic, but we believe we will see greater than five percent growth in the second quarter.
Our Takeaways from the Week:
- As we move into spring, we would expect U.S. economic growth to continue to pick up
- We would use the recent strength in the bond market as an indication to reduce exposure and move those funds to U.S. equities