Spinning Wheel

by Ralph Cole, CFA Executive Vice President of Research

Spinning Wheel

The strong dollar has been a headwind for S&P earnings so far this year. However, that headwind appears to be dissipating. Having traded at $1.40 less than a year ago, by last month the Euro had plunged to $1.05. The Euro's 25 percent devaluation has been a positive development for European economies. Paired with quantitative easing, this has led to a rally in European equity markets.

As confidence has started to build in the Eurozone, we have seen economic growth starting to accelerate. In fact, first quarter GDP in the Eurozone was 1.6 percent, which compares favorably to the meager .2 percent reported  in the U.S. for the first quarter. This change at the margin, with Euro growth outpacing U.S. growth, has led to a strengthening of the Euro relative to the U.S. dollar. As Shawn Narancich stated in our March 13 blog, "the dollar was due for a break after such a parabolic run." Since mid-March, the Euro has strengthened 8.5 percent relative to its U.S. counterpart. We view this moderation in dollar strength as a positive for U.S. multi-national companies, and we also see it as a healthy indicator for the capital markets. We still believe that the dollar will strengthen against the Euro as the year moves along, but it will be gradual.

Finally

Along with a rally in the Euro, we have seen a rally in interest rates since the end of January. The U.S. 10-year bond yield bottomed at 1.64 percent in January; today it stands at 2.23 percent. Not only have U.S. bond yields risen over that time period, but so have yields in Europe. After bottoming at .08 percent, the German 10-year bund now stands at a .70 percent yield. We have long maintained that higher global yields would result in higher rates here in the U.S. and we believe yields are finally starting to discount expectations of stronger global growth in coming quarters.

 Takeaways for the week:

• The dollar has taken a pause against the Euro, and we view this as healthy for the global economy
• Higher yields are reflecting higher growth prospects in the second half of 2015

Disclosures

Pushin' Forward Back

by Jason Norris, CFA Executive Vice President of Research

The official start of earnings season kicks off next week and it looks like earnings for the broad market are going to be negative five percent. There are two main culprits for this. First, the recent strength in the U.S. dollar took large multinational companies by surprise, which resulted in major revenue and earnings revisions lower in 2015. The S&P 500, a standard large cap equity benchmark, has approximately 35-40 percent of its constituent’s revenues outside the United States. Therefore, a major strengthening of the U.S. dollar (see the below chart) results in U.S. goods being more expensive.

For example, if $1.00 = 0.80 Euro, then if a U.S. manufacturer were selling a $100 item in Europe, customers there would be spending 80 Euros. With the recent strengthening, $1.00 is now the equivalent of 0.95 Euros, thus that same $100 item would cost 95 Euros. This is a major price increase and headwind for U.S. exporters. We saw this instance with companies like Microsoft, Caterpillar, and more. On the other hand, the weakening Euro makes those products cheaper in the U.S. Thus, we believe European exporters should stand to benefit from this, and will be a catalyst to stimulating growth in Europe. As such, we recently increased our exposure to the International markets.

Down In a Hole

The other culprit for the major negative revisions for earnings is the reduction in the price of oil. In the past six months, the price of oil has been cut in half which is having a dramatic effect on the earnings in the oil patch. The year-over-year change in energy earnings in the first quarter is a negative 65 percent. Excluding this area of the market, earnings are forecasted to grow by three percent.

Outshined

These two attributes are setting up for a tough year for headline growth numbers. Earnings growth estimates have declined from seven to two percent for 2015. However, if you exclude Energy, earnings growth should come in closer to nine percent. Our belief is the overall economy is improving and the consumer will be the main beneficiary. While recent consumer spending data has been mixed, we are seeing an improving trend, particularly in consumer confidence. Therefore, continued low interest rates and energy prices throughout 2015 are a tax cut for consumers, and with a tightening labor market, we expect to see an increase in wages. This is all setting up to be a good year for “Main Street.”

Our Takeaways for the Week: 

• The strong dollar and low oil prices are a headwind for US earnings growth
• Main Street will be the winner in 2015

Disclosures

Putting It All Behind Us

by Brad Houle, CFA Executive Vice President

More than anything, the financial markets dislike uncertainty and the most recent source of angst was the election. With the mid-term elections behind us, the market participants are free to focus on economic data and not political minutia. One of our research partners, Cornerstone Macro, published a great summary of likely legislative change and probable market impact from the change in control of the U.S. Senate.

The European Central Bank (ECB) met this week and the takeaway from their meeting is the ECB is still poised to take extraordinary measures to keep the Eurozone economy from lapsing into a recession and possible deflation. Mario Draghi, the ECB president, reiterated the ECB's commitment to do whatever it takes to keep Europe's economy staggering forward. He did not go so far as to announce quantitative easing which just ended in the United States. The ECB has been doing some bond buying on a smaller scale and keeping the possibility of a large scale quantitative easing program on the back burner in the event the European economy goes from bad to worse.

The employment data for the month of October was released today. The unemployment rate declined to 5.8 percent and nonfarm payrolls increased 214,000 jobs. In addition, there was a 31,000 revision to the September employment report. While the absolute number of jobs was a bit behind the consensus number, this is a very solid report and continues to demonstrate that the labor market is healing.

Takeaway for the Week

• The equity markets traded around all-time highs this week as the labor markets continue to improve and the uncertainty of the election is behind us

Disclosures