Global Investing: The New Normal
As we embark on the third quarter of 2015, happily we leave behind the weather-slowed economy of the first quarter. Consensus expectations for the U.S. economy are pleasantly looking up for the remainder of the year. Consumer confidence is strengthening as evidenced by increased spending on durable goods such as housing and automobiles. Jobless claims, the number of people who claim unemployment benefits for the first time, continue declining albeit with a few bumps along the way.
Real gains in housing are being made for the first time in seven or more years. Consider the fact that the consumer represents nearly seventy percent of the U.S. GDP, therefore, decisive moves to build, sell or buy homes have a marked impact on the economy. Recent reports indicate that housing permits rose to the highest level since August 2008. Home construction rose 14.5% on a year-over-year basis in May with the boost coming from single family home sector. Investment in multi-family homes has cooled recently. Another indicator of the rebound in housing is the NAHB Index rising to 65, its highest level since 2008, demonstrating builders’ confidence.
Inflation appears to be stable as evidenced by Core CPI which is at a 1.7% annualized rate over the past four months, slightly below the Fed’s target 2% rate. While energy prices rose about 4% year to date they remain 16.3% below year ago levels. Adding to the benefit of lower oil prices, the consumer also gained on the wage front. Real average hourly earnings are up a healthy 2.2% in the past twelve months. Reflecting on the two indicators makes us wonder when the Fed will begin raising rates. Consensus expectations still look for a Fed Funds rate increase in the second half of this year.
We believe that the initial rate increase will not squeeze the money supply. Short rates have been so low for such a long time, held artificially low as the economy healed from the financial shocks of 2008. An increase at this point will be a step towards restoring a “normal” rate. Fixed income returns moderated in the period as investors begin to digest the prospect of rising rates. The 10-year Treasury yields 2.35% versus 1.65% at the end of 2014, anticipating the Fed’s next move.
The fixed income markets have continued to demonstrate volatility with a bias towards modestly higher rates. In Japan and the Euro-markets these moves, from very depressed rate levels, have tended to be more about continued reaction to local market monetary policy and concerns over Greece and less a reaction to robust economic growth.
Foreign sovereign bond rates remain at very low levels (France, Germany, Japan, Switzerland, etc.) combined with continued strength of the U.S. dollar, therefore we expect any increase in U.S. interest rates will be limited. In part this will be due to our modest inflation rates and also because if our rates move up too much, foreign investors will expand their purchases of our bonds to obtain the twin benefits of our higher yields and a strong currency.
Within market segments, municipal bonds look especially attractive as concerns about issuers, such as Chicago, State of Illinois and Puerto Rico, have pushed tax exempt rates, relative to taxable bonds, to higher spreads. Thus, even strong municipal credits can be very attractive on an after-tax yield basis.
The stock market continues to float along as the “bull market that investors love to hate”. Underlying fundamentals have improved as companies make capital investments, buy back shares and raise dividends to improve shareholder returns. On the earnings front, S&P 500 earnings are expected to be $120, 6% ahead of 2014’s earnings. Stronger than expected GDP growth, continued low interest rates and contained inflation add to companies’ abilities to grow earnings. We are watching profit margins as they have risen to high levels.
During the quarter ended June 30, 2015, equity markets had lackluster returns as indicated in the chart below.
|Market Indicies (Total Return as of 6/30/2015)
|MSCI World ex-USA**
|MSCI Emerging Markets**
|Source: Bloomberg; *Annualized; **USD
Given the modest inflation outlook, research indicates that stock prices can continue to rise in light of rising interest rates. Volatility has declined since the beginning of the year resulting in the S&P 500 Index trading in a narrow range over the period. The Forward P/E ratio of the S&P 500 is 17.3x; slightly ahead of the 15.7x average Forward P/E over the last 25 years. On an aggregate basis, we believe that valuations do not appear to be extended.
Investors have been net buyers of equity ETFs. The “T.I.N.A.” thesis remains intact as “there is no alternative” to equities in this low rate environment. The 2% dividend yield on stocks is attractive when compared to the 1.6% yield available on a 5-year U.S. Treasury note. In response to the Supreme Court ruling on the Affordable Health Care Act, Healthcare stocks rose 15% on a year-to-date basis. Interest rate sensitive utility stocks fared the worst during the period amidst rising rate concerns.
Boring, but important, is the ruling surrounding the 2008 Federal Government bailout of A.I.G., Inc. The ruling stated “the Board of Governors and the FRB did not have the legal right to become owner of A.I.G. ……”. Although the ruling will most likely be appealed – the message is clear – the Fed’s ability to aid in bailouts in the future will be limited to nonexistent. Companies in trouble under this interpretation will be allowed to fail.
Shifting to foreign markets, there have been mixed results for the period as the European Central Bank and Bank of Japan employ monetary policies to provide stimulus to their sluggish economies. Economic growth in Europe and Japan has begun to pick up which makes developed foreign markets attractive in our view. Emerging Markets are another story. Largely dominated by the slowdown of the Chinese economy, emerging markets struggle to gain traction.
In our opinion, the Greece situation will be volatile and not be a contagion in the region. The impact of a withdrawal from the Euro would not be a huge detraction from the European GDP since Greece’s economy comprises 2% of the total. However, to remove itself from the EU would be a devastating blow to the Greek economy.
The global world of investing is here to stay. As is our tradition, we analyze the investing landscape looking for opportunities where we are rewarded for taking on risk. We appreciate your business and are delighted to be of service to you and yours.
Please contact a member of the Wealth Management Department if you have any questions about this information.
Rich Gartelmann CFP® – (630) 844-5730 firstname.lastname@example.org
Jean Van Keppel CFA® – (630) 906-5489 email@example.com
Brad Johnson CFA®, CFP® – (630) 906-5545 firstname.lastname@example.org
Joel Binder, SVP – (630) 844-6767 email@example.com
Jacqueline Runnberg CFP® – (630) 966-2462 firstname.lastname@example.org
Tamara Wiley, CFP® – (630) 844-3222 email@example.com
Ed Gorenz, VP – (630) 906-5467 firstname.lastname@example.org
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