Weekly Update: Where do you suppose we'll go from here?
As I write this morning, the market is rallying but opened the day up only a point from where it ended 2013. A third of the stocks in the S&P 500 are at new 20-day lows, and a lot of data on the economy is mixed. Manufacturing, employment, housing have all disappointed but the weather gets a lot of blame (see below). China has disappointed as well, but there are signs authorities there are ready to intervene to keep growth going (see below). Inflation and inflation expectations remain well contained and fear gauges remain low, yet investors clearly have made a shift toward more defensive assets such as utilities and staples. This is confusing, and has a lot of people wondering, “Where do we go from here?’’ Many are counting on spring. Many are wondering about China—oh, and Putin, of course. So what do we know? For one, market returns in this first quarter have been underwhelming compared to each of the past four years. Indeed, in the first quarters of 2010 through 2013, the market was up 4.8%, 5.5%, 12% and 10% respectively. While the economy today is much improved from those years, it is also less volatile. Many of those strong Q1 rallies were on the back of large corrections in the prior quarters.
We also know the biggest sell-offs of late have been in biotech, Internet and small-cap stocks, all of which represent high beta, high “risk-on’’ market sectors that went parabolic last year. While their recent correction could be signaling the beginning of the end to this bull market, Yardeni Research says it’s more likely this is another in a string of internal mini-corrections associated with money coming out of risk-on stocks and into risk-off stocks. In this latest case, it seems to be moving from high to low P/E stocks. As the equity markets continue to churn at or just below their 2013 highs, RBC says the more important technical story continues to be that of a rapid rotation from Growth leadership to Value laggards. This rotation is tracking the bear flattening in the U.S. yield curve on expectations tightening is in the wings. Renaissance Macro says this rotation out of riskier assets over the last week also can be seen in IPOs, whose relative performance to the S&P is now at a 65-day low. These are indications of less willingness to take on risk and usually coincide with deteriorating credit, which we are not seeing yet as the BBB spread to Treasuries made a new low this week!
The thing is, one of the biggest “risk-on’’ asset classes, the emerging markets, are on a tear. Does it make common sense that the S&P may suffer a significant correction when the emerging markets are rallying? And does it make sense that a broad sell-off is in the offing when there are signs the domestic economy is on the verge of accelerating and China is sending out reassuring signals? ISI notes its proprietary surveys on employment, trucking activity and capex are all signaling stronger growth, and that household formations are so low that the only move is up as all those millennials start to move out of mom and dad’s basement. This would provide a significant tailwind for housing. This week’s upward revision to fourth-quarter GDP to a 2.6% annual rate was driven by higher consumption and fixed investment, and after-tax corporate profits rose 8% on the year, pushing their share of GDP to their highest in two years. None of this is indicative of a market in distress. So, where do you suppose we’ll go from here? Market melt-up?
All roads lead to jobs Initial jobless claims unexpectedly fell by 10,000 in the week ended March 22, pushing the four-week average to 318,000—its lowest reading since computer issues artificially lowered claims in September of last year. This suggests next week's print on March nonfarm jobs could surprise to the upside and could give us the +200K print that would solidify our view on accelerating growth and higher earnings. ISI also notes the number of Americans desiring to work full time but only able to work part time continues to fall, though at 5%, it's still high on a historical basis and only slightly lower than the pre-Great Recession peak reached in 1982.
Confidence turns with the weather While consumer confidence has been volatile in recent years, it has improved significantly from the levels seen during the recession. The volatility in the Conference Board’s headline index has been driven largely by swings in the expectations component, while current conditions have been steadily grinding higher since the start of 2011, with the overall gauge rebounding in March to its highest level since January 2008. Michigan’s consumer sentiment gauge has been following a similar pattern, as this morning’s final take on March showed sentiment rising a tad from the initial read, held back by declining expectations while the current conditions component was very robust. This indicates consumer confidence should move broadly upward in the coming months as housing and labor markets continue to improve, helping unleash pent-up demand. February consumer spending, which rose at its fastest pace since November, and personal income, which also rose 0.3%, fits with this view.
Regional capex surging The 6-month outlook on capital expenditures from the Richmond Fed’s March survey jumped 9 points to 18, echoing the surge in the New York Empire and Philly Fed surveys, which advanced 14 and 11 points, respectively, to 16.5 and 31.3. This corroborates our view that pent-up demand is being released this year, despite soft readings on actual activity (see below) during the weatherworn winter months.
Housing looks to spring After steadily moving higher through the middle of last year, new home sales have leveled—they fell 3.3% in February—amid the headwinds of higher mortgage rates and bad weather. February pending home sales also fell more than expected and for the eighth straight month. Prices continue to rise, with the Case-Shiller and FHFA indices reaching levels last seen in 2008. The good news is the sales decline and price increases appear to be stabilizing, banks are loosening standards, loans for residential construction are picking up and mortgage rates have steadied—events that could aid buyers and builders as the market enters a seasonally strong period.
Factories look to spring Durable goods orders ex-transportation rose just 0.2% in February and year-over-year were up the least since April 2013. The Richmond Fed's March manufacturing gauge also fell, while Markit's flash PMI for the month slipped though it still remained firmly in expansionary territory. This is indicative of a manufacturing sector that has lost momentum since the early stages of the recovery and was hit particularly hard this past winter. However, the Kansas City Fed’s regional manufacturing gauge perked up this month, and within the durable goods report, the relative softness in core shipments was more than offset by strength in inventories, which over the past three months advanced at their strongest pace in 2 ½ years. Order backlogs also are at a record high, indicating production should continue to expand and potentially accelerate when the weather turns.
All eyes on China Its PMI is now down month-over-month, year-over-year and has slipped below 50, signaling economic contraction. However, Chinese authorities have indicated they’re readying stimulus measures to ensure GDP growth remains at 7% or higher, a pronouncement that has helped to rally emerging-market equities and ease worries about a hard landing.
Empathy can be profitable Human qualities, including an understanding of individual needs, are highly valued by high-net-worth investors younger than 40, according to a study by SEI Investments, Scorpio Partnership and NPG Wealth Management. Financial advisers' personal attention is more important to wealthy clients than online services, the study says.
Corporate balance sheets are in really good shape The overall funding ratio of the 100 biggest corporate pension plans in the U.S. has reached 89% this year, up from 73% last year, according to consultancy Towers Watson. Twenty-two plans had a funding surplus in 2013, the most since 2007.
Two good reasons to get—and stay—married A report from the U.S. Government Accountability Office suggests single people older than 65 are significantly more likely to fall below the poverty line than married people. Also 71% of households headed by a married couple with one partner age 50-64 have a retirement account, with a median balance of $122,560, while only 48% of households headed by single woman age 50-64 have retirement savings, with a median balance of $32,800.