The latest U.S. economic data has been somewhat mixed. A reasonably strong start to the year relative to investors' expectations gave way to some softness heading to the summer months. Growth concerns bubbled up again during the second quarter 2012 and 'risk-off' remerged as the common attitude across financial markets. While certain indicators have shown signs of weakness in recent months, other statistics are clearly improving. As these headwinds and tailwinds collide, thunder clouds may form occasionally, dampening investor spirits.
However, the overall slow growth trend remains intact and we continue to expect a muted pace of expansion going forward. In recent years, we've often noted that growth may be variable from one period to the next and as a result of this, investor expectations could ebb and flow around the slow growth trend. Amid the current growth scare, perhaps it is useful to take a look at the things that are going right for the U.S. economy, in addition to the areas that are more troublesome. Doing so helps illustrate why we believe growth should persist, albeit slowly.
Examples of things that are going right, or perhaps more accurately, factors that bode well for the economy today include: lower gasoline prices, low interest rates and ongoing improvements in the flow of credit, as well as signs of encouragement in the domestic housing sector.
The average price for a gallon of gas in the U.S. fell to a five month low in June. This gives consumers a little more flexibility in their spending decisions. Falling gasoline prices do not motivate consumers to increase overall spending, but rather allow them to spend on a wider variety of items which is advantageous to economic growth.
Interest rates are low and credit growth is moving at a solid pace. On a year-over-year basis, Commercial and Industrial loans (C&I) are growing at a double digit rate. Meanwhile, consumer lending is expanding at a mid-single digit rate and has quickened in recent months as compared to the same time last year. With regard to housing, progress has been choppy, but the trends in sales of both new and existing homes show improvement. Mortgage rates remain at or near all-time lows and ongoing traction in this aspect of the U.S. economy could become more constructive for growth in the months ahead relative to the soft patch of the past several months.
In contrast, other factors have become more tepid. For example, the slide in equity markets during the second quarter dealt a blow to consumer confidence. The Conference Board's Consumer Confidence Index declined for a fourth consecutive month in June 2012, falling to 62.0 from 64.4 in May. At June's level, consumer confidence is much improved from the lows experienced last fall, but is still generally indicative of weak overall confidence. Consumers are less likely to spend when they are feeling uncomfortable about the economy and this weighs on the potential for growth.
Job creation in the U.S. has also weakened meaningfully since the end of last year. In May, payrolls rose by only 69,000, a distinct slowdown versus the 200,000+ monthly run rate of new job additions witnessed from December through February. Indeed, with the year-over-year change in real disposable personal income hovering below 1%, it's clear that consumers have limited firepower to fuel a substantial near-term pickup in the domestic economy.
U.S. economic growth remains fragile and susceptible to external shocks. A spillover of substantial weakness from Europe, or policy errors in addressing domestic fiscal challenges later this year, may lead to intensifying downward pressure on growth. That being said, growth expectations are generally well grounded today which means that there is also a possibility of upside surprise. Even the softer data are still indicative of growth and we are not seeing signs of excess in the economy. Investor uncertainty has been on the upswing in recent weeks, but as it pertains to the U.S. economy, we believe investors can take comfort in the fact that the slow growth trajectory remains in place.
The Global Economy
The situation in Europe remains very fluid, but recent news that Greece was able to form a functioning coalition government following its second round of parliamentary elections in as many months is an incremental positive. With a pro-European/pro-bailout majority leading the way in Greece, the potential for a near-term Greek exit from the common currency bloc is reduced. That being said, the month or so that Greece spent in limbo did not help it move any closer to rectifying its long-term structural problems, and made the situation perhaps even more challenging. Fortunately, the Eurogroup agreed to disburse the remaining €1bn that was part of a €5.2bn package allotted for Greece after the May elections failed to form a government. This should help Greece avoid larger disruptions to its economic and financial systems in the immediate future as European leaders continue to meet and discuss the best course of action for Greece and the broader Eurozone.
The news out of Greece did not give the markets much of a reprieve from ongoing uncertainty in the region, particularly as other European nations, namely Spain and Italy, continue to come under intensifying pressure. On the bright side, this latest growth scare, with Europe at the center, has pushed equity valuations across the continent to near 20+ year lows. While there is no question that economic growth in the region will remain challenged for the foreseeable future, the weakness is creating attractive buying opportunities for long-term investors in well-positioned, well-diversified European businesses that operate globally.
Beyond Europe, China recently announced a noteworthy policy easing move. The People’s Bank of China lowered its benchmark one year lending rate by a quarter percentage point, bringing it to 6.31%. The one year deposit rate was reduced by the same amount and stands at 3.25%. Markets reacted favorably to the news, interpreting it as a sign that Chinese policymakers will be more active in supporting demand and stabilizing economic growth going forward.
The year-over-year change in domestic headline inflation continued to decelerate in May, falling below 2% for the first time in 16 months. The Consumer Price Index (CPI) rose 1.7% in the twelve months through May, slower than the 2.3% pace recorded in the year through April. Declining gasoline and crude oil prices drove the bulk of the slowdown. Meanwhile, the core CPI, which excludes food and energy components, remained largely flat on a year-over-year basis with the prior month. Core CPI rose about 2.3% over the twelve month period ending in May.
In most other global economies, inflationary pressures remain generally well contained. The rate at which prices are rising across many emerging markets is quicker than in developed markets, but not so much that it is limiting the ability of policymakers to address growth pressures within the global economy. India, however, is a unique example. Economic growth in India has been slowing, but prices continue to move higher at a healthy clip. Still, given the persistence of global headwinds to growth, we do not expect inflation to re-emerge as a primary concern for investors in the near-term.
Weakness in equity markets during June moved our valuation indicators toward a more attractive area of the neutral range, but not enough to signal a strong buying opportunity. Similarly, sentiment has come under pressure and experienced modest declines; however, the level of pessimism we are seeing is not indicative of an ideal time to buy. Economic indicators are leaning toward the riskier side of neutral, meaning that the U.S. economy may be in the latter stage of the cycle, but excesses have not been built up to a point which would suggest future growth is unsustainable. Overall, we continue to advocate an overweight allocation to equities relative to bonds today.
Amid the slow growth environment, we believe an active and flexible investment approach, coupled with a disciplined valuation framework, is the best way for investors to capture absolute returns over the long-term. Subsequent bouts of volatility are likely as economic data ebbs and flows around the slow growth trend, but in our view, investors should continue to focus on well positioned businesses with attractive long-term industry and company-specific fundamentals. Our main goal today is to identify companies with sustainable competitive advantages that are poised to capture non-cyclical growth opportunities in existing or new lines of business, and in both native markets as well as abroad. We believe companies that display these characteristics and can execute effectively in a slow growth global economy should stand out in the long-run.
In fixed income markets, our preference continues to lean toward opportunities we are finding in the corporate sector. Our main focus is on investment-grade corporate bonds, although, we are also employing a selective approach to value opportunities we see in the below investment-grade corporate bond market. With regard to Treasuries, we continue to prefer U.S. Agency (i.e., Fannie Mae, Freddie Mac, Ginnie Mae) mortgage-backed securities over Treasuries.
Analysis: Manning & Napier Advisors, LLC (Manning & Napier).Manning & Napier Advisors, LLC. is governed under the Securities and Exchange Commission as an Investment Advisor under the Investment Advisers Act of 1940.
Sources: ABC News, United States Data Response: Capital Economics, Bureau of Labor Statistics U.S. Department of Labor, Factset, Financial Times, Reuters, ISI: International Strategy & Investment, The Wall Street Journal, Businessweek, Bloomberg.
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