Manning & Napier June Newsletter - U.S., Global Economy Analysis
May’s Employment Situation Report showed that non-farm payrolls rose by 165,000 during April, and the monthly gains for March and February were revised higher by a total of 114,000 (February revised to 332,000 and March revised to 138,000). The unemployment rate dipped slightly to a new post-recession low of 7.5%. Details of the report indicate that retail employment advanced 29,000, bringing the average hiring pace in the retail space to 21,000 jobs per month over the past year. Employment in leisure and hospitality also rose by a healthy 43,000 during April. Job gains in these consumer-facing areas dovetails with the reasonably good consumption data we’ve seen during recent weeks and months. The year-over-year growth rate of U.S. retail sales accelerated to 3.7% in April from a 3.0% pace the prior month.
Coincidentally, as the domestic unemployment rate reached a new cycle low during April, two key measures of consumer confidence advanced to post-recession highs the following month. The Thomson Reuters/University of Michigan Consumer Sentiment Index jumped to 84.5 from 76.4 in April and the Conference Board’s Consumer Confidence Index rose to 76.2 from 69.0 the prior month. Sub-components of each index, which reflect consumers’ assessment of current conditions as well as their expectations for the future, both rose relative to April. Among the drivers of an improving consumer mood are rising equity markets, as well as gasoline prices, which have stayed within a tight range near $3.60 per gallon on average nationally during recent months. The burgeoning housing market recovery is also cause for optimism. The 20-city S&P/Case-Shiller home price index increased 10.9% in the year through March. Interestingly, consumers’ attitude has moved higher despite expiration of the payroll tax holiday in January and the advent of the federal sequester in March. That being said, consumer confidence remains low today, as compared to historical non-recessionary periods going back to the early 1980s.
Although they remain above the critical 50 level, which represents the dividing line between expansion and contraction, the ISM manufacturing and non-manufacturing indices declined in April. At 50.7 and 53.1 respectively, both indices are signaling growth, but at a slower pace. Contributing to the fall in the headline manufacturing purchasing managers’ index was a drop in the employment sub-index to 50.2 from 54.2 in March. Indeed, manufacturing employment registered no change in April following a somewhat paltry 2,000 increase in March. The employment sub-component of the non-manufacturing report also declined in April to 52.0 from 53.3. This could be a sign that the 196,000 average monthly hiring pace witnessed through the first four months of the year could decelerate slightly in the near future.
First quarter earnings reports offered another glimpse of the slow economic growth environment facing businesses with operations in the U.S. By late May, after about 95% of S&P 500 companies had released financial results covering the first three months of the year, roughly two-thirds showed bottom-line figures that exceeded consensus forecasts. However, only about 39% beat consensus estimates on the revenue line. A portion of the top-line disappointment is the result of market expectations perhaps getting a little ahead of themselves, but it is also further evidence that companies continue to struggle to grow sales given the weak macro-economy.
On balance, there are some heartening developments taking place in the U.S. economy, but slow growth remains the most likely path from here. Federal Reserve Chairman Bernanke said as much in recent testimony to the Joint Economic Committee in Congress, and signaled that monetary authorities will maintain their accommodative stance for the time being. Bernanke also stated that adjustments to QE would be data dependent. If conditions worsen, the Fed could expand asset purchases just as it could slow the rate of buying if the economy (labor markets in particular) strengthens materially. While market chatter regarding the potential for tapering of QE has been on the rise of late, to us, a near-term reduction in the pace of securities purchases seems unlikely given clear signs of ongoing weakness in the domestic economy, and inflation that remains below the central bank’s 2% target.
Global economic growth remains under pressure. Quarterly readings on the year-over-year growth pace of the Organization for Economic Cooperation and Development‘s (OECD) measure of global GDP have been decelerating since March of last year. That being said, leading economic indicators have modestly improved during recent months, suggesting that the deceleration in growth experienced during the past few years could give way to a more stable economic growth trajectory in the quarters ahead.
The 17-nation Eurozone economy continued to shrink during the first quarter of 2013 as real GDP declined at a -1% year-over-year pace. As compared to the same time a year ago, most individual member nations saw their economies contract through the end of March. Weakness was most pronounced in peripheral nations such as Greece and Portugal, however, the larger European economies of Italy, Spain, and Germany experienced negative real growth on a year-over-year basis as well.
A bit of positive news emerged from Europe recently as the political stalemate in Italy came to an end. Leaders agreed to form a coalition government, and shortly thereafter Prime Minister Enrico Letta laid out a new reform agenda that is biased toward more growth-friendly policy action, as opposed to incrementally more austere policy. Of the reforms Letta proposed, we see his desire to improve electoral law as a key positive. Overall, while it is certainly good news that Italy now has a functioning government in place, we remain cautious on the productivity and sustainability of the grand coalition given the divergent political views within it.
Also in Europe, the ECB cut a key benchmark interest rate to 0.5% in response to incrementally weaker economic data across both the periphery and the core during recent periods. Admittedly, we do not see this rate cut as having any real economic impact in the region given our view that the primary impediments to credit growth are the result of unwillingness among banks to lend rather than unfavorable funding costs. As such, the transmission of the ECB’s loose monetary policy stance is not being felt in key segments of the Eurozone economy.
As a variety of global equity markets have provided very strong returns through the first part of the year, we expect subsequent market performance to be more modest. From an economic perspective, we believe the case for a significant reacceleration of growth today does not appear any more compelling than it was before the start of the recent rally in equity prices. The current rally in equities and other risky assets appear to be largely a liquidity-driven move in valuations rather than a true change in economic fundamentals. At the same time there are few economic excesses which say that the cycle is coming to a close. As such, if sentiment begins to weaken and trigger a pullback in stocks, we would approach it as a buying opportunity. Overall, we continue to prefer equities over bonds, however equity valuations in an absolute sense are neutral at best. In multi-asset class portfolios we are now advocating for neutral to slightly underweight allocations to stocks relative to blended benchmarks.
For clients with a long-term time horizon and a need for growth to meet their investment objectives, we continue to focus on companies that can grow in an otherwise growth challenged global economy. In many cases the companies we find most attractive have a well-established presence in regions, sectors, or industries that are expected to expand at a pace that is multiple times quicker than the broader economy, and are trading at attractive valuations relative to that growth potential. In our view, reinvestment rate risk is the main challenge facing such investors today, and long-term investors who maintain large exposures to traditionally “safe” investments are unlikely to earn absolute returns that are sufficient to meet their investment objectives.
For fixed income investors and investors with a shorter time horizon or current income needs, our focus in bond markets is centered on spread sectors (i.e., fixed income securities that trade at attractive yield spreads relative to a similar maturity Treasury). In particular, we’re seeing opportunities in investment-grade corporate bonds, however, a selective approach to the below investment-grade corporate space is helping us find value there as well. We continue to hold an unfavorable view of U.S. Treasuries, as yields hover around historic lows. In our view, short-term and income-oriented investors should also explore equities that display stable fundamentals and are trading at attractive valuations. We believe companies that generate strong, stable cash flows, and pay an attractive dividend could be compelling options for these types of investors in the current environment.
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: Bureau of Labor Statistics, FactSet, Yahoo! Finance, Capital Economics, The Conference Board, GasBuddy.com, ISM (Institute for Supply Management), Market Watch, ISI (International Strategy & Investment), Board of Governors of the Federal Reserve System, Financial Times, Bloomberg.
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