Current economic events
Federal Reserve (Fed) Chair Janet Yellen testified in front of the Senate last week and continued to point to recent softness in inflation data as being transitory. Last week’s consumer and producer price indexes both came in below consensus estimates and year-over-year growth is slowing. Modest wage growth and evidence of consumer aversion to debt, in addition to recent weakness in food and energy prices, may be contributing to softer inflation. In our view, the leading indicators of inflation still indicate we should see prices rise modestly. The jobs market is relatively tight, leading to improving wage growth. Commodity prices are low, which should ultimately lead to falling supplies and a recovery in prices, as well.
- Retail sales for June were soft for the second month in a row and are stoking investor concerns of a weak consumer. Wage growth has been slow, but the solid jobs market and easier credit conditions for consumers imply the softness should be transitory.
- Manufacturing and the industrial economy continue to point to solid economic results. June industrial production has risen 2 percent over the past year, reflecting recent gains in purchasing manager surveys. We believe the business sector appears to be on a path of improved spending.
Contributed by: Robert L. Haworth, CFA — Senior Investment Strategy Director
Our outlook remains for equities to trend higher, driven by rising earnings and a slow but growing global economic environment as second quarter earnings releases begin to ramp.
- Earnings are increasing, which is a favorable backdrop for equities. As of July 17, consensus estimates are for second quarter year-over-year revenue and earnings growth of approximately 4 percent and 8 percent, respectively. For 2017, revenue is projected to increase roughly 7 percent, with earnings advancing 11 percent, according to Bloomberg and S&P Global. With valuations elevated (the S&P 500 trades at roughly 21.5 times and 18.5 times trailing 12-month and 2017 estimates, respectively), rising earnings provide valuation support while serving as the basis for stocks to trend higher.
- The global economy is in slow growth mode, without widespread inflation. Recent economic releases continue to reflect a not too hot/not too cold economic environment, which is typically favorable for equities.
There are risks to our constructive outlook, mindful that at some point equities will experience a correction. To a large degree, the margin of error is relatively narrow, with equities arguably priced-to-perfection.
- Consumer spending remains soft.
- Valuations are elevated.
- Policy-related uncertainty and geopolitical tensions may impact the equity market.
Contributed by: Terry D. Sandven — Chief Equity Strategist
Fixed income markets
Bond yields declined last week, largely in response to Yellen’s Semiannual Monetary Policy Report to Congress, in which she noted that the Fed will be carefully monitoring inflation data over the next few months to ensure weak inflation data is indeed transitory. While investors continue to wager on long-dated rates remaining well anchored, we remain underweight fixed income due to the unattractive return potential relative to risks, an improving global economic backdrop and our expectation for moderately higher inflation into year-end.
The European Central Bank (ECB) is expected to reiterate hints of reducing the size of their asset purchase program at this week’s meeting. The ECB Governing Council already noted that while rates are expected “to remain at present levels for an extended period,” deflation risks had “definitely gone” and the risks to growth were now “broadly balanced.” Furthermore, ECB President Mario Draghi has noted that the deflationary forces have begun to turn into reflationary forces and that the ECB would likely “gradually adjust its policy parameters.”
Emerging market debt remains well-bid as capital outflows have been relatively subdued in the first half of 2017. Gradual U.S. monetary policy normalization and a retracement of early U.S. dollar strength have both served to support the sector. Most market factors remain positive, with narrowing current account balances, capital inflows rising and economic data from China exceeding expectations. Year to date, emerging market debt issuance has been comprised of less investment grade quality than has been typical relative to recent years, indicating it is an issuers market. While we remain constructive on the space, particularly local currency issues, deteriorating issuance quality bears watching.
Contributed by: Gregory L. Powell, CFA – Senior Fixed Income Analyst
U.S. dollar weakness provided some support to commodity prices last week, with oil gaining more than 5 percent and gold adding 2 percent. Gold has also been aided by a dovish market view on the latest Senate testimony by Yellen. In our view, solid economic results, coupled with Fed rate increases and rising real (net of inflation) interest rates, mean gold prices remain under pressure into year-end. Oil prices, in the meantime, continue to receive support from speculators seeking a conclusion to the market oversupply condition. Declines in U.S. oil inventories, improved projections of global demand from the International Energy Agency (IEA) and talk of production cuts from Nigeria and Libya have provided the impulse for bullish speculators. In our view, price gains are likely to be muted. Markets remain well supplied, demand growth has been disappointing and there is little evidence of meaningful economic acceleration globally, and U.S. production continues to climb.
Contributed by: Robert L. Haworth, CFA — Senior Investment Strategy Director
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