After a strong equity market last year some might have expected stock prices to decline in the first quarter, with news on the U.S. economy becoming much more negative than was expected. Corporate earnings have come under pressure from the impact of the stronger dollar. Capital spending and employment have weakened with the steep drop in the price of oil. Disappointing economic reports for manufacturing, retail sales and home building contributed to the malaise. As a result expectations have been reduced for first quarter GDP to +1.0%. In spite of all of these negative developments, the S&P 500 Index is up slightly year to date, reflecting expectations that most of these disappointing reports are temporary factors, and that growth is expected to resume later this year.
Lackluster markets also reflect investor concerns about the potential impact on the economy and financial markets of the long-delayed Fed interest rate hike that is now expected in June or September. The employment report for March was disappointing, but the number of persons employed is still growing and the unemployment rate is still falling. Fed Chair Yellen continues to have concerns about sluggish wage growth and the decline in the participation rate of the labor force that weighs on the decision to raise the Fed Funds rate. Our long-standing view is that the normalization of interest rates is long overdue, will reflect a stronger economy and should be taken in stride by markets.
Our macroeconomic perspective is that despite the first quarter blip, the economic recovery that has been under way since 2008 has moved on to the expansion phase and that growth looks sustainable over the near-term future. At the present time the risk of the economy falling into recession seems to be very low. The decline in oil prices has hurt the energy sector, impacting capital spending and jobs, but is a positive for the consumer sector and emerging markets.
While corporate profits collapsed in the 2008 recession, they rebounded and rose to a new high in 2014. Since then the decline in the price of oil and the strong dollar have put pressure on corporate profits which fell by 1.6% in the fourth quarter and were 6.4% lower than for the same quarter a year earlier.
This winter’s polar vortex of freezing weather and heavy snowfalls, the worst in 20 years throughout much of the nation, brought housing starts and retail sales to a standstill, even in the south where the winter weather is usually more temperate. With the change in seasons to the warmer spring weather the housing market is getting stronger. New housing starts, pending sales, mortgage applications and financing are all showing signs of strength. We believe that this welcome change in the housing will help lead to an improvement in consumer spending, which accounts for more than 70% of U.S. GDP. When families move to a new home or to an existing home that is new for them, they also go shopping for the numerous items that they will need. Much of this activity has been deferred, but is now likely to continue to increase for years to come.
At current levels stock valuations as a class are somewhat extended on an historical basis. As we see it, some individual issues and sectors have become overvalued, while others still have attractive fundamentals and valuations. We consider stocks, especially large-cap, to be attractive relative to most other asset classes. The prospects for growth in the economy, and earnings, along with continuing low inflation and interest rates create an attractive environment for equities. Price pull-backs of less than 10% and corrections of 10% or more can occur at any time, which we view as opportunities for further investment.
We appreciate the confidence our clients have placed in us to safeguard and grow their investment funds and we wish all a happy, healthy and prosperous year.
Note: We have gathered the information contained in this report from sources we believe reliable; however, we do not guarantee the accuracy or completeness of such information. You should not assume that any discussion or information contained in this market commentary serves as the receipt of or as a substitute for personalized investment advice from Whitnell & Co. No part of this publication may be reproduced in any form, or referred to in any other publication, without express written permission.