Stocks were largely unchanged in November, as the S&P 500 advanced just 0.3%. Signs of weakness emerged in the consumer space and several retailers reported discouraging third quarter earnings. However, with wages on the rise and energy prices slumping, we would not be surprised if consumption picks up in the months ahead. In early December the European Central Bank (ECB) disappointed investors with its expanded stimulus program, but in our view the market weakness that ensued was simply a knee jerk reaction resulting from lofty expectations.
The ECB’s measures include a reduction of the deposit rate to -0.3%, an extension of asset purchases for at least an additional 6 months, and a widening of the pool of securities eligible for purchase to include local and regional government bonds. Investors were underwhelmed by the announcement, as seen when stocks weakened and the euro strengthened considerably. Specifically, the Euro Stocks 600 index declined by over 3% on the day, and the euro saw its largest appreciation versus the dollar since 2009. However, we are not overly concerned with the negative capital market reaction. We believe this decline was largely a function of grand expectations and crowded bets against the euro, and will likely be short lived. Moreover, we also think it is possible that ECB President Mario Draghi held back to a certain extent because of the increased probability that the Fed will hike rates later this month. A Fed hike would likely weaken the euro, which would effectively act as a further easing of European monetary policy.
In the U.S., consumption-related data has weakened of late. October retail sales growth came in at a modest +0.1%, missing consensus expectations for +0.3%. In addition, several apparel retailers reported very weak third quarter earnings. However, we believe that certain one-time factors may have negatively impacted the retail space. Many companies cited unfavorable weather which hurt their Q3 results, and it appears that the sector has been dealing with an inventory imbalance which has pressured the business environment. Our view is that these headwinds are unlikely to persist. The strong dollar has been problematic as well, and we believe it has negatively impacted tourism and the spending habits of foreign visitors. However, with the Federal Reserve cognizant of the drag which a strong currency can exert on growth and inflation, and a tepid economic environment, the dollar is unlikely in our view to sustain its recent pace of appreciation. Moreover, we believe conditions may be in place for an improvement in consumer spending in the months ahead. Employment data has been robust over the last couple of months, and October saw an increase of 298,000 nonfarm payrolls, far and away the strongest month of the year. This was followed up by a solid November during which an additional 211,000 jobs were created. Wages too appear to be firming. October’s 2.5% year over year increase in average hourly earnings was the strongest gain since 2009, and for the third quarter overall, compensation growth of 3.4% was the best result in six years.
As we look forward, we are optimistic that stocks can close out the year on a positive note, though beyond that our view is more balanced. Historically, the market has tended to fare well in December, and this is particularly true during the third year of a presidential cycle. A few factors, however, give us pause from taking too bullish a stance on 2016. Given the persistence of below-trend economic growth both globally and here in the U.S., we do not expect that next year will be a strong one for corporate earnings growth. Moreover, while a tightening labor market and rising wages are certainly positive for the consumer, we expect that these circumstances could pressure corporate margins in what is already a challenging top line environment. If this is true, Wall Street estimates for profit growth next year may be too optimistic.
Despite this potential headwind, there are several factors which keep us from taking an outright negative stance. The market has been quite resilient this year despite numerous macroeconomic, geopolitical, and terror-related events. We see this resiliency as a positive sign moving forward. In addition, while it appears likely that the Fed will begin its tightening campaign, the market has had a long time to digest this shift and we expect that rates will remain low by historical standards for some time. Therefore, we still view monetary policy as quite accommodative. Indeed, Fed Chair Janet Yellen has noted on several occasions that she expects the pace of interest rate hikes to be rather deliberate. Finally, while we have a muted expectation for overall corporate profits moving forward, short of a further collapse in oil prices the energy sector could see a significant improvement in growth next year. As this group was the market’s largest drag on earnings in 2015, a stabilization of its profit profile should be supportive of stocks in our view.
While our sentiment remains positive through the end of the year, our view beyond that is uncertain. As always, we remain committed to applying our risk-conscious investment approach in seeking long-term growth.
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