A decent start to first quarter earnings season, oil’s continuing rebound, and positive economic data out of China appeared to boost investor sentiment during April, enabling stocks to generate modest gains for the month. While we maintain a neutral outlook on the market, we are bullish on certain areas including cyclical and value stocks. That said, political concerns keep our enthusiasm in check for the market at large.
With over half of S&P 500 companies having reported first quarter results, aggregate profits appear to be headed for a year over year decline for the third consecutive quarter. However, with expectations having been set very low, we believe that the results have by and large been satisfactory. In our view, management comments about business conditions have been generally positive, and suggest that the heightened financial market volatility earlier in the year may have been overdone.
We also suspect that the earnings picture will improve as the year progresses, and aggregate S&P 500 earnings estimates have inched up in recent weeks, moving from just shy of $120 to slightly over $122 for the current year. We anticipate the dollar’s recent decline and oil’s rebound should bode well for many U.S. corporations. With regards to the latter, the steep decline in oil prices in recent years has led to a drastic falloff in energy-related capital expenditures, putting immense pressure on the profits of companies which rely on them. However, with crude prices having firmed and drilling rigs already down nearly 80% from prior peaks, we expect that the worst is likely behind them for these companies.
U.S. oil futures rose 20% during April and have now bounced approximately 75% from their February lows, with these gains coming despite the breakdown in talks over a potential coordinated production freeze. We view this rebound as quite encouraging for the market as it has eased concerns over the possibility of widespread energy sector debt defaults, and the banking sector stresses that would likely have accompanied them. Looking forward, we note that the International Energy Agency recently updated its forecast and now believes that supply and demand will be in balance by early next year, if not sooner. Underpinning this projection is the expectation that non-OPEC production will fall by nearly 700,000 barrels per day this year, led by a significant falloff in U.S. shale production. Investors had been concerned that the recent escalation in prices might lead to a sharp ramp up in production, exacerbating the current oversupplied condition. However, a key takeaway of ours from Q1 earnings season is that most energy companies are still looking for meaningfully higher prices before they would consider production increases, and would likely take several months to implement them.
In China, economic data released over the last several weeks has been encouraging. The country’s manufacturing purchasing managers index has moved back into expansionary territory, and its forward looking new orders component is at levels which imply that further strengthening is likely. Exports jumped 11% in March, marking the first positive year-over-year growth rate in nine months. As well, recent readings on industrial production, fixed asset investment, and retail sales have all come in at levels above consensus expectations. Given that China’s growth slowdown has been a key concern for markets worldwide, we believe that these healthy indicators, despite being only a few months of positive data, have helped to boost investor sentiment.
We continue to hold a balanced view on the market. Positive factors, as noted above, include the rally in oil prices which has relieved pressure in certain areas of the economy. We are also encouraged by the recent weakness in the dollar, which should at least partially diminish what has been a significant headwind for U.S. based multinational corporations. In Europe, GDP growth accelerated materially during the first quarter to an annualized rate of 2.2%, nearly double the pace of the fourth quarter. It appears that the ECB’s stimulus measures may be gaining traction, as banks increased their lending to Eurozone businesses by 1.1% in March, the strongest increase since 2011, and loans to households grew by 1.6%, which also marked a multi-year best.
In our view, a weaker dollar, improving economic growth in China and Europe, and highly accommodative central banks are likely to benefit cyclical and value stocks. From a valuation perspective this cohort has been trading at what we would consider to be a significant discount compared to growth stocks, the magnitude of which is typically only seen during recessions. While this valuation discount has narrowed in recent weeks, we believe that there is likely still upside for the group.
Despite our bullish stance on certain market areas, our overall equity outlook remains balanced as there are several risk factors which concern us. We continue to believe that the U.S. election will add to market volatility and may impact the real economy as well. Anecdotally, we are already hearing from companies that certain business activities are being negatively impacted by the election’s inherent uncertainty. Similarly, we believe that uncertainty pertaining to the United Kingdom’s potential exit from the European Union is pressuring economic growth in the country, and may have wider implications as well. Finally, while we are encouraged by the recent spate of economic data out of China, it is too early to say that a definitive inflection point has been reached. Moreover, it is likely that a goodly portion of the strength may be explained by recent fiscal stimulus initiatives, which could exacerbate the country’s structural issues of excess capacity and rising levels of corporate liabilities.
As always, we remain committed to seeking long-term growth through our risk-conscious investment approach.
This information is intended solely to report on investment strategies and opportunities identified by Roosevelt. Opinions and estimates offered constitute our judgment and are subject to change without notice, as are statements of financial market trends, which are based on current market conditions. This material is not intended as an offer or solicitation to buy, hold or sell any financial instrument. References to specific securities and their issuers are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Please contact us at 646-452-6700 if there is any change in your financial situation, needs, goals or objectives, or if you wish to initiate any restrictions on the management of the account or modify existing restrictions, or if you would like to request a copy of our Code of Ethics. Our current disclosure statement is set forth on our Form ADV Part II, available for your review upon request, and on our website, www.rooseveltinvestments.com.