Stocks moved higher in April as investors turned their attention to first quarter earnings season, which thus far has come in significantly ahead of muted expectations. With nearly 75% of S&P 500 companies having reported, first quarter corporate earnings are on track to fall by 0.4%. While this would mark the first year-over-year decline since the third quarter of 2009, consensus expectations as of March were for a much sharper drop of -4.7%. One of the key headwinds contributing to the earnings decline has been the continued strength of the dollar. However, with the dollar having come off of its highs in recent weeks, we believe it is unlikely that currency fluctuations will continue to exert such a negative effect on profits for the remainder of the year.
April’s economic data was largely disappointing, continuing the weakness seen in the first quarter. The initial estimate of first quarter GDP came in at a paltry 0.2%. Industrial production saw its first quarterly decline in over five years, and core capital goods orders fell for the seventh consecutive month in March. However, there was some positive news suggesting the manufacturing sector may soon see more favorable conditions. The Institute for Supply Management’s measure of new orders and production showed healthy gains in April. We think the recent rebound in oil prices and retrenchment of the dollar also should bode well for the sector going forward.
Turning to the labor market, while the March jobs report was notably weak, most other indicators that we track have been robust. Unemployment claims recently hit their lowest level in 15 years, and it appears that wages are moving higher. In addition to recent announcements of wage hikes from several large companies, the employment cost index rose by 2.6% during the first quarter, marking its strongest year-over-year growth rate since 2008. We continue to believe that improving labor conditions will ultimately drive stronger consumer spending, a key cog of the U.S. economy. Lower gas prices on a year-over-year basis should also help in this regard. We note that the personal savings rate was 5.5% for the first quarter, which was the highest level since 2012. We believe that this bodes well for a potential boost in consumption moving forward should consumer spirits be buoyed by an improving job market.
Elsewhere, there was significant news out of China during the month. The country’s central bank cut its reserve rate requirement by 100 basis points, the largest such reduction since 2008. Moreover, it has been reported that policy makers there are considering a program similar to the European Central Bank’s long-term refinancing operation in an attempt to boost lending to certain targeted industries. Should these initiatives successfully stimulate Chinese economic activity, we believe the benefits would reverberate globally.
Our view is that economic growth will pick up as the year progresses, and the Fed will begin its rate tightening campaign. We also believe that it is unlikely that the U.S. dollar can sustain the tear that it has been on in recent months. For these reasons, we are seeking to add exposure to cyclicals and higher interest rate beneficiaries to the portfolio. Consistent with this rationale, we have modestly increased our Energy weightings. We think that the rebound in oil prices is sustainable given recent inventory data that has come in favorable relative to expectations, declining rig counts, and continued Middle East geopolitical instability.
As we look forward, we maintain our guardedly constructive view on the market. We believe that the transitory headwinds which have impacted the economy during the first quarter may soon subside, paving the way for a possible consumer-led recovery during the back half of the year. Moreover, while we do expect that the Fed will begin its tightening campaign at some point this year, we continue to believe that it will do so in a measured manner so as to minimize any potential disruption to capital markets. That being said, we would not be surprised if the uncertainty with regards to the timing of these eventual rate hikes causes some choppiness for stocks. Similarly, we think the continuing Greek bail out negotiations may generate some headline risk and increased volatility. And with markets near all-time highs, we would not be surprised should a mild pull back ensue. Still, our forecast is that stock prices will see modest gains for the year driven by an economic rebound and improving corporate profits.
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