Entering May, market expectations were quite low regarding the potential for a near-term interest rate hike. Following the release of the minutes from the Federal Reserve’s April meeting however, investor sentiment changed markedly in this regard. The minutes revealed that most committee members felt that a rate increase might be appropriate as early as June. They also believed that risks to the U.S. economy from international financial and economic conditions had lessened. Market implied probabilities of a rate hike by June jumped to 34%, up from just 4% prior to the release. Subsequently, Fed Chair Janet Yellen said it would likely be appropriate to raise the Federal Funds rate “in the coming months,” and the odds of an action by July jumped to over 60%. Investor expectations, however, were again whipsawed following the release of the May employment report which showed that only 38,000 jobs had been created, far below the 160,000 that economists had been calling for. This surprisingly weak jobs report called into question the health of the U.S. economy, as well as the Federal Reserve’s appetite to raise rates following such a weak reading of the labor market.
While we were surprised by May’s anemic job growth, we caution against ascribing too much significance to any single data point, particularly an employment number which tends to be subject to meaningful revisions. Moreover, there were headwinds which may have skewed the data last month, including the Verizon strike and unfavorable weather. We therefore continue to see the potential for the economy to pickup following a subpar start to the year, though certainly we would reassess this view should other labor market indicators confirm the weakness seen in May.
In contrast to the weak jobs number, other areas of the economy have fared well of late, particularly in the consumer space. Retail sales grew by 1.3% in April, their best showing in over a year, while personal spending advanced by 1%, the strongest monthly growth rate since August 2009. We have written in the past about our expectation that firming wages and low unemployment should ultimately boost consumption, particularly if increased confidence were to lead to a drop in the savings rate. In this regard, we were pleased to see the savings rate hit a low for the year at 5.4% in May, down from 5.9% in April. Looking more closely into the consumption data, the continued secular shift towards online spending is apparent. April retail sales got a significant boost from the internet/catalog category, which grew by over 10% on a year over year basis, while department store sales declined by nearly 2%. Many apparel retailers appear to be struggling with this dynamic and are likely losing meaningful amounts of market share to online competitors. We view the poor first quarter earnings results from several major apparel companies as further confirmation of this trend. We believe that our client portfolios are well positioned in this regard, as we have limited exposure to the apparel space, while we also hold stakes in companies that we believe to be beneficiaries of this continuing shift as part of our Mobile World theme.
Housing is another area of the economy which has shown strength lately. New home sales jumped 17% in April, easily exceeding consensus expectations, and an index of pending home sales hit its highest level since 2006. We continue to see value in this space and believe that we are well positioned with our Reconstructing Housing theme. Moreover, we note that home prices in many cases have now surpassed prior peak levels. We expect this will bode well for future consumption to the extent that homeowners feel more confident with their financial situation. Should this occur it would be another reason to expect economic activity to pick up.
We currently have a constructive outlook on the market. Certainly risks abound, but we continue to believe that economic growth is poised to accelerate, which should support corporate profits. In recent years, there has been a pronounced seasonality to economic activity which has tended to be weakest during the first quarter. We believe that this may, at least in part, be a result of distortions in the seasonality adjustments used to calculate GDP, and therefore would not be surprised to see a similar pattern play out again this year. In addition, as discussed, we believe that consumption has the potential to drive growth in the quarters ahead should wages continue to firm. In this regard, even the feeble May jobs report contained a silver lining in that wages grew a by solid 2.5% from the year ago period. We also believe that industrial activity may soon strengthen after having been pressured by weakness in the energy sector. Additionally, we note that industrial capital spending tends to correlate with rig counts, the latter of which had been declining consistently due to the collapse in oil prices. In our view, the recent stabilization of the rig count augurs well for future industrial activity.
Risk factors which keep our enthusiasm in check include the U.S. election, which we believe has been, and is likely to continue to be, a source of volatility for capital markets. In the UK, we remain concerned about the market impact should voters elect to exit the European Union. We believe that markets are largely pricing in a favorable outcome, setting up an unfavorable risk-reward dynamic in which a vote to ‘remain’ would have little impact on stocks, but a vote to ‘leave’ could significantly derail them. Therefore, while we do not expect the UK to ultimately exit the EU, we still consider it a potential risk factor and one to keep a close eye on. Finally, we would certainly have to reconsider our optimism regarding the outlook for the domestic economy should the labor market weaken considerably. As noted above, we are not yet changing our forecast based on the weak May jobs number, but if other labor market indicators weaken as well we might be inclined to downgrade our assessment.
Our tone is optimistic, but we remain cognizant of these risks as we continue to seek to preserve and grow purchasing power over time.
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.