The market had a strong August, with the Russell 3000 returning just over 4% for the month. In our view, positive economic data in the U.S. and heightened expectations for more forceful policy actions by the European Central Bank (ECB) helped to drive stocks higher. These factors mitigated escalating geopolitical tensions in Eastern Europe, allowing stocks to continue to reach new highs.
We are encouraged by recent domestic economic data trends. The estimate for Q2 GDP was revised upwards to 4.2%, indicating that the economy entered the current quarter with solid momentum. Recent measures of both the manufacturing and service sectors appear to support this notion, as both the Institute for Supply Management’s surveys as well as Markit’s purchasing manager indices are at robust levels. There were also positive signs in the labor market. The number of job openings notched a 13 year high, and unemployment claims continue to make new lows for the current expansion. While still stubbornly high, the long term unemployment rate continues to decline, and the decline seems to have accelerated since the beginning of the year. Perhaps related to this, the Conference Board’s measure of consumer sentiment hit a level in August not seen since October 2007.
Source: Bureau of Labor Statistics.
Of course, not all of the data exceeded expectations. The August employment report was weak by any measure, as only 142,000 jobs were created during the month. The market did not seem overly concerned with this, as stocks actually rose on the day of the release. Investors may believe that the data reduces the odds of more hawkish language coming out of the next Federal Reserve meeting. In addition, retail sales were flat in July, missing estimates for modest growth on a month over month basis. The July readings of both personal spending and income growth also came in below forecasts. Still, we were impressed with the preponderance of positive data released during the month, and our overall takeaway is that the economy continues to show signs of improvement.
In Europe, conditions appear less encouraging. The second quarter showed zero GDP growth on a sequential basis, and growth of just 0.7% as compared with the prior year’s period. Moreover, inflation rates are dwindling to dangerous levels, with the latest reading of consumer inflation at a 5 year low of just 0.3%. However, these signs have clearly not gone unnoticed by the ECB. During August, bank President Mario Draghi noted that financial market expectations of future inflation have fallen, and he made it clear that the ECB was ready to take further action to combat deflation should it be necessary.
Draghi made good on these comments at the ECB’s September 4th meeting. The bank’s governing council took several new steps, including a further reduction in interest rates and the announcement of a new asset purchase program. Draghi also noted that the council stands ready to provide more stimulus should conditions warrant. European stocks reacted well to the announcements, as the Euro Stoxx 50 Index closed 1.8% higher on the day. We believe this policy stance has the potential to boost the market, particularly if the ECB follows through on additional measures.
Turning to domestic monetary policy, the Federal Reserve held its annual Economic Policy Symposium in Jackson Hole, Wyoming during the latter part of August. Chairperson Yellen delivered a speech focusing on the U.S. labor market. We wrote last month that while still dovish, we felt that her recent remarks pertaining to monetary policy have been a bit more balanced, and we hold the same view of her speech at Jackson Hole.
For some time now, Yellen has pointed to the number of part-time workers seeking full-time employment as evidence of significant slack in the labor market. While certainly not abandoning that view in this latest speech, she did acknowledge that some of those part-time workers might be prevented from attaining full-time jobs for structural rather than cyclical reasons. Put another way, there now appears to be an open debate at the Fed with regards to the amount of slack in the labor force. This is an important consideration, as it is a key factor in determining the timing and magnitude of rate hikes. That said, we still see monetary policy as decidedly accommodative. Asset purchases, while nearing their end, are still in place for now. We continue to believe that when rate hikes commence, they will be slow and steady and will be capped at lower levels than has been the case historically.
We maintain our constructive outlook on the market. As we have noted previously, we believe that an improving economy, better corporate profits, and an accommodative Federal Reserve should bode well for stocks going forward. We view the domestic economy as the strongest market globally, and our portfolio is positioned to participate should the bull market continue its run. Moreover, we believe that the new easing measures taken by the ECB could have a positive effect on the U.S. market, depending in part on the amount of liquidity created as part of the asset purchase programs. We will have more clarity in this regard when further details are provided at the ECB’s October meeting.
It is our view that the greatest risks to the market presently are geopolitical in nature. During August, tensions seemed to have escalated in the conflict between Russia and Ukraine. While we are monitoring the situation closely, for the time being the conflict appears unlikely to have a material impact on U.S. stocks, particularly as Western powers appear to have little appetite to engage Russia militarily. We view the present level of sanctions as not rigorous enough to create a spillover effect into domestic equity markets – though the same cannot necessarily be said for Europe.
In the Middle East, from a capital markets perspective, we see the main risk as the Islamic State’s potential to disrupt oil production in Iraq. Fortunately it appears that key oil-producing areas in the country remain secure, and recent U.S. airstrikes against the Islamic State seem to have been helpful in thwarting their progress.
At Roosevelt, we continue to scrutinize geopolitical, market, and individual security risks, and maintain the flexibility to adjust portfolios accordingly, in an effort to protect investors’ capital over the long term.
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