Stocks showed resiliency during April as the market was able to generate modest gains despite some disappointing economic and inflation data. Sentiment was buoyed by healthy corporate earnings and a favorable outcome from the French presidential election. Overall, we continue to expect a pick-up in economic growth, and we maintain a positive outlook on corporate profits and the market at large.
In the US, economic activity decelerated during the first quarter, with GDP growth coming in at a paltry 0.7%. Consumer spending was a drag during this period, as it increased at an annualized rate of just 0.3%, its worst showing since 2009. More recent data has also been mixed. Surveys of the manufacturing and service sectors have declined in recent months, though they remain at levels consistent with positive economic growth. Perhaps most disconcerting to investors was the weakening in consumer prices during March. Both core CPI as well as the Fed’s preferred inflation gauge (the core price index for personal consumer expenditures) saw monthly declines for the first time in several years. Deflationary environments are typically indicative of fragile economies, and often result in falling stock prices.
The uneven data notwithstanding, we do see reasons to believe that economic activity will reaccelerate. While consumption stalled during the first quarter, it appears that temporary factors, including delayed tax returns and unusually warm weather, may have played a role. Moreover, with the unemployment rate at 4.5%, and measures of consumer confidence still at high levels, we think it is likely that the consumer will bounce back from the weak first quarter showing. As well, there were positive signs from the GDP release. In particular, a measure of capital expenditures advanced by 9.4% during the period. We view this as a strong result which may bode well for future business investment. Finally, we note that over the last several years apparent issues with seasonal adjustments have resulted in consistently weak first quarters. The past eight years have seen Q1 GDP growth of just 1% on average. Subsequent quarters have accelerated to 2.3% growth, and we think it is likely that the current year will follow a similar pattern.
In contrast with the mixed economic data, corporate earnings for the first quarter are coming in at healthy levels. As of this writing, with approximately 60% of S&P 500 companies having reported, earnings are on pace for a 12.5% advance. Corporate guidance also appears quite healthy. The number of companies providing guidance ahead of expectations has outpaced those whose forecasts have missed consensus estimates, which has typically not been the case. This surprise to the upside has resulted in many analysts raising their earnings estimates for the year. We view this positive guidance as a healthy indicator of corporate sentiment, and it gives us more comfort that economic conditions will likely pick-up over the near-term.
The European economy continues to show signs of improvement. The European Commission’s Economic Sentiment Indicator, a measure which aggregates both corporate and consumer confidence, recently reached its highest level in nearly 10 years. Purchasing manager surveys of both the manufacturing and service sectors are also coming in at healthy levels consistent with positive economic expansion. In addition, political risk factors appear to have lessened. Markets reacted quite well to the initial round of France’s presidential election in which Emmanuel Macron and Marine Le Pen garnered the most votes. Macron subsequently won the election in the second round of voting over this past weekend. These results seemed to reassure investors, as Macron was considered the favorite over populist candidate Le Pen and his victory dramatically reduced the potential for France to exit the European Union. We also believe that Macron’s desire to deregulate the labor market and work more closely with the rest of Europe could support the French economy.
We continue to hold a positive outlook on the market. As noted, we expect economic growth to accelerate in the second quarter and beyond. We also expect that a strengthening European economy may give a further boost to US based multinationals. In this regard, we began the year with concerns about Europe’s political environment as a potential risk factor for US stocks, particularly given the populist wave which appeared to have been strengthening. However, following market-friendly election results in France and the Netherlands, and healthy economic momentum, we now see the potential for the region to positively contribute to global business activity. Should that happen, it would represent a key inflection point, as Europe has been a drag on global economic growth for much of the last several years.
In terms of potential risk factors, we are currently monitoring Fed policy developments. The Federal Open Market Committee (FOMC) currently expects to hike interest rates twice more over the course of the year, and may also begin the process of reducing its balance sheet. Given our expectation for the economy to accelerate following a weak first quarter, the Fed’s projections appear reasonable. The risk, however, is if the economy fails to pickup steam, and the FOMC nevertheless continues with its plan to tighten monetary conditions. While we would expect this scenario to result in pronounced stock market weakness, we are heartened by the Fed’s recent history in which it has adapted well to changing economic conditions. While Fed forecasts have consistently overestimated economic growth in recent years, the central bank, true to its data-dependent mantra, has prudently responded by slowing the pace of its planned rate hikes. We would expect the Fed to do the same this year should a similar scenario unfold.
We are also keeping a close eye on trade, and specifically whether the new administration’s nationalistic bend will lead to curtailed international commerce. There have been signs of this already, including the recently enacted tariff on Canadian lumber imports. President Trump has also ordered an investigation into the steel industry which could result in more tariffs being imposed. Finally, it remains unclear how the administration will handle NAFTA negotiations. The President came out strongly against the trade agreement during the campaign, though most recently he indicated that he would attempt to renegotiate the deal instead of terminating it outright. Overall, initial policy steps with respect to trade appear more moderate than the campaign rhetoric, which gives us some confidence in this area.
As always, we will continue to monitor risks as we seek to protect and grow capital over the long term.
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