Stocks rebounded sharply during the latter part of February, erasing losses from earlier in the month and leaving major indices largely unchanged for the period. We believe that investors were heartened by improved economic data out of the U.S., a stabilization of China’s currency, and rising oil and other commodity prices. While we too have incrementally upgraded our market outlook, we see too many potential risk factors to take an outright bullish stance.
Several economic data points out of the U.S. have surpassed consensus expectations in recent weeks. In the consumer space, both personal spending and core retail sales had their largest monthly gains since last spring. Perhaps consumer spirits were lifted by recent advances in average hourly earnings, which in January came in at one of the healthiest levels of the current expansion. Even the manufacturing sector, which has been battered by the strong dollar and depressed oil prices, saw some healthy data releases. Both industrial production and durable goods orders rebounded strongly in January following weak December readings, with the former notching its strongest monthly gain in over 5.5 years. Inflation too may finally be approaching levels targeted by the Federal Reserve after being depressed for much of the last several years. We believe that these readings have helped to alleviate investor concerns over the health of the domestic economy. They also bolster our view that the U.S. will not be entering a recession anytime soon.
Oil prices continued to rebound during the month. We believe that an agreement among several countries to freeze production helped to lift sentiment in the energy markets. While the agreement itself may not be that impactful given high current output levels, we believe that any cooperation among major oil producing nations is supportive of crude oil prices. Moreover, we think the agreement may set the stage for additional countries to freeze output levels and perhaps enter into discussions about implementing actual production cuts.
Bank stocks staged an impressive rally during the latter part of February. They had been hit hard on concerns over deteriorating borrower credits, particularly in the energy and commodity markets, as well as worries about future profitability levels in a flat yield curve environment. In our view, the key catalysts that helped to boost sentiment were Deutsche Bank’s announcement that it will buy back $5.4 billion of its outstanding debt, as well as Jamie Dimon’s personal purchase of roughly $27 million of his company’s stock. We believe that these actions show that insiders have a strong degree of confidence in the health of the banking industry. This is significant as many investors believe that market rallies are difficult to sustain without participation from financial sector stocks, and we therefore think that this group can have a disproportionate impact on overall market sentiment.
We have taken an incrementally more positive outlook on the market in recent weeks. In our view, meaningful declines in both the VIX volatility index and high yield bond spreads are indicative of an improving environment for risk assets. We are also encouraged by the stabilization of China’s yuan, as we viewed the currency’s volatility in recent months as a key risk factor for global capital markets. As noted above, we see healthy signs from the consumer space – and with wages generally firming and home prices continuing to rise, we would not be surprised to see continued strength from this all important sector of the economy. Lastly, we note a significant amount of investor cash on the sidelines which could potentially support stocks going forward.
Yet we do have some concerns which keep us from taking an outright bullish stance. While the stabilization of the yuan has been encouraging, we continue to view stresses out of China as a significant risk factor for equities, and despite the recent spate of better than expected U.S. data, overall global growth remains challenged. Corporate profits have weakened in recent quarters, while stock market valuations remain at levels above historical averages. Finally, as we have noted previously, we remain concerned about the political environment in the U.S., which could make for choppy markets ahead as the election draws nearer. As always, we remain committed to seeking long-term growth through our risk-conscious investment approach.
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