Investors had much to consider in the first month of 2015, with a number of big price changes occurring simultaneously across different areas of the market. Numerous central banks took policy actions, the 10-year Treasury yield dramatically declined, the U.S. dollar continued to strengthen, oil continued its plunge, and other commodity prices declined as well. We see an increasing divergence between the U.S. and international economies, and view these price moves as the global market’s attempt to deal with this period of uncertainty. While U.S. stocks ended January with declines of approximately 3%, we remain positive on the market and expect the domestic economy to continue to outperform many of its global peers over the course of the year.
Perhaps the most significant event of the month was the European Central Bank’s (ECB) announcement of its quantitative easing program. The bank’s officials had telegraphed this for some time, but it remained to be seen whether the program’s details would meet investors’ growing expectations. Thus far it appears that it has, as European stocks jumped nearly 2% on the day of the announcement, and have continued to move higher, while many European sovereign bonds saw their yields approach record lows. The plan calls for 60 billion euros per month in asset purchases consisting of both public and private sector debt across the maturity curve. It is expected to last through September 2016, but is open-ended in so far as purchases may persist beyond that date if the bank’s officials remain unsatisfied with economic conditions.
The ECB was far from the only central bank active during January. Both Canada and India surprised markets with unexpected rate reductions, and the Danish central bank cut its rate twice in one week. Singapore also took steps to ease monetary conditions. Most banks cited lackluster growth and/or falling inflation readings as an explanation for their actions. In this global environment of slow growth, we expect that some countries will seek to weaken their currencies as a competitive advantage.
In contrast, in terms of domestic monetary policy, the Federal Reserve has reduced its accommodative stance and is moving in the direction of raising rates, though investors continue to debate the timing of the first rate hike, as well as the forward path of interest rates beyond that. This divergence in the behaviors of global policy makers is reflective of contrasts in underlying economic performance. The global economy remains challenged, while the domestic economy continues to progress. In the U.S., consumer sentiment again reached multi-year highs in January, and the labor market continued to strengthen. Retail sales, while optically disappointing with a 0.9% drop in December, were actually quite strong in our view; removing the weakness in gasoline (a net positive for consumers) and accounting for seasonal adjustments, sales rose by a healthy 5.3% clip on a year over year basis.
Weakness abroad can be seen in the recent behavior of commodity prices. Oil continued its decline in January, falling 15% for the month, while copper dropped by 13%. There are certainly supply factors contributing to these declines, but with slowdowns in China, Europe, and Japan, falling global demand is playing a key role. Weak commodity prices typically conjure the specter of deflation, and this has played into the appeal of U.S. debt as a safe haven for investors. Increased demand puts downward pressure on the 10 year Treasury yield, and we saw a relatively large monthly yield decline in January.
Another consequence of these divergences is an appreciating dollar relative to other currencies, which has started to negatively impact the earnings performance of U.S. multinational companies. This had been a concern of ours in recent months, so we had proactively reduced exposure to these types of companies and added to more U.S.-centric names.
One area of the economy that we are particularly focused on, given our exposure to the space, is the housing market. We are enthusiastic about recently released housing data. In December, both single family starts and permits reached new highs for the current expansion. New home sales and mortgage applications were robust as well, and we believe there is a surge of refinancing activity occurring. There was also news on the regulatory front, with the government recently reducing premiums charged for FHA mortgage insurance. We believe that this will help to stimulate the market, and we generally remain upbeat on housing’s prospects going forward.
We maintain our constructive view on the market. We continue to expect solid domestic economic growth, driven by lower energy prices and a firming labor market. We believe that this scenario should bode well for corporate earnings and ultimately stock prices.
That said, we expected to see heightened volatility during the year, and that is proving to be the case. We have started to see investors take a more discriminating tone this earnings season, as companies with strong earnings are rewarded, and those that do not meet expectations are punished. This is the type of environment we prefer as stock pickers, but it does tend to be accompanied by increased volatility.
Risk factors going forward primarily include the aforementioned weakness in many major foreign economies and the potential for difficulties abroad to impact the domestic economy. In this regard, we believe that recent moves by many central banks, particularly the ECB’s new quantitative easing program, may help to mitigate these issues. While the Federal Reserve is moving in a different direction, it’s important to note that the total amount of QE globally has not declined. There continues to be a lot of liquidity in the financial system, and as we see the U.S. as the best positioned country globally, we anticipate benefitting.
Another potential source of volatility is the negotiation between Greece’s new coalition government and its creditors. While there appears to be a meaningful gap between the two sides, we do not expect the issues to have a major impact on capital markets elsewhere. The situation today is very different compared to a few years ago when Greece’s financial issues initially threatened to rattle global markets. Most major banks have dramatically cut their exposure to the country, and the Eurozone now has the European Stability Mechanism (ESM) in place, which is designed to act as a firewall by providing financial assistance to member countries in need. At this point, our view is that there will not be a meaningful spillover effect from these negotiations, and note that while Greek stocks have tumbled following the election, other markets have been relatively stable.
Overall, our belief is that domestic tailwinds will continue to push stocks higher, albeit not necessarily in a linear fashion.
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