Easy Money

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RalphCole_032_web_

by Ralph Cole, CFA
Executive Vice President of Research

The global economic expansion continues to run at very different speeds around the world. However, the common thread among most all developed economies has been easy money. Today, China joined the party by lowering interest rates for the first time since 2012. The reasons for lower rates has been stubbornly slow growth, and as long as inflation remains low, central banks can feel confident in their choice to stimulate their economies.

Markets were also buoyed this week by dovish comments out of the European Central Bank. With most European economies mired in little to no growth, and the ECB has embarked on its own version of quantitative easing (QE). Mario Draghi hinted in a speech yesterday that their asset-buying program could expand if necessary. The lack of economic growth in Europe can at least be partially explained by Draghi’s habit of speaking about, rather than actually enacting, central bank policy. In Texas, they would call this “all hat and no cattle”.

Thrift Shop

This week just about wrapped up earnings season for retail companies. Earnings were basically strong across the board for retailers from Dollar Tree and Target to Foot Locker and Best Buy. We believe retailers and consumers are starting to feel the benefits of lower prices at the gas pump. Lower gas prices often coincide with higher consumer confidence numbers, which in turn leads to increased consumer spending.

What makes the retail industry so interesting is the plethora of stores from which shoppers have to choose. I don’t think any of us would argue that we aren’t over-retailed in the U.S. This abundance is one reason we don’t see much inflation. Despite a zero percent interest rate policy and a massive expansion of the Fed’s balance sheet, inflation is not yet finding its way onto store shelves. Competition for the consumer’s discretionary dollar remains fierce. Case in point: the phenomenon of Black Friday sales moving earlier into our Thanksgiving holiday week.

Our Takeaways from the Week

  • Global markets continue to respond positively to easy money policies around the world
  • Lower gas prices should lead to positive sales for retailers this Holiday season
  • Have a Happy Thanksgiving and travel safely

Disclosures

Notably Accomplished

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by Shawn Narancich, CFA
Executive Vice President of Research

Onward and Upward

As the sun sets on another round of quarterly earnings that again proved the ability of companies to stay ahead of expectations, investors are left to observe that the “mini-correction” stocks experienced a month ago proved to be a fleeting buying opportunity. With just a small handful of retailers left to report, blue-chip stocks at record levels are in part a reflection of corporate America’s winning scorecard for the quarter, one in which S&P 500 companies produced sales growth of 4 percent that combined with better margins and share buybacks to generate high single-digit earnings gains. Not bad for a quarter where many feared that a suddenly stronger dollar would wreak havoc with so many blue-chip companies doing business overseas.

Puts and Takes

Topping the list of key themes we’ve observed over the past month’s reporting season is a stronger U.S. economy that companies are seeing juxtaposed against incrementally weaker economic conditions in Europe and slower growth from China. The stronger dollar is a by-product of a globally decoupled economy. But while it creates challenges for multinationals translating earnings from countries using the weaker euro and yen, it has had a silver lining for the American consumer. The comparative strength of the U.S. dollar has coincided with lower commodity prices in general and oil prices in particular. Each one-cent-decline in fuel prices at the pump boosts consumers’ disposable income by $1 billion, providing a major boost to household budgets ahead of the holiday selling season.

Ka-Ching!

Investors got their first glimpse into how this dynamic might play out with Macy’s kicking off the third quarter reporting season for retailers with mixed results. The company delivered earnings above expectations, but on disappointing same-store sales that fell in the period. Despite management lowering earnings expectations, investors bid the stock higher, perhaps acknowledging Macy’s solid track record of expense controls, capital returns and the stock’s undemanding valuation. Whether the twin tailwinds of lower energy prices and a strengthening job market will fuel better holiday sales of the apparel, accessories and footwear that Macy’s sells is open to debate, but our bet is that Americans will spend their newfound income; it might just be that what they’re after turns out to be new gaming consoles, smartphones and SUVs!

Rocket Science

Finally, we would be remiss to deny recognition of Europe’s impressive accomplishment of a space mission this week that, for the first time ever, landed a space probe on a comet. If only a continent with the bright minds required to pull off such a feat could realize and act upon the knowledge that its stagnant economy and accompanying 12 percent unemployment rate aren’t fixable by monetary policy alone. ECB leader Mario Draghi knows that newly enacted European style QE by itself won’t pull Europe out of its funk—only labor market reforms, a more competitive tax system, and lower power prices can pull off that deft landing.

Our Takeaways from the Week

  • With all but the last few retailers yet to report, corporate America has delivered another solid quarter of earnings that have helped push stocks to record highs
  • Tailwinds for the American consumer should result in healthy levels of holiday spending

Disclosures

Putting It All Behind Us

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Furgeson Wellman

by Brad Houle, CFA
Executive Vice President

More than anything, the financial markets dislike uncertainty and the most recent source of angst was the election. With the mid-term elections behind us, the market participants are free to focus on economic data and not political minutia. One of our research partners, Cornerstone Macro, published a great summary of likely legislative change and probable market impact from the change in control of the U.S. Senate.

election chart

The European Central Bank (ECB) met this week and the takeaway from their meeting is the ECB is still poised to take extraordinary measures to keep the Eurozone economy from lapsing into a recession and possible deflation. Mario Draghi, the ECB president, reiterated the ECB’s commitment to do whatever it takes to keep Europe’s economy staggering forward. He did not go so far as to announce quantitative easing which just ended in the United States. The ECB has been doing some bond buying on a smaller scale and keeping the possibility of a large scale quantitative easing program on the back burner in the event the European economy goes from bad to worse.

The employment data for the month of October was released today. The unemployment rate declined to 5.8 percent and nonfarm payrolls increased 214,000 jobs. In addition, there was a 31,000 revision to the September employment report. While the absolute number of jobs was a bit behind the consensus number, this is a very solid report and continues to demonstrate that the labor market is healing.

Takeaway for the Week

  • The equity markets traded around all-time highs this week as the labor markets continue to improve and the uncertainty of the election is behind us

Disclosures

Exit Stage Left

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Jason Norris of Ferguson Wellman

by Jason Norris, CFA
Executive Vice President of Research

Exit Stage Left
Wednesday’s release of The Federal Reserve’s meeting minutes raised more of a hawkish tone. On the surface, the minutes may be viewed as negative; however, due to an improving labor market and an indication of a better growth environment we would welcome an increase in the Federal funds rate next year. As expected, the Fed did formally end its quantitative easing (QE) program with its final active purchase of mortgage-backed securities and government bonds. This is a positive sign for the equity markets and the U.S. economy at large. Coincidentally, U.S. Gross Domestic Product (GDP) data was released this week showing a solid 3.5 percent growth rate, which was better than most expectations. Our forecast has been for the U.S. economy to pick up steam throughout the year, and this data has confirmed that call. This information has supported stocks, yet it has a minimal effect on the bond market with the 10-year treasury yielding 2.3 percent.

Signals
Third quarter earnings reports have reinforced our belief of continued economic growth. Seventy percent of the companies in the S&P 500 index have reported earnings to date and the results have shown year-over-year earnings-per-share growth of nine percent and revenue growth of four percent. Healthcare and technology companies have led the way with higher reporting of 11 percent and nine percent top-line growth, respectively. These are two sectors we favor in our equity strategies. These positive earnings reports have enabled stocks to reclaim their footing in this bull market. From the recent all-time high in September, the S&P 500 fell 10 percent over the subsequent four weeks. However, in the last two weeks we have seen a nice snap back with equities sitting just below the record of 2020 set on September 19, 2014. At current valuations (the market is trading 15.5x forward earnings) and with the strong earnings we are witnessing, we continue to favor stocks over bonds.

Different Stages
The quarter’s earnings season has not been friendly to the higher growth, momentum stocks. Last week Amazon “cautioned” investors that they are going to reinvest more money into “growth”. Historically, this wouldn’t have been viewed very negatively but it seems investors may be getting impatient for their return on investment as the stock declined by almost 10 percent. Over the last 10 years, Amazon’s profit margins have fallen from six percent to under one percent, while the stock has been a stellar performer. It looks like investors are shortening the leash. Twitter suffered a similar fate this week. Twitter’s growth metrics (advertising, users, etc.) were disappointing, resulting in a 20 percent decline this week. The overall growth of the company is still strong, but investors may be getting anxious when they are paying over 100x future earnings. While many of us are big users of both of these companies’ services that does not make the underlying stock a great investment. Investors need to make sure that the price they are going to pay for future cash flows allows them to earn a competitive return. We just don’t see that in these two names at this time.

Our Takeaways for the Week: 

  • U.S. economic growth is improving which will lead to the Fed raising the funds rate earlier rather than later
  • Third quarter earnings growth is healthy which supports a reasonably valued equity market

Disclosures