Overview
It’s not exactly the apocalypse, but in early 2015 we have encountered Four Horsemen of sorts: Cold and snowy winter weather. West Coast port closures and a related work slowdown. A strong U.S. dollar. Oil-sector retrenchment.
Much in economic growth and financial markets hinges on whether these four factors are temporary or long-lived. Our view? They’re both, though perhaps not as you might think. Specifically we feel that the harsher-than-normal weather and port problems will be reversed rather quickly. As to the U.S. dollar and oil-patch weakness, we’re living through their harshest impacts as we speak, but, in another 3-9 months, we could see some reversal and may actually see their symbiotic value come through. Whether that will be enough to reverse tepid profit growth, though…
North America
Tony M. Caxide, CFA®
Chairman - Senior Investment Council
Economic statistics adjust for normal or expected variations that we see at the same time each year. But when the event is stronger or weaker than average, the data will be impacted, even if temporarily.
Both a harsher-than-normal winter and problems in West Coast ports temporarily delayed growth. These don’t worry us a great deal as we see an offsetting “catch-up” in the months ahead, similar to 2014. But the other factors noted in the Overview are much trickier.
In an economy burdened by a still-heavy debt load (particularly in government and government-sponsored enterprises like FNMA), where our politicians (in their search for voter approval) have failed in their duty to implement effective fiscal policy and the central bank is doing all it can to keep it all together under a heavy barrage of undeserved criticism, profit growth has faltered and temporary factors can shake growth that’s moderate in nature.
Japan
Jeffrey G. Wilkins,
Deputy Chief Investment Officer
Recent Japanese economic data has been mixed. In the industrial sector, manufacturing PMI has been trending down, while industrial production has continued its plodding upward trend, albeit with significant volatility. The country’s trade balance turned positive once again in March, for the first time since early 2012, thanks in no small part to lower energy prices. In the consumer sector, which accounts for approximately 60% to 70% of Japan’s economy, household spending growth rates have been robust while retail sales have rolled over but remain at a decent level. Perhaps most importantly for profits and inflation, the yen remains weak and employment indicators are strong. Employees won decent wage increases at this year’s Shunto (the annual negotiation between large companies and their unions), but they were still below the Central Bank’s 2% target for inflation.
Europe
Srinath Sampath, CFA®, PhD
Managing Director, Portfolio Management
The European equivalent of Quantitative Easing, which commenced its monthly bond purchases of €60 billion in March, was initially welcomed by participant economies and markets. However, a recently strengthening euro and rising bond yields have resulted in increased market volatility. The prospect of a Greek default or exit from the EU is a continuing concern, but the financial consequence of such an event – at least to the EU – is expected to be muted today compared to five years ago since the vast majority of Greek debt is now in the hands of the IMF, the ECB and European governments. The greater risk arising from a “Grexit” is political contagion. With substantial Greek debt payments forthcoming, Greece and its lenders need to reach a compromise quickly to avert further turmoil.
UK
Jeff (Shengde) Liu, CFA®
Managing Director, Portfolio Management
The UK economy slowed in the first quarter, growing at about 1.5% (annualized) – the lowest since the second quarter of 2013. The slowdown was caused largely by weak net trade. However, consumer spending in the form of retail sales and car registrations is doing well. The “good dis-inflation” caused by oil and other commodities prices has helped UK family budgets, and we should not read too much into one quarter’s growth figures. We believe consumer spending and the European Bank’s Quantitative Easing program will push the UK economy higher in the next few quarters because the euro area is a major export market for the UK. Affected by the oil sector and strength of the pound (against the euro), UK corporate earnings face downward pressure, which may reverse if economic growth picks up.
Emerging Markets
Jeff (Shengde) Liu, CFA®
Managing Director, Portfolio Management
China seems to be continuing on its path to a managed economic slowdown. Both large and small manufacturing sectors appear to be slowing. This may be the necessary, painful process for eliminating over-capacity, cooling the red-hot property market and restructuring the economy (from export-driven to consumer-driven). As China slows, so may other EM countries. Earnings also continue to be under some pressure due to declining commodity prices, a strengthening dollar and the slowing growth rate in demand-pull from China.
That said, most EM countries’ consumer sectors (including China) are doing well. The wealth effect, cheap credit and low inflation are major contributing factors. Although it may take a couple of years, the consumer sector, along with the reform initiatives of major EM countries, may become the catalyst for re-energizing EM economies and profit growth.