Overview
In just a few short months we have gone from a period of enthusiasm (around mid-summer) to a couple of months of fear (late in the third quarter) to, once again, hope and relative confidence. Riskier assets have followed this yo-yo pattern and are now in the midst of a rebound toward stocks and higher-credit risk and away from cash.
In a show of the power of a single number, the latest strong U.S. payroll number helped further this trend. But the U.S.’ role as the locomotive of the world – now that China is wavering – remains vulnerable, and few others are ready to grab the baton of economic leadership.
Meanwhile, the rebound in U.S. stock prices to fair-to-slightly expensive levels once again creates a close link between future performance and earnings growth, which unfortunately has gone missing in the homeland.
North America
Tony M. Caxide, CFA®
Chairman - Senior Investment Council
The U.S. economy is being buffeted. Robust performance in sectors like auto sales, other consumer spending and construction activity is being assessed against weakness in manufacturing and an inventory correction.
The trade sector has been a non-event, much better than fears of a worsening trade balance. And growth, although volatile, seems to remain near 2.5%. But confidence remains fragile, and a sharp fall in commodity prices in the last year is obscuring underlying trends in inflation, earnings and credit quality. Everyone is trying to gauge what the Federal Reserve will do about rates, and the current modest pace of growth provides few clear clues as to whether inflation pressures are truly building.
We continue to see gradually rising wage pressures, which, along with a steady increase in housing prices and rental charges, is indeed slowly increasing pressures on prices.
Japan
Jeffrey G. Wilkins,
Deputy Chief Investment Officer
Japan’s recovery remains fragile and volatile. Recent data suggest that the corporate sector is benefitting the most from “Abe-nomics”, with strong corporate profits due in large part to a weaker yen. This is the first step in the virtuous cycle of deleveraging and reflation that Abe and the central bank are aiming to create. Judging by workers’ cash earnings in recent months, those profits are beginning to be passed along to workers, as cash earnings have risen 8 out of the last 12 months and real cash earnings are positive for the first time in two years. The preliminary release of September leading indicators is showing some weakness, and nominal inflation remains stubbornly negative. Equity valuations suggest that many market participants remain skeptical as to whether or not the larger profits and positive core inflation are sustainable.
Europe
Srinath Sampath, CFA®, PhD
Managing Director, Portfolio Management
Since September, ECB President Mario Draghi has hinted repeatedly at the possibility of employing additional stimulus measures to stabilize the eurozone. This second stage of Quantitative Easing could commence as early as this December and involve a combination of tools such as the acceleration of asset purchases beyond the current €60 billion per month, the extension of the program term past September 2016, and a further reduction in rates. Equities rose and the euro declined in response to the possibility. These are challenging times for Europe, as it diverges in monetary policy from the U.S. (itself on the verge of a monetary tightening cycle), suffers anemic inflation, endures a double-digit unemployment rate, and contemplates a post-election Greece that needs to make good on its borrowings and promises.
UK
Jeff (Shengde) Liu, CFA®
Managing Director, Portfolio Management
The economy grew at close to a 2% annual rate in Q3 against headwinds from a stronger currency (against the euro) and lackluster external demand. However, the buoyant UK purchasing manager indexes, especially in the service sector, suggest that the growth in Q4 could come close to the 2.5% expected pace. That would put the UK GDP growth at 2.2% for 2015, a rate close to that of the U.S. The healthy job market, growing wages and low inflation continue to benefit UK households. The concerns over tighter labor supply may set the stage for the Bank of England to start rate normalization in mid 2016. On the equity side, weak corporate earnings are still a concern.
Emerging Markets
Jeff (Shengde) Liu, CFA®
Managing Director, Portfolio Management
Emerging economies remain under the curse of China’s slowdown and a possible Fed rate hike. Recent releases suggest that EMs’ manufacturing sectors are weak across the board. Brazil’s economy rolled into a deeper recession. Its Q3 GDP growth is expected to fall at -3.6%. Both China’s exports and imports continue to slow down. Indonesia Q3 GDP was less than expected, though India and South Africa showed moderate growth. EM corporate profits are still under pressure due to weak export demand and a high debt burden.
The silver lining with EMs is in services. Except Brazil, most EM countries’ service sectors remain strong. The possibility of further stimulus measures from the Chinese government also gives hope to the future EM prospect.