Last week’s big economic news stories were another great US jobs number on Friday and the release of the July ISM Purchasing Manager’s Index (PMI) report (which measures manufacturing activity). The US economy created 255,000 jobs in July, which was well above expectations of around 180,000 and a strong compliment to the striking 292,000 number reported in June. The Purchasing Manager’s Index came in at 52.6, a slight decline from June’s 53.2, but in expansion territory. In recent years, there has been a big gap between the weaker performance of the struggling industrial sector in the US and the stronger performing (and larger) services sector. Nevertheless, a PMI above 50 indicates expansion in the manufacturing sector, and a PMI above 43.2 indicates expansion of the overall economy based upon historic relationships. Interestingly, July’s number if annualized would be consistent with 3% GDP growth, and that’s similar to what current nowcasting models are forecasting for the 3rd quarter, though it is early! The Atlanta Fed’s model is indicating 3.8% growth for the third quarter (but again, it just started), while the New York Fed’s model is at 2.6%. I think the important point is that the economy, while experiencing below average growth, has been accelerating since the beginning of the year.
In an interesting way, it is probably both the accelerating and the below average characteristics of GDP that have helped to keep US stock market indices in record-high territory. The S&P 500 is up over 7% for the year, well above average so far, while small-cap stocks are up over 10%. That’s consistent with an accelerating economy, based upon the notion that smaller companies tend to have a higher proportion of domestic or US-only sales and hence are more levered to the US economy. By the way, there is a kernel of truth behind many of these kinds of anecdotal stories about large and small company stock performance, or between value and growth stock performance, or industry “rotation” or domestic versus international stock performance. But always take them with a grain of salt, because there are plenty of exceptions in the data! As for the below average growth rate of the US economy, that has had an influence on the Federal Reserve’s decision to hold off on rate hikes this year (so far anyway). This has helped to keep interest rates down and has probably contributed to stronger equity prices. But the real lesson this year for stock investors, which I mentioned on our webcast, is that it is unwise to try to time the market by moving in and out of stocks. Believe it or not, stocks in the US are up over 20% from their February bottom (that’s February of this year). Given the horrible start to the year, many investors were tempted to move to cash at the time, “until things get a little clearer.” Had you done that your wealth could be 20% lower right now, and that would have all happened in just the past five months!
I’ll do a little (obvious) forecasting about the rest of the world. The Monetary Policy Committee of the Bank of England had been holding their benchmark policy interest rate at .5% (50 basis points) since 2009, but they cut rates to 25 basis points last week, even though UK second quarter GDP came in a lot stronger than expected. That’s because the more recent months’ data has been deteriorating, and many expect a UK recession in the offing. The Bank of England has also increased its asset purchases (its “quantitative easing” program), and it has widened the purchase focus to include corporate, not just government bonds (Wells Capital). China growth concerns have been out of the headlines lately, mostly because of the government's temporary hiatus from focusing on long-term structural change, instead favoring policies aimed at stimulating short-term growth (MRB Partners). That means government investment spending. In fact, private sector investment in all major sectors in China has flatlined, while government sector investment spending has increased. This is not really sustainable, and expectations are for poor numbers coming out of China sometime in 2017. So looking ahead and anticipating the headlines, I think it will be UK/Europe concerns through year end, followed by China concerns thereafter. There are global positives as well, particularly the fact that global equity (i.e. stock) valuation levels already seem to reflect a lot of this. That means that any positive surprises can create a lot of upside. As for US election probabilities, PollyVote (evidence-based election modeling) gives Hillary Clinton a 52.5% chance of winning the White House this fall, with Trump’s odds at 47.5%.
Posted on Mon, August 8, 2016
by Danny Aleman