Lower than expected numbers on international trade, manufacturing and wholesale inventories, and retail sales likely will push the second estimate of 1Q 2015 real GDP into negative territory, from a first estimate of 0.2% q/q saar. Alternative measures of economic growth estimate that the economy is still expanding above 2.0%, especially after tax collection data reflected the major increase in employment over the past year, with income taxes being up 6.0% y/y. Despite some measured weakness this quarter, we see the expansion continuing at its moderate pace supported by strong housing numbers in April.
The April employment report met expectations for job growth, while further data about the March employment situation confirmed a still tightening labor market. April nonfarm payrolls rose by 223,000, and the unemployment rate moved slightly lower to 5.4%. Wage growth was again mild, but the March quits rate rose to 2.0%, suggesting workers are feeling confident enough to leave in search of another job, potentially signaling a coming increase in worker bargaining power. Overall, the labor market appears healthy, despite some indications of a growing skills gap in the labor force.
S&P 500 1Q 2015 earnings season is coming to a close, with about 92% of the S&P 500 market capitalization reporting through last week. Estimates were reduced over the quarter due to continued U.S. dollar strength and low oil prices, leaving room for companies to surprise to the upside. While we are estimating S&P 500 earnings growth to be -5.0%, S&P 500 earnings excluding the energy sector are projected to grow at 9.1%.
Headline consumer prices rose 0.1% between March and April (-0.2% y/y), while core CPI inflation firmed slightly to 1.8% y/y. High month-to-month increases in medical and education costs pushed overall costs up, while evidence that the housing market is tightening can be seen in shelter costs rising at their fastest pace over the past four months since before the housing bubble popped. Despite oil prices edging upwards, energy costs did not move much in the April CPI report and are still down 19.4% y/y.
There were no policy changes in the FOMC's April statement, but it was noted that weakness in U.S. economic data in 1Q is "transitory." However, minutes from the meeting signaled less willingness to begin policy normalization in the first half of the year. The Fed stressed a rate increase would only come after further improvement in the labor market and when the Committee had "reasonable confidence" inflation would hit 2% in the medium term. In March, the Fed lowered its forecasts for both the long-run unemployment rate and near-term economic growth, signaling the Fed sees more slack in the economy than previously thought.
- Volatility caused by the timing and communication of Fed tightening.
- Political risk potentially caused by Middle East turmoil and lower oil prices.
- Deflation worries in other developed economies outside of the U.S.
- Volatility caused by sharp swings in commodity prices and exchange rates.
- A slow upward trend in earnings (despite special factors depressing 4Q 2014 numbers), coupled with low interest rates, still make stocks look attractive in relative terms.
- Cyclical and small cap stocks are generally favored in a rising interest rate environment.
- High yield bonds look more attractive than Treasuries, but a diversified approach to fixed income investing seems appropriate given likely Fed tightening in 2015.
- Despite disappointing returns due to a stronger dollar in 2014, international exposure is still warranted given growth prospects abroad.