The U.S. economy expanded at a 1.5% q/q saar pace in 3Q 2015. Consumption remained strong, with consumer spending up 3.2% year-over-year following a 3.3% increase in 2Q. Fixed investment was up 3.4% year-over-year and residential investment increased 8.9% on a year ago basis. Despite expectations of foreign trade being a substantial drag, it only detracted -0.03%. As expected, the inventory accumulation in the first half of the year took its toll, deducting 1.4% from growth. However, this means the worst is behind us and future quarters would only need to see an incremental -0.6% taken from annualized GDP to get back to the average pace of inventory accumulation.
The October employment report saw the unemployment rate fall to 5.0% and last month's job openings number rose to 5.5 million (the second highest number on record), further evidence that the U.S. labor market is nearing full employment. Such confirmation of lessening slack should add ammunition to the argument for the Fed to raise rates for the first time since 2006 at the December meeting.
As the earnings season comes to a close, two of the major themes this year, falling energy prices and a high U.S. dollar, certainly continued to take a bite out of earnings. Our estimate for S&P 500 earnings per share in 3Q has now fallen 15.2%, but ex-energy has risen by 1.9%. The high dollar has hurt foreign sales, with only 35% of companies beating revenues estimates. Looking ahead into 2016, these themes should continue to play out, but the hit from low prices should begin to roll off and lead to stronger earnings growth.
CPI firmed in October as headline consumer prices increased 0.2% m/m, in line with consensus expectations, helped by strength in oil and food prices. Headline inflation is now up 0.2% from October 2014 held back largely by the energy index, which is down 17.1% in the same time. Core CPI inflation maintained a solid 1.9% yoy growth and improved by 0.2% mom with core services prices increasing 0.3%, driven by a 0.8% increase in medical care services. With the drag from energy prices set to fade in early 2016, headline inflation should move closer to the Fed's 2.0% mandate in the medium term.
The FOMC left rates unchanged in October and indicated in its statement that it is focusing more on near-term incremental improvement in the U.S. economy rather than longer-term trends. They reduced their emphasis on international developments and upgraded their assessment of the U.S., stating that although the "pace of job gains slowed" labor market slack has still diminished. They included a reference to "its next meeting" and while this is not a material change from previous statements, the Fed seems to be preparing investors by striking a more hawkish tone and implying that a December rate hike is still on the table.
- Volatility caused by the timing and communication of Fed tightening.
- Concerns about a slowing Chinese economy and its ripple effects on emerging markets.
- 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 the temporary drag from cheap oil and a high dollar), 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.