A second estimate of 4Q 2014 real GDP put growth at 2.2% q/q saar, below the first estimate of 2.6%. The downward revision largely came from a slower inventory build, which means that inventories should be less of a drag on 1Q 2015 growth. A decline in government spending and a rising trade deficit lowered 4Q GDP growth from 5.0% experienced in 3Q 2014. However, personal consumption increased by 4.2%, the strongest increase since 1Q 2006, reflecting an increase in spending on nondurable goods and services. Despite the downward revision, the U.S. economy continues to grow at an above-trend rate.
In the January employment report, nonfarm payrolls rose by 257,000 and the unemployment rate rose to 5.7% on higher participation in the labor force, remaining below the 50-year average of 6.1%. Hourly earnings rebounded from the December report by 0.5%, resulting in 2.2% growth over the past year. Initial jobless claims came in higher at 313,000, although we still expect a strong employment print for February.
S&P 500 operating earnings are estimated to be $26.67 for the fourth quarter, representing year-over-year growth of -5.6%. Lower earnings were mainly due to low oil prices, a strong dollar, and pension write-offs.
Consumer inflation fell to -0.2% year-over-year in December as measured by headline CPI. Core CPI was flat from December at 1.6% year-over-year. Final demand producer inflation was down in January (-0.1% year-over-year), with weakness coming from a 10.3% monthly drop in energy prices. Additionally, import prices decreased 2.5% month-over-month driven by falling energy prices and a stronger dollar, further illustrating deflationary pressures.
In Janet Yellen's semi-annual testimony to Congress she reaffirmed the strength of the labor market, maintained that rate increases will be data dependent, and provided additional color around inflation expectations that suggest that the Fed remains on track to begin policy normalization in the middle of this year. The latest FOMC statment indicated that, in addition to employment and inflation, the Fed is also watching international developments when considering appropriate policy action.
- 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.