Although the second estimate of 1Q 2015 real GDP was bumped into negative territory from a first estimate of 0.2% to -0.2% q/q saar, it appears economic activity in the U.S. has picked up in 2Q 2015. A strong retail sales report and the strongest consumer spending growth since August 2009 bode well for consumption. Additionally, a swath of stronger housing market data indicates that the residential investment component of GDP may also get a bump, especially as stocks of unoccupied existing homes continue to dwindle. Overall, despite a few remaining areas of weakness, we see the U.S. economy continuing to expand.
June's employment report showed the labor market continuing to tighten, while also highlighting the structural problems in the U.S. labor force. The unemployment rate fell to 5.3%, although this drop was due to a decline in labor force participation, rather than a bump in payrolls. That being said, payrolls still increased by 223,000, in line with the 3-month average. However, wage growth has yet to materialize, as average hourly earnings only rose 2.0% from a year earlier.
S&P 500 operating earnings are estimated to be $25.80 for the first quarter of 2015, representing year-over-year growth of -5.6%. Lower earnings were mainly due to low oil prices and the strong U.S. dollar. S&P 500 earnings excluding the energy sector grew at 8.5%.
Headline consumer prices rose 0.4% between April and May (0.0% y/y), while core CPI inflation firmed slightly to 1.7% y/y. The headline month-to-month increase was driven higher by increasing energy prices, as the gasoline price index increased 10.4% m/m. Excluding volatile food and energy prices, core prices rose 0.1%, the slowest month-to-month pace since December.
There were no policy changes in the FOMC's June statement, but it was noted that U.S. economic growth has picked up since April. While negative first quarter growth caused the FOMC to adjust its 2015 growth projection lower, it made upward revisions to its expectations for 2016 and 2017. Additionally, downward revisions to medium-term Federal Funds rate expectations highlighted the dovishness of the meeting. Following the announcement, the 30-day Federal Funds Futures market moved lower, as market participants cast doubts on whether the FOMC will raise rates even once in 2015. Still, the Fed maintains its commitment to raising rates after further improvement in the labor market and when the Committee has "reasonable confidence" inflation will hit 2% in the medium term.
- Volatility caused by the timing and communication of Fed tightening.
- Political risk caused by a potential Greek default and/or exit from the single currency area.
- 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.