The U.S. economy expanded at a 2.3% q/q saar pace in 2Q 2015, according to the BEA's preliminary estimate. The report sent mixed signals about growth in the U.S. On one hand, data showing an economic contraction in 1Q 2015 was revised up to 0.6%, painting a better picture of growth in 2015. On the other hand, the BEA's annual revision process, in which it restates GDP for the past three years, caused average GDP growth since the financial crisis to drop from 2.2% to 2.1% y/y. Since the first statement, improvements in construction spending, retail sales and inventory accumulation data suggest that 2Q 2015 growth may be revised higher when its second estimate is released on August 27th. Overall we see the U.S. economy continuing to expand.
The July jobs report came in very close to expectations, with payrolls increasing by 215,000, and shows a labor market that continues to see, in the words of the FOMC, “some further improvement”. However wage gains remain subdued, rising only 0.1% m/m for production and nonsupervisory workers. While this report likely leaves the Fed on track to raise rates for the first time in September, it increases the focus on the August jobs report, due out on September 4, as a final deciding factor on the timing of an interest rate liftoff.
With over 90% of market cap having reported, the S&P 500 looks on track for earnings per share to fall 10.1% y/y in 2Q 2015. The fall in our estimate over the last week is largely due to energy names reporting signficiant earnings misses. Although there have been significant upside earnings surprises in the financials, tech and consumer discretionary sectors, the S&P 500 ex-energy growth is still below trend at 2.6% y/y due in part to the strong U.S. dollar.
CPI received a small boost as headline consumer prices rose 0.2% y/y in the July report; core CPI inflation continued to firm at 1.8% y/y. Energy prices outside of gasoline again dragged on the overall number, but the increase in prices at the pump was enough to bring the overall energy index into positive territory. The increase in core prices once again came from the increasing costs of medical care and shelter.
The FOMC left rates unchanged in July, but indicated in its policy statement that it needs to see only "some" improvement in labor market before moving to raise rates. References to the labor market were more positive throughout the statement indicating that another robust employment report along with signs of wage growth should be enough for to warrant a rate increase in September. Parsing the language of the FOMC statement may seem extreme, but market participants eagerly consume all Fed communications for an indication that the initial hike is around the corner. Given recent data and the Fed's outlook on labor and inflation, we anticipate the first rate increase will occur in September.
- 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.