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.
The Febuary employment report showed broad-based improvement in the labor market. Nonfarm payrolls rose by 295,000, and the unemployment rate fell by 0.2% percentage points to 5.5%. Measures of labor market health unaccounted for in the overall unemployment rate, such as the involuntary part-time work and the long-term unemployment rates also improved. Wage growth, on the other hand, was disappointing in this report, increasing $0.03 overall and remaining flat in the more reliable production & nonsupervisory workers series.
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.
Headline consumer prices fell 0.7% between December and January, and are now down 0.2% yoy, while core CPI inflation remained flat for the second month in a row at 1.6% yoy. Headline inflation declined largely due to a fall in energy and gasoline prices. Final demand producer inflation was down further in Febuary (-0.7% yoy), with weakness coming from a previous 10.3% 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.
There were no policy changes in the FOMC's March statement, but it opened the door for a rate increase this year by removing the word "patient". 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 percent in the medium term. The Fed lowered its forecasts for both the long-run unemployment rate and near-term economic growth, signalling 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.