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Growing Economy and a Healthy U.S. Consumer Will Contribute to Equities Ultimately Moving Higher

Beaten down areas of the market have staged a nice turnaround. U.S. stocks have moved well off the lows and the S&P 500 is now within shouting distance of the flatline for the year. Areas of the market that were some of the hardest hit—such as materials, energy and financials—have posted some of the best gains over the past month. Other measures of risk aversion have also moved in a positive direction: Treasury yields have risen, meaning some money has moved out of the safe haven investment; commodities—including oil—have risen; and junk bond yields have fallen; all indicating an increasing appetite for risk among investors.

Measures of risk aversion have fallen

So is it clear sailing from here? Not exactly. While we’ve been of the opinion that stocks were overestimating the chances for a recession in the United States, headwinds remain. From a contrarian sentiment perspective, investors don’t appear to be embracing this rally, as according to the Ned Davis Research Crowd Sentiment Poll investors have moved off of extreme negative sentiment, but are only now in neutral territory. We believe U.S. stocks can move modestly higher over the course of the year, but believe investors should be mindful of risks and not become greedy. Earnings will likely play a large part in market movements in the coming months after a couple of quarters of negative earnings growth, with investors looking for any increase in profits momentum.

Economy growing, but not booming

The earnings outlook will be greatly influenced by the economic outlook, which in our view remains relatively modest. It still appears to us that we’re in a 2-2.5% “real” (inflation-adjusted) gross domestic product (GDP) growth environment, so the muddle along characterization of the economy remains apt. The labor market continues to be the star of the economic picture, with unemployment at 4.9%, the labor force participation rate ticking up recently, and the sharp decline in forward-looking initial jobless claims indicating continued strength.

Politics play a role, while the Fed maintains flexibility

Business confidence is important for the US economy to start to see accelerating growth. Businesses have hired to keep up with increasing demand, but capital spending has been decidedly lackluster. It appears that a lack of confidence in the future could be playing a role in the reluctance to make long-term capital commitments. In the same survey by NFIB referenced above, business owners said economic conditions and the political climate were their top two concerns. Nearly a quarter of small business owners said complying with government regulations was their biggest challenge over the past 12 months.

And we have a less-than inspiriting election season so far, which has likely contributed to market volatility and is not inspiring a lot of confidence among business owners. Bombastic statements from both sides of the aisle blasting trade and promising to restrict the movement of goods between countries through various measures doesn’t strike us as being conducive to improving economic growth.

The Federal Open Market Committee (FOMC) met and declined to make a move on rates, as was expected, but set the stage for potential hikes later in the year. Although the tenor has been dovish, in speeches before the meeting, several members noted that the labor market is tight and inflation is starting to pick up. Those comments, combined with the FOMC’s continued desire to normalize policy, leads us to believe two rate hikes in 2016 are possible, which is what the Fed’s projections also indicate.

So what?

We’ve seen a nice rebound in stocks off the lows but we don’t believe the market can sustain the pace of gains seen over the past month. Economic growth remains sluggish, earnings growth has been weak, and monetary, political and regulatory uncertainty is elevated. We think U.S. stocks continue to experience bouts of volatility but that a growing economy and a healthy U.S. consumer will contribute to equities ultimately moving higher.

Important Disclosure
This material is issued by Charles Schwab, Hong Kong, Ltd. The information provided here is for general informational purposes only and has not been reviewed by the Securities and Futures Commission in Hong Kong.

Content provided by Charles Schwab, Hong Kong
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