22 May 2017
Investing Landscape in the U.S. Remains Healthy
After some weakness in March and early April, due to slowing growth fears and political uncertainty both here and abroad, U.S. stock indexes are again trading at or near record highs. Growth concerns have faded and investors are becoming more accustomed to the "unique" way that the new administration approached issues. Markets used to move "bigly" on a Presidential tweet or off-the-cuff remark, but investors have increasingly tuned out the noise. A case in point—the President mentioned in an interview with Bloomberg that he might look into breaking up big banks; yet the stocks shrugged off the comments and banks finished the day roughly where they were before the comments were made.
Although we are entering a period that has at times ushered in weakness for equities, we caution against trying to trade around the phenomenon. First, you would have to get two decisions right—the sell and the buy—which is extremely difficult. Second, there have been multiple time periods, according to S&P data, that have shown good returns during the summer months, even though past performance is no guarantee of future results. Finally, it appears that we could hit a sweet spot for equities where economic growth is good but not overheated, corporate profits are strong, inflation is tame, global political risks are fading, and fiscal tailwinds are developing. It doesn't mean we won't see pullbacks, especially given ongoing uncertainty around monetary policy and the Fed’s balance sheet; geopolitical risks; and investor sentiment. But the underlying foundation of the secular bull market looks solid.
Economy moving past soft spot
We believe the weak first quarter real gross domestic product (GDP) growth rate of 0.7% annualized understates the longer-term trend rate. Recently we've seen some signs of the economy perking up since the first quarter's soft patch, although there are still some areas of concern. The so-called "soft" data (confidence- and survey-based) remains historically elevated; which is a bit of a surprise given the ongoing turmoil in Washington and the likely delays in getting tax reform done. In the meantime, the "hard" data (actual measures of growth) has played a little catch-up. After falling a bit last month, the Institute for Supply Management's (ISM) Non-Manufacturing Index rose again to 57.5, while the forward looking new orders component jumped back to 63.2. And while the ISM Manufacturing Index fell modestly to 54.8, it still remains well above the 50 mark that separates expansion and contraction.
Actions are backing up higher business confidence as jobless claims, a forward-looking indicator, remains historically low; while employers added another 211,000 jobs in April, rebounding from a soft March reading, according to the Bureau of Labor Statistics. And the unemployment rate fell to a decade low level of 4.4% with the underlying drivers suggesting it can go lower still.
This is how sweet spots develop. Wages are rising at a modest pace; but not enough to trigger higher inflation and a more aggressive Fed. And despite higher labor costs, first quarter earnings season has largely bested elevated expectations; with year-over-year profit growth for the S&P 500 expected to come in at roughly 14%, up from about 11% expected at the beginning of the season according to Evercore ISI Research.
After a long downturn, we're also starting to see an encouraging uptick in both home ownership and household formations. This suggests that consumer confidence is starting to translate into some economy-boosting action, notwithstanding the recent drop in auto sales.
Fed remains on track, for now
The Federal Reserve is likely to remain methodical in its approach to tightening monetary policy. The May Federal Open Market Committee (FOMC) meeting came and went with no action, as expected, but the accompanying statement was seen as more hawkish—noting that first quarter weakness was likely "transitory." Odds of a hike at the Fed's June meeting rose to (and remains at) nearly 100% right after the statement release from about 70% right before the meeting. We also believe we’ll see a hike at the June meeting.
Hope for swift action by politicians in Washington, however, is waning. With Congress still embroiled in the effort to repeal and replace the Affordable Care Act, the potential for tax reform is likely no earlier than late this year, or even into 2018. But while many can quibble with the spending bill that was passed, it did ensure that the U.S. government will continue running for the next several months, removing at least one near-term concern for the market.
Subscribing to the "sell in May" theory has not always been financially rewarding, so be cautious about trying to trade around any likely volatility. The U.S. economy is growing, but not too fast, earnings have accelerated sharply, and fiscal tailwinds are still blowing. Pullbacks are possible but stay focused on fundamentals and your long-term goals.
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.