14 March 2016
Neutral Does Not Mean Boring
Recently, stock indexes have moved out of correction territory but have remained quite volatile, with triple-digit Dow moves more common than not. This illustrates why we continue to recommend that investors have a neutral allocation toward equities in their portfolio. Uncertainty remains elevated and trying to chase, or even interpret, every move in the stock market seems to us to be a losing game.
Our view is akin to dating vs. marrying. A lot of the action recently has been from folks that are simply “dating” stocks—no long-term commitment, trying different things out, never settling on a set path—exciting at times but ultimately mostly exhausting and unsatisfying. We suggest investors take an approach more like marriage—a long-term, stable commitment, sticking with the plan through ups and downs, knowing there will be good times and bad, but hopefully ultimately fulfilling in the long term.
Domestic economic picture muddled, and concerning
Investors are also trying to get a handle on the U.S. economic growth vs. the risk of a recession. We remain in the no recession camp, but the data remains mixed. For example, existing home sales rose 0.4% month-over-month, while new home sales (which are a much smaller portion of the market) fell 9.2%. The manufacturing vs. service picture is mixed as well, with manufacturing remaining relatively weak, but improving on some metrics. Both the latest Empire and Philadelphia regional surveys moved higher; although remaining in negative territory. And the national Institute of Supply Management’s (ISM) Manufacturing Index posted a surprising rise to 49.5 from 48.5; while the forward-looking new orders component stayed at a decent 51.5. Additionally, we’ve seen bounces in iron ore prices, the Baltic Dry Index (measuring global shipping price trends), and the general commodities complex—providing some evidence that the downward trend in manufacturing may be ending.
Inflection point for manufacturing?
Supporting the more optimistic view, we received a nice surprise from the durable goods report, which followed a solid industrial production gain of 0.9%. Orders for non-defense capital goods ex-aircraft, considered a proxy for business spending, rose a robust 3.9% month-over-month, while the previous month’s decline was revised slightly higher.
But the much larger service side of the economy is becoming more murky. Markit’s Flash US Services PMI fell below the 50 mark that delineates contraction and expansion; however Markit noted that much of the weakness was attributed to the massive snowstorm in the northeast. The ISM Non-Manufacturing (Services) Index remains in territory depicting expansion, although it ticked very slightly lower to 53.4 from 53.5; with a similar story for the orders component, which is leading, and remains in expansionary territory at 55.5.
Finally, the labor market continues to look quite solid. Initial unemployment claims—a leading economic indicator—show no signs of increasing; while the February jobs report showed that 242,000 jobs were added in February while the unemployment rate was 4.9%. The tight labor market means that future gains may be more muted, as there are fewer folks to hire, while also pressuring wages higher.
Feds’s job getting harder
This conglomeration of striking colors mixing into a neutral picture puts the Fed in a bit of a pickle. The Federal Open Market Committee (FOMC) is still biased toward normalizing monetary policy, but the uncertainty in the U.S. economy, combined with volatility in financial markets and foreign central banks easing, means rates will likely not be increased at the March meeting. But the market may be underestimating the chances of further hikes this year, especially given the latest uptick in inflation. The Consumer Price Index (CPI) reading, ex-food and energy (the “core” rate), posted a surprising 2.2% gain year-over-year—not robust but the highest since June 2012. And the Fed’s “preferred” measure of inflation—Personal Consumption Expenditures (PCE)—has also ticked higher, with the core rate at 1.7%. Remember, the Fed’s target rate for inflation is 2.0%.
Economic uncertainty has contributed to heightened volatility across U.S. and global asset classes. We remain optimistic that the United States is not headed into a recession, which should keep the correction from becoming a bear market. We continue to recommend a neutral allocation to U.S. equities and acknowledge that risks are elevated but urge investors to remain disciplined around their investment plan.
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.