If you don’t know who you are, [the stock market] is an expensive place
to find out.”– George J. W. Goodman aka “Adam Smith” in The Money Game (1968)
Economic Perspective
Extremely cold winter weather clobbered the American economy in the first quarter, which recorded its first significant decline in growth since 2009. (Though it looks like suspect health services results may have distorted reported GDP suggesting a future upward revision.) The United States economy should rebound in the second half of the year as depleted goods inventories are rebuilt. Housing activity continues to advance as the recent spike in mortgage interest rates alerts buyers to greater costs ahead; the result: anticipatory buying. A weaker dollar should also assist the export picture and thereby boost the economy. The slowing of China’s economic growth pace will dampen commodities prices for all global customers and assist our economy. While observed price increases abound in the supermarket, true price inflation requires wage rates to rise. Employer job listings continue to post seven year highs. The job market is opening up. And while many discouraged workers remain, the unemployment rate approaches 6%.
Just as Europe was poised to escape the sovereign debt crisis (with exits by Ireland and Portugal), Russia seized Crimea. Now, amidst flare ups in Iraq and Israel, the strutting Russian President Vladimir Putin seems to realize he is no match for the economic might of Europe and the US. Ukrainian political tensions may ease in coming months. But Italy remains an economic weak sister in the EU. And the Portuguese bank Espirito Santo teeters on the brink. It’s a bad case of déjà vu.
Global economic growth is mediocre, held down by continued balance sheet repair in economies where leverage got out of hand, especially on the household and banking side in the United States and the United Kingdom. Yet global growth should approach 3% this year and exceed that next. Inflation remains under control and will continue so until employment expands substantially
Market Thoughts
Recent comments by Federal Reserve Chair Janet Yellen reaffirming their commitment to easy money via continued low interest rates, bodes well to buoying the stock market for the second half of this year. Nevertheless, bond buying will end in October. Stock valuation continues extended but not excessive. So far every stock (and bond) market dip elicits buying.
Corporate profitability remains high thanks, amongst other things; to the low cost of borrowing and wage growth restraint (high unemployment restrains wages). There has been a massive increase in corporate profit margins. Strong profit margins provide substantive support for stocks. However, the quality of earnings in the banking sector, through the reversal of loan loss reserves, leaves a great deal to be desired. And now the banks are paying substantial for misdeeds.
In an effort to navigate the difficult market waters we have re-emphasized more defensive sectors: consumer products (Church & Dwight, Nestle, Smucker’s); pharmaceuticals and medical equipment firms (Pfizer, Johnson & Johnson, Covidien, Bristol-Myers Squibb); media and entertainment (Disney, Liberty Media); financials (Allied World Assurance, Loews) and as inflation hedges, energy (Devon Energy, Matador Resources and Whiting Petroleum) and timber (Rayonier and Weyerhaeuser).
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Stephen K. Bache, CFA
Sources: BloombergBusinessweek, The Economist, New York Times, The Wall Street Journal, The New Yorker; Simon Winder, Danubia
