August 2016 Monthly Outlook
Employment rebounded in June as it was reported that 287,000 new jobs were added. This helped alleviate fears that the poor job growth in May might become a trend.
The first estimate of Q2 GDP came in at 1.2%, showing that the US economy continues to grow very slowly as this is the third straight quarter of growth below 2%. The slow growth has been caused by weak business fixed investment (in part reflecting weakness in oil and gas drilling) and declining inventory investment that has largely offset gains in consumer spending, home prices and personal income. The slow growth is expected to further push back the next Federal Reserve interest rate increase. Long term rates continued to decrease in July as the 10 year government yield dropped 3 basis points to 1.46% at month end, which is near an all-time low. The core consumer price index remained stable in May, within the Federal Reserve 2% target.
The Conference Board Leading Economic Index® (LEI) for the US increased 0.3% in June to 123.7. “The U.S. LEI picked up in June, reversing its May decline,” said Ataman Ozyildirim, Director of Business Cycles and Growth Research at The Conference Board. “Improvements in initial claims for unemployment insurance, building permits, and financial indicators were the primary drivers. While the LEI continues to point to moderating economic growth in the U.S. through the end of 2016, the expansion still appears resilient enough to weather volatility in financial markets and a moderating outlook in labor markets.”
Indicators point to the US economy growing slowly (~2% annually) and being in the late stages of a long business up-cycle without major excesses that brought down some prior economic upturns.
Bond and Stock Market Commentary:
With Q2 earnings season in full swing, it is proving to be a fulfilling one in which nearly 84% of the companies in the Standard and Poor’s 500 Index have beaten profit forecasts. However, the actual earnings per share growth was -1% year over year and +1% excluding Energy. The lack of earnings growth along with the increase in stock prices has pushed valuations near all-time highs. The market has tried to justify these high valuations because of low interest rates and the absence of compelling alternatives to stock ownership. This will make stocks more susceptible to a significant drop if earnings decrease further due to a recession.
In July the US stock index increased 3.65%. This increase was led by technology stocks. The price of oil deceased in July causing the energy sector to be the worst performing sector. In July we reduced allocations to high valuation consumer staples stocks to reinvest into stocks with lower valuations. Despite interest rates being low, we shy away from the utilities and consumer staples sectors due to their P/E ratios being in the 25-30 range, which is too high relative to the growth prospects on these sectors. We continue to find the healthcare sector valuations to be attractive.