September 2016 Monthly Outlook
Employment remained strong with the July jobs report showing that 275,000 new jobs were added. A second-half pickup in the economy appears to be right on schedule. After a slow first half, in which GDP growth hovered around 1%, there is continuing strength in most housing categories, new gains in the leading indicators, further increases in personal income and spending, and a nice increase in consumer confidence. Moreover, in a sign that the industrial sector is stabilizing, orders for durable goods rose in July, jumping 4.4%. This combination should lift GDP growth above 2% as the Atlanta Fed estimate for Q3 GDP is 3.2%. Long term rates increased in August as the 10 year government yield increased 11 basis points to 1.57% at month end. The core consumer price index remained stable in July, within the Federal Reserve 2% target.
The Conference Board Leading Economic Index® (LEI) for the U.S. increased 0.4% in June to 124.3. “The U.S. LEI picked up again in July, suggesting moderate economic growth should continue through the end of 2016,” said Ataman Ozyildirim, Director of Business Cycles and Growth Research at The Conference Board. “There may even be some moderate upside growth potential if recent improvements in manufacturing and construction are sustained, and average consumer expectations don’t deteriorate further.”
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:
The S&P500 was flat in August and has traded in the smallest 30 day range in over 50 years, staying within a 2% range for the past 30 days. This is the only time in the past 20 years the market has not had a 1% move. August 2016 traded in a range of only 1.54% and this is the 7th smallest range since 1928. This lack of volatility is unheard of and we can expect volatility to return soon and with a vengeance.
The U.S. stock market keeps pushing against new all-time highs despite the second quarter of 2016 being another quarter with negative earnings growth. Earnings were down approximately 5% (or 1% excluding energy) from the same quarter a year ago. This will be the sixth consecutive quarter with declining earnings - not the stuff of which record high stock prices are made. The last time the S&P 500 experienced double-digit earnings growth was in Q3 2014. Prior to that, there were three down quarters for earnings from Q3 2012 to Q1 2013. The last time there was really impressive earnings growth was in Q3 2011 - almost five years ago - when earnings were up 21%. This was during the final phase of recovery from the earnings collapse that took place between Q4 2007 and Q3 2009.
The recent behavior of earnings and stock prices has been somewhat surprising in the face of weakness in the fundamentals. This market price resiliency can only be explained by the way that in the short and intermediate term central bank liquidity drives stock prices (in the longer term, the piper must be paid and stock prices must regress back to the mean). The last time there was an analogous earnings situation to today was in 1998-99. Company earnings growth was negative for five quarters from Q1 1998 to Q1 1999. A short and sharp bear market in Nasdaq stocks took the index down 30% in August. In response to this and the impending Y2K issue (which turned out to be insignificant), Fed Chair Alan Greenspan flooded the financial system with a wave of excess liquidity (nevertheless, fed funds only fell as low as 4.63% in January 1999). Stocks consequently began a major blow off top starting in late 1998.
Central banks have maintained unprecedented easy money policies with close to zero rates and massive amounts of quantitative easing (QE) since 2008. The ante has been upped in 2016, with the ECB expanding its negative rate regime, the Bank of Japan instituting negative rates, and the UK beginning a new round of rate lowering with the goal of getting to zero, while at the same time expanding its QE program. This liquidity sloshing around the global financial system is enough to push U.S. stocks to new highs. This doesn't mean a massive 1999 type of rally is on the way. The situation now is very different than it was back then. After eight years of extreme levels of central bank stimulus, a little more easy money has a diminishing effect. Stimulus in all systems eventually loses its effectiveness because the system adjusts to it.