Quarterly Market Update
Consumer Spending Trends are Critical Determinant of Economic Growth
The Fed’s discussion of interest rates pivoted in first quarter from assurances that rates will remain low as long as necessary to a more pointed discourse about when the first hike will occur. The parsing of Fed Chairwoman Janet Yellen’s every sentence continued, particularly after the all-important word “patient” was removed from the Fed’s official statement following the March Federal Open Market Committee (FOMC) meeting. And small wonder, given that when the word was first added at a press conference in December, the stock market subsequently saw the best single-day rally of the entire year. Market consensus following the recent more dovish statement was that the new language could set the stage for a fed funds rate hike earlier this summer, rather than later in the fall.
Certainly the payroll data has been supportive of tighter monetary policy. The U.S. economy added 295,000 new jobs in February, marking the 12th consecutive month of 200,000-plus gains, despite the fact that much of the Northeast and Midwest were slammed by harsh winter weather. The headline unemployment rate fell to 5.5%, the lowest in almost seven years when it stood at 5.4% in May 2008.
Figure 1. Non-farm payrolls have increased by over 200,000 in each of the past 12 months.
However, despite overall robust jobs growth, average hourly wages have risen at a very sluggish average annual rate of only two percent since the expansion began. In an indication that perhaps the labor market is tightening and competition for low-wage workers increasing, both Starbucks and Walmart announced increases in entry wage levels. Walmart is increasing minimum wages to at least $9 an hour in April and to $10 an hour in 2016, above the minimum wage of $7.25.
U.S. consumer confidence rose in March, according to the Conference Board, a private research group, driven by an improved short-term outlook for employment and income prospects. However, consumer spending rose by only 0.1% in February after declining in January. Winter weather and cheaper oil and gasoline prices may have contributed to February’s paltry gain, but the concern is that even though gas prices have essentially been cut in half across the U.S., there has yet to be a jump in consumer spending. The disappointing results pushed down the estimates for first-quarter GDP.
The real question is whether or not the ECB can successfully navigate a massive bond-buying program to the extent that the Fed was able to do so.
We are currently forecasting 2.9% U.S. GDP growth for 2015, up from the 2.4% posted in 2014. Although the economic data has not been as robust as we would like, estimates for the first-quarter 2015 growth are still largely positive, unlike the first quarter of 2014 when the economy contracted under harsh weather conditions.
Conditional upon continued progress in the jobs market, the Fed will likely begin the process of normalizing interest rates before the year is over. Certainly inflation remains below the 2% target, which gives the Fed additional wiggle room should the economic advance show signs of stalling. We anticipate that the interest rate hike will be slow, gradual, and data dependent which will allow the economy time to adjust to the change.
We view the anticipated rate hike as indicative of healthy economic recovery. While the labor market is in no danger of overheating, nonetheless, the economy has come a long way since losing over eight million jobs in 2008 and 2009 after the financial crisis pushed the economy into a deep recession that lasted from 2007 to 2009. The Fed created the most expansive monetary stimulus in its history to turn employment around. The fact that the Fed is finally able to begin unwinding such an expansive stance is a strong evaluation of the resiliency and promise of the U.S. economy.
The impact of higher rates on stocks could be a different story. While company earnings have continued to rise and are at an all-time high, the twin drags of falling oil prices and a surging U.S. dollar could dampen the jobs market recovery. Some U.S.-based multinational companies like Coca Cola and Johnson & Johnson are cutting back on hiring because almost half of their revenue is generated overseas, and a stronger dollar reduces the value of the profits earned abroad when they are converted back into dollars.
On the other hand, spring and summer is typically a good season for the housing market, although affordability and tight inventory still prevent many families from purchasing homes. New housing starts fell 17% in February to less than 900,000 after reaching levels as high as two million in the past. However, once past the deterrent of winter weather, conditions are favorable for a rebound. Interest rates are near historic lows and the economy has added on average over 321,000 jobs in each of the past four months. Should improvements in the jobs market translate into more housing starts, the resulting payroll gains could help offset hiring weakness among companies with more global footprints.
The consumer is key to the outlook for the remainder of the year. There is some concern that what is good for Main Street and employees does not necessarily translate into gains for the stock market. Companies should be in the position to raise wages because higher discretionary incomes translate into greater demand for their products. But just as we have seen lower gas prices fail to translate into higher consumption, there is some concern that wage increases could also fail to move the consumption needle.
Consumers are certainly more reticent about spending money. While corporate profits have been strong coming out of the recession, the pain has been felt to a much greater extent at the consumer level by normal people who may have lost their jobs and their homes, or taken jobs at a lower pay level. Those that were impacted by such loses have a longer memory than the stock market. Consumer spending may not return to the pre-financial crisis spending levels for a time, and for an economy that is over 70% consumer consumption driven, the impact could be significant. However, if the concerns are unfounded, and we see lower gas prices and higher wage growth eventually translate into an increase in consumer spending, then it could be a huge tailwind for the stock market.
The European Central Bank (ECB) began a massive QE program this quarter, and the equity market has judged the program an early success as money flowed out of foreign debt and into foreign equities. A more long-term reversal of the sluggish growth conditions in the Eurozone should be a positive for global economies. The as-of-yet unanswered question is whether or not the ECB will be able to successfully navigate their QE program to the extent that the Fed has done.
We conclude with the reminder that the risk of geopolitical events is, as always, an unpredictable headwind for global economies.
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