Quarterly Market Update
In this edition of the BBVA Compass Market Outlook, coming off a turbulent third quarter and a slowing global growth environment, Mses. Shackelford and Viguier-Galley were challenged to identify and defend five critical and positive measures of the U.S. economy.
1. Personal Disposable Income is Growing.
The U.S. is a consumer-driven economy, as is evident from the approximately 70% share of GDP held by Personal Consumption Expenditures. Money to support consumption comes from either a growth in real disposable income or by a reduction in the savings rate. In August, personal income increased $52.5 billion, or 0.3%, and disposable personal income increased $47.1 billion, or 0.4%, and is up 2.83% year-over-year according to the Bureau of Economic Analysis. Wages and salaries which account for about half of personal income increased by 0.5% nominally in August. Savings rates which are under less pressure as housing prices and incomes rise declined from 5.2% in July to 4.6% in August.
U.S. households have benefited from job growth, rising real wages as inflation is subdued, improving home prices, and lower gasoline prices at the pump. Supported by auto sales among others, consumer spending is up – nominal consumer spending increased by 0.4% in August. Consumer confidence has jumped around a bit, but at the September level of 103, it has come a long way since the all-time low in October 2008 when it plummeted to 38, its lowest level since its inception in 1967, as the financial crisis weighed on American household budgets.
The Fed’s preferred measure of inflation, the PCE, strips out food and energy, but these two items make up a large portion of consumer consumption, particularly at lower income levels. But cheaper or stable prices at the pump lift consumer confidence at all income levels – everyone gets a psychological boost seeing $2.00 a gallon gas at the pump.
Given that personal consumption is the primary driver of the U.S. economy, the strengthening in the financial positions of households acts as a stabilizer, offsetting headwinds from lower energy prices to other sectors of the economy, a strong dollar, and slowing global growth, particularly in China.
2. The lower price of oil has positively impacted consumers at the pump and given that U.S. production has fallen since April, the price of oil may be set to stabilize.
According to the National Association of Convenience Stores, close to 40 million motorists fill up on a daily basis, and gas purchases account for approximately 5% of total consumer spending. Given these numbers, it would be difficult to argue that gas prices do not play a role in how consumers feel about the economy, the hypothesis being that lower prices contribute to increased optimism.
Crude oil prices make up 71% of the price of gasoline. The balance of the price at the pump depends on refinery and distribution costs, corporate profits, and Federal taxes, and these costs usually remain stable, according to the Energy Information Association (EIA). Also, oil prices are a little more volatile than gas prices which means oil prices may rise higher, and fall farther, than gas prices.
Figure 1. Weekly U.S. crude domestic production fell on average by 500,000 barrels a day between April and August.
Figure 2. The price of oil per gallon appears to have stabilized during the month of September.
U.S. crude output fell by roughly 500,000 barrels a day between April and August according to the most recent EIA estimates. The agency also expects output declines to continue through August 2016. Recently lower production has helped oil prices to trade in a relatively tight range. Ideally, from a consumer’s point of view, it might be better if oil prices stabilized, rather than have any significant increase in the price in the short-term because this boosts consumer spending and confidence. We anticipate that with lower production, even if the WTI does not go to $50 or $60, at least it should not fall to $25. Stabilization in oil prices will certainly benefit the energy companies as well as those companies where energy costs make up a larger portion of their overhead.
3. The stock market’s correction during the quarter may herald the first widespread buying opportunity in over four years.
Most corrections are sharp, dramatic, and happen quickly, so what we saw in August was not unusual. The correction was primarily valuation based, and as such it brought valuations closer to their long-term historical average which is a healthy thing. A market that goes on for too long ends up in a bubble and then ultimately a crash, rather than a correction, occurs because markets always come back to a fair price.
But not only does the correction wring out excesses, bringing prices back to fair value, it creates buying opportunities. The market on average may be back to fair pricing, but there are many companies that appear cheap or are trading at attractive valuations. Many investors view the correction as an opportunity to buy or add to their positions, rather than a reason to sell, and see opportunities not just in the U.S., but globally.
We are coming to a seasonally stronger time of the year as November and December tend to be resilient performing months. If we see stabilization in some of the growth numbers around the world then there is good reason to believe the markets will stabilize for the remainder of the year without experiencing another leg down, and possibly with a modest continuation of the recent rally, which followed the correction.
4. Despite an increase in job layoffs this year, to-date, the layoffs have not increased claims.
Last month saw a surge in layoffs, primarily due to large-scale employee cuts at companies like Hewlett-Packard. U.S. companies laid off 58,877 workers in September, up 43% from August when about 41,000 workers were let go, according to data released by Challenger, Gray & Christmas. So far this year, employers have announced 493,431 planned layoffs, a 36% jump over the same period last year and 2% more than the total for 2014.
Although it is difficult to say how much of a lag effect there is from announcement to impact, the recent increase in layoffs has, as of yet, failed to show up as an increase in new claims or continued claims. A number of jobs cut will be absorbed through attrition, job freezes, and retirements. And while job cuts are never a good thing, job growth trends should absorb some of the loss. Although it is something to be aware of in the future, for now, claims are stable. In something of a colorful anecdote, J.P. Morgan contends that the percentage of people with some kind of criminal record has increased over the past few years, and that these people cannot pass the background checks that many companies require. J.P. Morgan believes that some portion of the currently 5.1% unemployment rate is attributable to these persons.
Although the most recent monthly jobs gains were disappointing, September is something of a seasonal time of the year. As long as monthly jobs gains continue on the current pace, the labor force will tighten which will at some point translate into wage growth. Companies will require economic growth or a declining or stable dollar to provide pricing power to offset the wage increases. But for now the fact that the labor market is stable to improving is certainly a positive.
5. After appreciating for almost a year and a half, the U.S. dollar appears to be stabilizing and even depreciating which mitigates one of U.S. multinational companies’ primary headwinds.
The greenback appreciated for over a year on the possibility of higher interest rates, but recently it has begun to depreciate relative to the euro and other currencies (see the differences in Forex movements for the different periods on the graphs below). Indeed, the dollar has strengthened so much so quickly over the last 14 to 18 months that is very possible that it could stabilize over the fourth quarter.
Figure 3. The greenback appreciated for over a year relative to key currencies on the possibility of higher interest rates in the U.S.
Figure 4. Year-to-date the greenback has begun to depreciated relative to the euro and other currencies.
A strong dollar is important for imports which benefits consumers. While a strong dollar has been a negative for companies who derive a large percentage of their revenues from overseas sales, a stable dollar would provide the opportunity to stabilize their accounting translation from foreign exchanges and help their revenues in U.S. dollars. The change should soon impact corporate year- over-year results.
Certainly what has revalued in over a year and a half will not entirely reverse in a quarter. And even if we get stabilization in the price of the dollar as well as with oil, the fourth quarter could be something of a non-event from the point of view of earnings, although going forward the impact should certainly be discernable.
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