Federated Investor's Senior Equity Strategist, Linda Duessel, provides her insight on this year's market volatility in Federated's weekly update, Main Street is Calmer than Wall Street for a Change.
"I spent most of the week in San Diego, where I wasn’t prepared for the 80-degree temperatures and blinding sunshine, leaving my sunglasses at home (living in cold and cloudy Pittsburgh, I only associate sunglasses with summertime). Well, a chill adviser gave me hers! It’s all chill here. Walking along the water, there is a young man practicing tai chi—be calm, find your center. He’s not worried. Further along my walk is a tarot card reader having an intense discussion with a couple—I’m not eavesdropping but I think the discussion is personal and not about the markets. And a little further down is a vendor selling dream catchers—ever heard of them? Off to meetings with advisers, one lamented, “What do you tell clients?! They look at the screens and say ‘blankety blank blank.’ ” Indeed, despite very good fundamental data (see below), markets are behaving as if the global economy is sleepwalking into a low-intensity recession. No systemically important economy is contracting, but many sectors are experiencing recession-like conditions—manufacturing in the U.S., where today’s data show inventories to sales still out of whack—and some markets are delivering recession-like returns. JP Morgan notes that what isn’t recession-like is volatility, which has risen less than the trough-to-peak moves typical of major economic downturns—hence the concept of a low-intensity recession, i.e., the same dismal returns without the economic distress and extreme market volatility.
Deteriorating financial conditions reflect concerns about the health of European and Japanese banks, the effects of negative interest-rate policies and the contagion effects on U.S. banks, Ned Davis Research says. It thinks the Fed should be more focused on shoring up confidence in U.S. banks than on its primary monetary policy objectives (i.e., employment and inflation). Fed Chair Yellen’s congressional testimony this week didn’t touch on such or much new, though she did discuss negative interest rates (oh great, something new for my nightmares). Renaissance Macro thinks financial-crisis worries starting with European banks are overdone. It notes the Portuguese central bank’s handling of a problem bank relied on a “bail-in’’ solution that put the burden on senior debt holders, not a counterparty. This suggests that while European banks may face multiple hurdles with compressed margins and a slowing global economy, counterparty risk does not appear to be among them. And without counterparty risk, it’s difficult to have contagion risk. At the end of the day, the market trades on earnings, and the news there doesn’t seem to be as bad as the market is taking it. With more than four-fifths of the S&P 500’s market cap having reported, earnings are beating by 4.4% while revenues have met expectations. Ex-energy, earnings-per-share (EPS) is on pace to rise 4.1%. In Q4 2015, EPS for the core of the S&P (i.e., excluding commodity businesses and the financials) was up about 4% on a top-line gain of 3% adjusted for currency translations, and margins were up slightly. In past periods when top-line growth was in the low-single digits, margins usually came down, so any increase is an achievement of sorts. The debt coverage problems of some energy and metals producers don’t look generalizable to the rest of the market, Empirical Research says, noting the rise in the debt-to-equity ratio for other sectors isn’t that much and is largely attributable to debt-financed acquisitions and the effects of buybacks on shareholder’s equity. The bottom line: profits are less likely to crumble in a downturn than they were in those of the past.
The drama is in the emerging world, not in Corporate America. It will take a demand shock considerably bigger than what we’ve witnessed thus far to undermine profitability. (I am Team USA.) At a fascinating meeting in San Diego, advisers wanted to first discuss negatives and then positives. Their view that energy is a huge percentage of our economy has them very worried about economic and earnings growth prospects. On the other hand, these Californians were very well versed in the unbelievable technological advances that will continue to change/remove/create new industries. Well, isn’t progress bullish? “Yes!” Millennials—115 million people, many of whom will marry and buy homes (people don’t change)—isn’t that bullish? “Yes!” A U.S. economy in which the labor market and household finances continue to improve does not fit with an economy about to head into a recession. Even the typically cautious Atlanta Fed has raised its 2016 GDP forecast to 2.5%. Lower recession odds should reduce worries about more significant downside risk in the short term, though increasing wage pressure and still-weak top-line growth aren’t positives for profits. In short, this environment is better for Main Street than Wall Street, a common theme in my travels around San Diego. I was asked what I’m seeing along this country’s Main Streets and I told them outside of the secular decline in shopping malls, I see packed restaurants and relaxed consumers. Sitting in the airport, waiting for my flight back home (to subzero wind chills!), a man walks down the hall, singing at the top of his lungs and no one is looking up! This place is quickly rising to my top two destinations." Download below to read full report.
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