Despite Lackluster Growth, Equities Remain Attractive

There were a number of events for markets to react to last week, including decisions by the Bank of England and Bank of Japan to enact new stimulus programs, sharp polling shifts in the U.S. presidential election and further decent corporate earnings results. U.S. stocks rose last week, with the S&P 500 Index climbing 0.5%.1 The technology sector saw particularly impressive earnings results and climbed 1.5%. In contrast, most other markets around the world were flat or down.(1)

Weekly Top Themes

1. July’s jobs report confirmed that U.S. economic growth remains on track. 255,000 new jobs were created last month, the unemployment rate remained at 4.9% and average hourly earnings climbed 0.3%.(2) These stronger-than-expected results raise the chances of a Fed rate hike before year end.

2. Long-term U.S. growth has been lackluster and will likely remain so. Since the start of the recovery seven years ago, real gross domestic product growth has averaged just over 2%.3 Tailwinds such as the improving labor market and low mortgage rates have been counteracted by headwinds such as low business confidence. We expect these crosscurrents will persist.

3. Nominal growth has been particularly weak this cycle. Compared to previous expansions, nominal growth (which includes the effects of inflation) has been extremely low.(3) Since nominal growth is determined by both unit growth and pricing power, this trend has been a primary culprit behind recent weakness in corporate earnings.

4. Increases in government spending are a mixed bag for the economy. After several years of a sequester-enforced decline in spending, government spending has increased in 2016.(4) While this boosts economic growth, additional regulations and increased control of private resources through stringent health insurance rules limit the economy’s ability to promote higher standards of living.

5. China’s economy is slowing, but the rate should be manageable. Fears of a Chinese hard landing have been a persistent worry for investors. Chinese authorities have been slowly shifting the country’s economy away from exports and investment spending and toward domestic consumption. We believe Chinese growth is slowing from the officially reported 10% level of a few years ago toward something closer to a more-sustainable 5% by the end of this decade.(5)

Despite Risks, the Global Economy Remains Resilient

Since the current economic recovery began, investors have contended with a number of economic issues. The most recent risk has been the extent to which the Brexit vote might trigger widespread contagion. So far, it appears that outside of slowing growth in the United Kingdom, effects have been limited. Investor worries are now focused on Italy’s banking and political systems. Italian banks are struggling with a rash of bad loans on their balance sheets and thin capital buffers. This storm has been brewing for some time, and coincides with the upcoming constitutional referendum that could reshape Italy’s political system. Investors are rightfully viewing the turmoil with caution.

In addition, many are questioning the overall state of the world economy in light of rising geopolitical instability, consternation over the upcoming U.S. elections, questions about global monetary policy, relatively low business confidence and a renewed slump in oil prices. Yet, we believe the global economy has been, and should continue to be, resilient in the face of all of these risks. We believe global monetary policy remains supportive of growth and the global recovery will continue, especially in the United States.

In this sort of environment, we continue to prefer equities over bonds and believe that 2016 will mark the fifth consecutive year in which U.S. stocks outperform U.S. bonds.1 Neither asset class is cheap, but we believe equities appear more attractive on a relative basis. For stock prices to continue to climb, we believe we will need to see better corporate earnings results, evidence that the European economy will continue to recover and more stability in oil prices. We think there is a reasonable chance that all of these themes will emerge.

1 Source: Morningstar Direct and Bloomberg, as of 8/5/16

2 Source: Bureau of Labor Statistics

3 Source: Bureau of Economic Analysis

4 Source: Congressional Budget Office

5 Source: Chinese National Bureau of Statistics

The S&P 500 Index is a capitalization-weighted index of 500 stocks designed to measure the performance of the broad domestic economy. The Dow Jones Industrial Average is a price-weighted average of 30 significant stocks traded on the New York Stock Exchange and the Nasdaq. The Nasdaq Composite is a stock market index of the common stocks and similar securities listed on the NASDAQ stock market. FTSE 100 Index is a capitalization-weighted index of the 100 most highly capitalized companies traded on the London Stock Exchange. Deutsche Borse AG German Stock Index (DAX Index) is a total return index of 30 selected German blue chip stocks traded on the Frankfurt Stock Exchange. Nikkei 225 Index is a price-weighted average of 225 top-rated Japanese companies listed in the First Section of the Tokyo Stock Exchange. Hong Kong Hang Seng Index is a free-float capitalization-weighted index of selection of companies from the Stock Exchange of Hong Kong. Shanghai Stock Exchange Composite is a capitalization-weighted index that tracks the daily price performance of all A-shares and B-shares listed on the Shanghai Stock Exchange. MSCI EAFE Index is a free float-adjusted market capitalization weighted index designed to measure developed market equity performance, excluding the U.S. and Canada. The MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance of emerging markets. Barclays U.S. Aggregate Bond Index covers the U.S. investment grade fixed rate bond market. The BofA Merrill Lynch 3-Month U.S. Treasury Bill Index is an unmanaged market index of U.S. Treasury securities maturing in 90 days that assumes reinvestment of all income.

RISKS AND OTHER IMPORTANT CONSIDERATIONS

The views and opinions expressed are for informational and educational purposes only as of the date of writing and may change at any time based on market or other conditions and may not come to pass. This material is not intended to be relied upon as investment advice or recommendations, does not constitute a solicitation to buy or sell securities and should not be considered specific legal, investment or tax advice. The information provided does not take into account the specific objectives, financial situation, or particular needs of any specific person. All investments carry a certain degree of risk and there is no assurance that an investment will provide positive performance over any period of time. Equity investments are subject to market risk or the risk that stocks will decline in response to such factors as adverse company news or industry developments or a general economic decline. Debt or fixed income securities are subject to market risk, credit risk, interest rate risk, call risk, tax risk, political and economic risk, and income risk. As interest rates rise, bond prices fall. Noninvestment-grade bonds involve heightened credit risk, liquidity risk, and potential for default. Foreign investing involves additional risks, including currency fluctuation, political and economic instability, lack of liquidity and differing legal and accounting standards. These risks are magnified in emerging markets. Past performance is no guarantee of future results.

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