▪ U.S. economic growth is improving, but this expansion remains anemic compared to previous cycles.
▪ We anticipate modest, if uneven, improvements in corporate earnings, which should help equity prices.
▪ A rising protectionist, anti-globalization wave could be a negative for the economy and financial markets.
U.S. equities climbed once again last week thanks to a Friday rally. The S&P 500 Index climbed 0.2% for the week.1 The first presidential debate dominated discussion early in the week, and investors focused on what Deutsche Bank’s capitalization issues could mean for the global banking system. OPEC announced preliminary plans to cut production, which drove up oil prices. The energy sector was the strongest performer last week, while defensive sectors underperformed.1
Weekly Top Themes
1. U.S. gross domestic product growth appears to be improving modestly. Second quarter growth was revised higher last week from 1.1% to 1.4%.2 Based on the economic data we have seen to date, we expect third quarter growth to climb to between 2.5% and 3%, with consumer spending rising more than 3%. Friday’s payroll report will be key to the outlook.
2. OPEC’s decision should help prevent another near-term collapse in oil prices. Details are vague and skepticism over exactly how OPEC’s production cuts will occur is warranted, but the decision to cut production by 200,000 to 700,000 barrels-per-day is significant. Increased odds of oil price stability are positive for both the global economy and financial system.
3. Slow growth and low inflation have created a weak economic expansion. Since the current recovery began in 2009, nominal U.S. GDP growth has averaged only 3.3%, compared to 5.3% during the last expansion.3 Low levels of credit growth, deleveraging, slow productivity growth, tight lending standards and the need for structural reforms suggest these trends may persist.
4. Corporate earnings may continue to struggle. Slow economic growth and deflationary concerns have put downward pressure on corporate earnings over the past eighteen months. These factors remain concerns, but we are seeing signs that earnings may improve. Nevertheless, it will be an uphill road for many areas of the market.
5. Profits are also under pressure. Poor pricing power conditions and rising labor costs will likely complicate an already difficult corporate earnings environment. Uneven profits and earnings trends make the need for investment selectivity critically important.
Slowing Global Trade Represents an Economic and Financial Risk
At this juncture, we think it makes sense to retain a pro-growth, pro-risk investment stance and believe that equities are better positioned than bonds or cash. We need additional clarity surrounding U.S. economic policy (which should come after the elections), and are closely watching the European banking system for signs of instability. On the positive side, we believe business confidence is strengthening, labor trends are positive and consumer spending should improve. This should help the U.S. economy accelerate modestly over the coming year. Government bond yields are exceptionally low, and we think it would take a significant deflation scare to push them lower, which we think is unlikely. As such, we anticipate government bonds will struggle to post positive returns in the coming quarters. Equities, in contrast, should experience modest tailwinds from improving economic growth and greater stability in commodities prices.