Guest Contributor: Sentiment Improving, Expectations Muted

By: Daniel Wildermuth, Co-Founder & Chief Executive Officer of Kalos Management, Inc.

Markets quickly dove down double digits to start 2016 before recovering all their losses within 90 days – a market first! Now various U.S. indices are within shouting distances of new highs, although they are also near the same levels first reached in late 2014. The strange mix of pessimism and limited good news has failed to inspire seemingly any level of investor confidence.

While we have been saying no recession is on the near-term horizon all year, consensus opinion finally appears to have grudgingly agreed. According to the Federal Reserve, the U.S. economy should expand at an annualized rate of 1.7 percent in the second quarter, half a percentage point higher than estimated as late as early May. While U.S. economic expansion did slow in the first quarter, growth was stronger than thought at 0.8 percent rather than the 0.5 percent reported last month. While the numbers are not great, they are well above recession levels, and past recession fears appear to have been largely driven by too much focus on struggling sectors such as manufacturing, bricks and mortar retail, and exports. In addition, some countries in recession seem to have gotten too much attention.

In the U.S., the main growth driver remains the consumer. Ongoing job growth, wage increases, reduced debt, higher cash levels, and strong consumer confidence are all drivers. The cash increase resulting from lower energy prices has not been factored into most consumers’ spending yet given the speed at which it arrived. This oil “dividend” check is larger than the greatest tax cut ever, and it’s continuing to build.

Housing data continues to impress. Contracts to buy previously-owned U.S. homes surged far more than expected in April to the highest level in more than a decade. U.S. retail sales recorded their biggest increase in a year during April as Americans purchased more of many goods including big ticket items such as automobiles. Online shopping remains the primary driver in the sector with growth expected to top 10 percent for year. Meanwhile, bricks-and-mortar stores continue to struggle, which has often resulted in a misrepresentation of the health of the sector as a whole.

While manufacturing in the U.S. continues to flirt with a recession as widely reported, the much larger and more important service side of the economy continues to perform well. The ISM Non-Manufacturing Index rose to 55.7 from 54.5 and the forward looking new orders component jumped to a robust 59.9 – a measure above 50 signals expansion.

The labor market continues to improve with the unemployment rate remaining at 5.0 percent while wages appear to be gaining some momentum. Average hourly earnings rose 0.3 percent and climbed 2.5 percent over the past year, the fastest rate of increase since the downturn. Wage growth is welcomed by consumers, but perhaps offers an early signal of coming inflationary pressures, which for now remain minimal.

After dipping all the way down to $27 per barrel, oil has bounced back strongly, breaching the $50 per barrel level in late May. As usual, the cure for low oil prices, is…low oil prices. Oil will likely remain within a $30-$60 price range for the near-term, but the destabilization of sub-$30 prices is likely past us, while the benefits of low oil prices continue to accrue to the wider economy.

While past threats to raise rates have rattled markets, expectations for a slow return to a rate policy closer to past norms appears mostly welcome by investors – a positive change from past panics that have commonly accompanied any hint of rate increases.

The elections will give this year a unique twist. The U.S. appears to have settled for two presumptive candidates, both with higher negative ratings than positive – a first. While markets usually mostly ignore elections, a year in which a new president must be elected because of term limits reveals a different pattern. Historically, markets have delivered returns over 10 percent less than usual. So what about this year? While no one knows, this year appears to offer a unique combination of extra domestic and international uncertainty that has impacted markets and may already be factored into prices. Regardless, it seems highly reasonable to expect increased election-related volatility, particularly as elections draw closer. It seems unwise, however, to get too caught up in any rhetoric. Short-term jitters and a new president rarely impact long-term market trends.

The International picture is also improving. Fears over a meltdown in China yet again appear vastly overblown. While China’s growth may have dipped below 7 percent, the second largest economy in the world is still growing at the second fastest rate in the world, somewhere north of 6 percent per year. News coverage on China has been so dire that I’ve been asked by more than one person about the “recession” in China. China is hitting some bumps as emerging economies inevitably encounter, but growth remains incredibly robust.

Europe also appears to be strengthening in spite of the recent turmoil. Business and consumer sentiment is improving, even in countries at the center of Europe’s political uncertainty. Overall, the Eurozone appeared to grow more rapidly in the first quarter than the 2.1 percent rate estimated by the EUs statistics agency. French economic growth in particular was stronger than anticipated, although strikes protesting labor law changes threaten to undo recent improvements. Progress remains slow, but growth appears to be picking up and recent policy moves appear likely to add to economic momentum.

U.S. economic growth remains anemic, but still very much alive and likely solid for the foreseeable future. Bull markets end for various common reasons such as recession expectations, accelerating inflation, tight money, excessive wage inflation, high interest rates, and investor euphoria. Today, none of these events appear imminent. As a whole, we believe global economies are solidly healing, which should drive a recovery in corporate earnings. Despite a seven-year bull market in the U.S. that is showing some age, various trends and indicators remain positive for equities.

Market conditions and current valuation, however, likely suggest that performance expectations for stocks should be muted. U.S. stocks could easily average only 6-8 percent for the next decade making a solid investment strategy and good investment manager particularly important.

The opinions in the preceding commentary are those of the author alone and do not necessarily reflect the views of The DI Wire.