Last week saw risk assets move substantially higher as domestic, international and emerging markets recorded gains of more than 2%. On a year-to-date basis, equity performance is less noteworthy as domestic equities have risen 3.7%, global equities 1.9%, and emerging markets 1.7%. By contrast, frontier market equities are the best performing geographic category, having risen 8.7% through last week. The S&P 500 is now within 1.5% of its all-time high set one year ago. In the two previous times the S&P has reached this level over the last 12 months, it has failed to break through the new high and declined shortly thereafter by more than 12%. That is not a prediction for what is to come, merely an observation of what has occurred recently.
The yield on US Treasuries remained relatively unchanged on the week, which is unusual given the strength in equities (yields generally increase when equities rise) and may be an indication that bond investors (often referred to as the “smart money”) don’t believe the equity rally is sustainable. Anecdotally, a number of hedge fund managers that I speak with regularly are viewing the market with skepticism, as they are finding few fundamentally cheap stocks to add to their portfolios.
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Q1 Doldrums: On Friday first quarter GDP growth was revised upward (drum roll)…. by a paltry 0.3% to 0.8% on an annualized basis. This represents the third year consecutive year in which the economy expanded by less than one percent in the first quarter (including 2014 when growth was -0.9%). In previous years, poor first quarter growth was blamed on the weather (i.e. the “Polar Vortex” events in 2014 and 2015). In 2016, warm weather was cited as a reason for slower growth, particularly in the retail sector. The chart below highlights the quarterly GDP composition during the last nine quarters (Source: FTN Financial)
In both 2014 and 2015 GDP growth rebounded solidly in the second quarter. We expect there will be a bounce in 2016 as well, but that it will be well below the Q2 growth rates of 4.6% and 3.9% experienced in the last two years (indeed the Atlanta Fed’s GDP NOW algorithm is currently forecasting Q2 annualized real growth of 2.9%). One reason we believe the rebound will be more muted is that U.S. companies have cut capital investment budgets in light of shrinking profits and political uncertainty. Equipment investment, while only making up 6% of GDP, can have a much larger impact on growth. For example, new equipment enhances labor productivity. Fortunately, the largest GDP component, consumption, remains an area of strength, as does housing, but sustained GDP growth in excess of 3% requires more than two cylinders of the economic engine to be firing.
Full Nesters: For the first time since the data began being recorded in 1880, more Americans 18-34 years old are living in their parents’ homes than with a spouse or partner in their own household.
There are a couple of interesting demographic characteristics related to gender and education level of the adult population living at home:
· Males are more likely to live at home (35%) vs. females (29%)
· Young adults without bachelor’s degrees are more likely to live at home (approx. 36%) vs. college educated (approx. 19%)
While this represents a new high, the “nesting” trend has in fact been decades in the making. One reason is that the median age at first marriage for both men and women has been steadily increasing. This is a generational shift that may be related to increasing life expectancies reducing the pressure on young adults to get married early. Another likely factor is that the percentage of employed young men and the level of their wages have been declining, reducing their ability to support a family. Yet another explanation may be that less stigma is attached to living at home versus earlier time periods. Whatever the reason, or reasons, the idea that parents raise and support their children for 18 years and then live happily ever after is increasingly a fairy tale. On the other hand, the Millennial cohort at 71 million is on par with the Baby Boomer Generation and far larger than the preceding Gen X cohort (41 million). At some point the Millennials will move out, which should increase new household formation and provide a tail wind to the housing sector (rentals and home sales). (Sources: Pew Research Center, Bloomberg and WJSchroer Company)
Economic Data Wrap-Up: April New Home Sales jumped 16.6% from March levels to a 619,000 annual pace, recording their highest level since January 2008 and the largest one-month increase since 1993. Flash Manufacturing PMIs for May show reduced manufacturing activity in developed economies. Specifically, they imply that economic growth in the Eurozone economies and Japan slowed in Q2. The flash PMI for the US also fell, but strength in the services sector should push Q2 GDP growth higher. While the headline Durable Goods Orders increased by an impressive 3.4% month-over-month (“m/m”) rate in April, it was largely related to a 64.9% spike in the volatile commercial aircraft component. Stripping that out, core orders increased by a meager 0.4% m/m, while (as noted above) equipment investment was weak declining by 1.9%.
Enjoy the Memorial Day holiday, but remember that freedom isn’t free. Thank those that have served, or are currently serving in the armed forces, and remember those that gave their lives for this nation.
Be well and godspeed.