Hercules Holds Up 2014—Weekly Market Review
As many of our readers discovered, the New Year arrived with a bang (or a blizzard, depending on your perspective). Winter storm Hercules (yes, the weather service has started to name winter storms, too) pummeled the Northeast and Midwest of the United States, and residents ran for the warmth and safety of their homes. Thinly-traded financial markets also shivered a bit during the holiday week with the S&P 500 Index losing about half a percent and Treasury bond yields ending slightly higher after a New Year’s Eve close just over 3% for the 10-year note. Although the snow in New York City at least has begun to recede, meteorologists are warning of an unusually cold winter to follow in much of the northern half of the U.S. Economists are often compared unfavorably with weathermen, but I think we’d be too cautious if we projected the past week’s financial losses to continue as well.
In our 2014 Outlook, Art Steinmetz and I laid out a case for global equity markets to outperform high-grade bonds again in 2014. For us to be right, major economies need to sustain the momentum they’ve built during 2013. We’ll have plenty to say week by week because that outcome is hardly assured, but most trends are favorable.
Start with the world’s largest economy. The economic expansion in the U.S., dating back to mid-2009, has been relatively lackluster, but it appears to be maintaining its recent momentum with manufacturing a surprisingly robust contributor. The Institute for Supply Management’s Manufacturing Purchasing Managers’ Index, despite falling in December to a still-healthy 57.0 from November’s 57.3 reading (any reading above 50 is consistent with economic expansion), saw the all-important new orders component remain very strong. Supporting this manufacturing story, U.S. total vehicle sales in December totaled 15 million on an annualized basis, a step below November’s robust sales but a far cry from the Great Recession days when automobile sales were tracking around 10 million per year. Sales for the year beat 2012 by 7.5%. The average life of a car on the road in the U.S. still remains elevated leaving room for continued growth in 2014.
Housing has also turned from being the economy’s biggest problem to becoming a source of growth. Although pending home sales in November were 4% lower than a year before, prices have continued to rise and, according to the S&P/Case-Shiller surveys are 13.61% higher than a year earlier. Houses are selling but at a slower pace and higher price—factors that along with higher borrowing costs are likely related. With a 1.1 million current annual rate of home construction and about 1.6 million new units per year required to meet potential demand, housing should continue to support private investment, employment, and household wealth during 2014.
A major question in my mind is when these positive trends produce acceleration in corporate capital investment and, crucially, employment. As I pointed out in the Outlook, U.S. capital stock is on average as old as it’s been anytime in the past 60 years and would seem poised for replacement. But it was nearly as old a year, even two years ago, and business have been as slow to invest as they’ve been slow to hire. As we recently discussed, November saw a sharp increase in investment, we’ll be watching to see whether this was a blip, possibly related to expiring tax credits, or an inflection point. The continuing fall in unemployment claims suggests that the cap-ex picture might be brightening.
We’ll learn more about employment on Friday with the monthly report for December, which will probably show some 200,000 net jobs created. I’d always urge that we pay more attention to the net job creation statistics than the unemployment ratio that always grabs the headlines. The unemployment percent will be even less useful over the next few months as emergency unemployment insurance lapses for as many as 1.3 million workers.
So far equity markets have generally punished business that use cash to expand, but they have also disliked revenue disappointments. 2014 winners will probably be companies that can convincingly invest in both capital and labor and also generate enough additional revenue to support earning growth. As we’ve shown in our paper on active management Active Investing: The Case for a High Conviction Approach, the margin pressure that may be the initial result of expansion reinforces the need for investors to select carefully as they seek equity market returns.
The Second Largest Economy
As we’ve said before, China’s ability to transform itself from an investment/credit-driven economy to a self-sustaining, domestic consumption model is the decade’s most important economic issue. The near-term story, however, is one of slower growth thanks to recently announced reform measures that are beginning to bite sectors dependent on easy credit like state-owned enterprises and local governments. In that light the slippage of the Chinese manufacturing PMI from 50.8 in November to 50.5 in December is the kind of modest expansion we should expect.
Evidence continues to mount that the Eurozone in the aggregate has become a modest contributor to global economic growth rather than the problem child (or grandparent) it’s been for the past four years. For example, the Eurozone manufacturing PMI for December rose to 52.7 from 51.6 the prior month. This positive reading masks many internal variations among countries, however, as France’s manufacturing PMI weakened to 47.0 from 48.4 and Spain’s strengthened to 50.8. Though “internal devaluation” (a euphemism for falling wages) may prove painful, at least some European economies may prove more capable of competition-enhancing reforms than we may have thought.
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