Current economic events
Global markets largely shook off last week’s scare of increasing tensions between the United States and Iran when both sides opted for de-escalation. Iran initially struck back after the U.S. killed top Iranian General Qasem Soleimani, targeting an Iraqi base that housed U.S. service members in an air strike, though there were no casualties. President Trump responded by issuing new sanctions on senior Iranian officials, but not executing further military actions, which was taken as a signal of de-escalation by the market. This caused crude oil and gold to lose early week gains while equity markets continued their steady march higher. Markets also responded positively to greater clarity on U.S./China trade when Vice Premier Liu confirmed he will travel to Washington this week to sign the “phase one” trade deal. Though specifics of the agreement are still unknown, we expect the United States will reduce tariffs on Chinese imports and China will increase purchases of American agricultural goods. Finally, the U.S. December jobs report showed the economy adding 145,000 jobs during the month, which is on the lower end of recent readings. The rate of growth in payrolls was the slowest since September 2017 and temporary hires, which tend to lead payroll growth, contracted faster. Even so, the unemployment rate of 3.5 percent remained at a 50-year low. Wage growth continued to slow off early 2019 highs, dropping below 3 percent for the first time since September 2018. Our proprietary global Health Check, which tracks more than 700 economic data points to analyze the relative well-being of economies worldwide, ticked down in December but remains near its strongest in eight months. We believe this indicates economic growth is stabilizing around current low levels.
U.S. economic data trended upward last week, with increasing business confidence offsetting the soft jobs and manufacturing data. The Institute of Supply Management’s (ISM) non-manufacturing purchasing manager’s index (PMI) and Markit’s services PMI both increased in December and remain indicative of expansion in the sector. Sentix’s survey of investor confidence showed another strong increase in both expectations and the perceived current situation of the economy. The Conference Board’s CEO Confidence survey showed sentiment rebounding in the fourth quarter from near-recessionary levels, though it remains in moderately negative territory. Factory orders for November were mixed, with core capital orders growth rising into expansion for the first time since June, but headline orders contracting faster. Our U.S. Health Check, which is a statistical measure of the average health of current U.S. economic data, is flat month-over-month, indicating some stabilization of economic growth at recent low levels.
Foreign developed data was divergent across economies, with Europe appearing to stabilize and Japan tipping closer to contraction. The eurozone’s economic confidence indicator, which is highly correlated to growth in gross domestic product (GDP), rose for the second straight month, but remains near its weakest point since early 2015. Composite PMI for the bloc increased, indicating a modest expansion in the private sector. Eurozone price inflation rose in December for both consumers and producers. While still at low levels, the improvement is a positive for economic expectations. In Japan, the Leading Economic Index fell to its lowest level since November 2009 and the Coincident Index, another Japanese economic indicator, dropped to its softest point since February 2013. In addition, November personal consumption expenditures (PCE) did not improve meaningfully in the month after Japan’s consumption tax hike and continued to decline year-over-year. It’s getting difficult to see where Japanese growth is going to come from in its fourth quarter GDP report with key indicators like PCE and industrial production contracting. Our foreign developed Health Check has fallen to its lowest level since August 2013, indicating this region is likely to continue its recent economic slump.
Emerging market economic data continues to improve in most major nations. Sentix’s January survey shows that Asia, not including Japan, has seen the biggest rise globally in investor perceptions, with expectations the highest since December 2017. December services PMIs improved in many emerging markets, though both the official data (managed by the China Federation of Logistics and Purchasing) and Markit PMIs slowed in China. Chinese consumer inflation was stable in December, with a slowdown in pork price inflation, which had driven much of the rise in overall consumer prices, offset by an acceleration in non-food inflation. Producer prices also deflated slower during the month but remain in a firm downtrend. Our emerging market Health Check slipped in December but is still the second-best reading in nine months. The indicator is well below its long-term average, though trends have turned up, indicating that growth may be accelerating off the lows.
U.S. equities are off to a strong start in 2020, with the S&P 500 advancing to new highs last week and up 1.1 percent for the new year as of January 10. Many of the factors that bolstered performance in 2019 remain intact. Fundamental and sentiment indicators are mostly positive, supportive of a risk-on (more aggressive) bias, and momentum indicators point toward a market that seems poised to trend higher.
Unlike 2019, when higher stock prices were derived largely from multiple expansion on flat year-over-year earnings, we believe upside to equity prices in 2020 will be derived from earnings. Consensus earnings expectations for S&P 500 companies in 2020 are approximately $175 per share, according to Bloomberg, FactSet Research Systems and S&P Global. We expect earnings projections to moderate from early-year optimism as the year progresses. Even earnings of roughly $170 per share for 2020, versus the expected $175, reflect year-over growth of approximately 8 percent, with overall growth spurred by modest economic growth both home and abroad, a stable U.S. dollar and slightly higher energy prices.
The fourth quarter earnings period unofficially begins this week with the release of results from several money center banks. Expectations are low, with year-over-year earnings projected to decline 1.7 percent, according to FactSet Research Systems. Fourth quarter 2019 is a transition quarter; expectations for the quarter are low compared to more optimistic outlooks for 2020. This environment seems ripe for beating expectations. If this were to occur, it should result in near-term upside to equity prices. We continue to track key macro-economic indicators, including our propriety economic Health Checks and manufacturing indicators, such as the Institute of Supply Management (ISM) manufacturing survey, which has been soft for the past two months. The January ISM manufacturing index is slated for release on February 3.
Sentiment remains generally positive for U.S. equities. Performance continues to be broad-based, with growth/cyclicals outpacing defensives in recent weeks. Valuations are elevated, but still short of extremes, thus increasing the importance of earnings to provide valuation support. The S&P 500 is currently trading at roughly 19.5 times 12-month forward earnings, above the 30-year forward 12-month average of 17.1 times. Equities are priced toward the high side of fair and, perhaps arguably, with a narrow margin of error.
Our published single-point year-end 2020 price target for the S&P 500 is 3,400, based on a multiple of 20 on earnings of $170 and roughly 4 percent above Friday’s close. The upper-bound of our price target range of 3,570 is based on a multiple of 21 times earnings of $170. Restrained inflation, low interest rates, the dovish Federal Reserve (Fed) and moderate earnings growth serve as the basis for higher stock price and our overall risk-on bias.
Fixed income markets
Treasury yields remain low and trading within a narrow range, while U.S. corporate credit spreads (the difference between corporate bond yields and Treasuries) remain tight by historical standards. Job data was slightly weaker than expected last week, with hourly earnings growth lower than expected and average hours worked ticking lower. The report reinforces our view that the Fed will remain on hold for the foreseeable future and the bar remains quite high for a rate hike. Low inflation and inflation expectations continue to suggest a cut is more likely than a hike later in 2020. U.S. consumer and producer price index data releases this week may shed additional insight into the inflation picture.
Low Treasury yields and tight credit spreads indicate bond returns are likely to be subdued in 2020, a stark contrast to strong 2019 returns across bond categories. It remains critical to maintain near-benchmark portfolio duration within bond allocations to help ensure ample portfolio diversification.
Defensive sectors of the market (Real Estate, Infrastructure and Utilities) traded higher last week, but were unable to keep up with the broader market. For the year, the defensive sectors are trailing the S&P 500 by 1.25 percent. We see these sectors as fully valued and with decelerating income growth. It will be hard for these sectors to outperform in 2020, unless global economic growth disappoints and interest rates move to lower levels.
Crude oil prices, as represented by West Texas Intermediate (WTI), collapsed 6.5 percent last week. For the first 10 days of the year, WTI is down 3.3 percent. The primary catalyst for the move was the fairly rapid de-escalation of United States/Iran tensions. However, domestic fundamentals also were negative for prices. Weekly crude reports showed large increases in inventory levels for both crude and refined products, such as distillates and motor vehicle gasoline. Also, domestic production remained at all-time highs. The crude oil market has experienced price spikes in response to increased tensions in the Middle East. However, those price spikes have been subdued. Additionally, the market retreats from those higher prices quickly. This tells us that the market currently is not worried about a lack of supply.
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