Key Points

• U.S. economic growth is slow, but may accelerate in the coming quarters.
• The key variable for equity markets remains corporate earnings. We expect better results in the second half of 2016.
• Investor sentiment should improve as well, reinforcing our pro-growth investment view.

The uneven market uptrend in place since mid-February resumed last week, with the S&P 500 Index climbing 1.7%.1 The primary catalyst appeared to be better-than-expected corporate earnings results in the still-early reporting season, particularly from the banking sector. As a result, bank stocks performed particularly well, rising 7% last week, marking the best weekly gain in over four years.1 Investors also focused on better economic data coming from China and ongoing evidence that the U.S. economy is growing slowly.

Weekly Top Themes

1. U.S. economic growth should rebound after a weak first quarter. We think first quarter real gross domestic product will likely have advanced by less than 1%. A deteriorating trade balance, declining inventories and falling automobile sales all point to an economy that is growing only modestly. Looking ahead, indicators such as the latest beige book reading from the Federal Reserve (which showed a pickup in wages, consumer spending and hiring) suggest growth should accelerate in the coming quarters.2

2. Manufacturing data remain mixed, but should also improve. Following positive results from the previous weeks, March industrial production numbers ended worse than anticipated.2 It appears that the effects of the stronger dollar and anemic global trade remain headwinds, but we believe these drags are beginning to fade.

3. Likewise, consumer spending should accelerate. Consistent with other economic readings, March retail sales figures were disappointing.3 But the strong jobs market and rising wages suggest consumer spending levels could be also poised for an uptrend.

4. Improving economic growth should help corporate earnings. S&P 500 earnings have been flat to negative for the past five quarters.4 This largely explains why equity prices have remained static over that time period. We think broader economic acceleration should help earnings to recover in the second half of 2016. This should be a positive for stock prices.

5. Rising labor costs are a potential risk. Slow wage growth has been a plus for corporate earnings over the past year. But wages are finally rising, which presents some negatives. Growth in average hourly earnings is approaching its fastest pace in five years,5 and declining unemployment levels should continue exerting upward pressure on wages. This is a positive for consumer spending, but complicates the corporate earnings outlook.

Long-Term Conditions Favor Equities

We have witnessed two double-digit equity market declines and subsequent rebounds since last summer. In both cases, the initial sell-off was mainly due to concerns over global economic growth (first in China and secondly in the United States). Over the past couple of months, conditions appear to have stabilized, and risk assets have held up moderately well. Signs of economic and policy clarity from China have helped, as have renewed commitments toward pro-growth policies from global central banks.

At this juncture, we believe the economic backdrop and relative valuations favor equities over bonds and fixed income credit sectors over government-related areas. The keys toward whether our view is correct will probably be ongoing improvements in the global economy and an increase in investors’ risk appetite. We are fairly confident that the former condition will materialize, but the latter is less certain. Sentiment is better today than it was a couple of months ago, but remains tilted toward the bearish view.

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