’Tis the season of the wonderful milestone of graduation, that rite of passage that marks a transition from one stage in a student’s life to another. Beyond all the pomp and circumstance, the caps and gowns, the boozy celebrations and maudlin speeches, graduations challenge us to shift beyond the preparation and anticipation of a contemplated destiny to embrace the living of its reality.
In many ways, the global economy and markets are experiencing a graduation of their own in 2014, from the anticipation of recovery from the depths of the Great Recession to the realization that we have now moved well beyond that fateful time. Supported by the juice of unprecedented monetary policy easing, equity markets, true to their forward-looking nature, anticipated an economic and earnings recovery some time ago, allowing many markets to achieve record highs since 2008.
Today, in 2014, that momentum is being tested some, now that we have actually graduated to the growth environment we anticipated. In our postgraduate life, market action is likely to be more volatile, oscillating between triumphant realization of milestones achieved and worried uncertainty. We continue to grapple with issues such as high unemployment and subpar growth, legacies of our past that could become structural problems rather than just cyclical overhangs.
Ultimately, as all graduates soon learn, success in the real world depends on the value you provide other people and organizations. Companies will likewise need to differentiate themselves with revenue and earnings growth. Countries will have to show economic leadership above and beyond their liberal application of monetary policy.
Fundamentals will matter again, making for a more nuanced environment sure to put investors to the test.
U.S. Will Return To The Head Of The Class
After a tremendous acceleration in 2013, the U.S. economy’s stall to a mere 0.1% annualized growth rate in the first quarter has raised doubts about the sustainability of our domestic recovery. To be sure, an unusually severe winter froze fragile consumer sentiment, capex and housing-related construction. GDP growth was also restrained by payback from a buildup in inventories in the third quarter of last year, not to mention a slowdown in exports thanks to difficult shipping conditions and weakness overseas.
While it may seem cavalier to dismiss Q1 U.S. economic weakness as isolated and unimportant to the long view, investors have been wise to not cast so gloomy a verdict, allowing stock prices to remain resilient, if not range-bound. That view is being supported by notable improvements of the data in recent months, including a return to healthy consumption as evidenced by the rebound in retail sales in March, which were up 3.7% from a year before, not to mention a recovery in vehicles sales now running at a 16 million annualized sales rate. By April, job creation had also reaccelerated, durable goods sales were on an upswing, and industrial production, which shrank in January, rebounded in February and March.
Unfortunately, the housing market’s loss of momentum seems more than just a transient weather-related occurrence, as limited supply and declining affordability are restraining activity. Another ongoing challenge is the trend of flat wage growth, which has restrained more buoyant consumer spending. On the corporate side, U.S. firms remain tentative about expanding their business and are holding back on investments.
And yet, first-quarter earnings trends were surprisingly strong, especially given the sluggish economic backdrop in which they were generated. By early May, with 89% of the S&P 500 reporting, earnings for large-capitalization companies gained a solid 5.2% on average, which was driven by revenue growth of 2.4%. Small and midsize companies were more impressive, showing revenue gains of 6.7%, which lifted earnings 10.2%.