We mentioned in several of our most recent commentaries that we could see the markets have a short term correction in the near term. This possibility will certainly be on the minds of investors as the reminders of the “April swoon” from last year will be discussed by the media. What are the implications for investors? Without uncertainties, there would not be opportunities. As we have noted in the past, bull markets do not announce themselves. The key is to look through the short-term noise and maintain focus on the big picture. In 1982, there were many factors keeping investors on the sidelines—unemployment of more than 16%, soaring oil prices on the back of the Iranian Hostage crisis, skyrocketing interest rates, near-20% mortgage rates and plummeting home sales. In short, if things feel bad today, they were awful then. But it was also the eve of the greatest secular bull market in American history. Those who waited till everything felt good again missed an enormous amount of upside.
U.S. Economic Data is still Improving
The U.S. looks positioned to maintain its slow but steady growth trajectory. Thanks to an upward revision in fourth quarter GDP growth, the U.S. has tallied 14 consecutive quarters of economic expansion. Many of the dislocations resulting from the 2008 financial crisis have abated. The recovery in housing has broadened. Home values and housing starts are on the rise, inventories have plummeted and the economics of buying versus renting favor ownership. Loan growth has resumed and delinquent loans have fallen. Mortgages aren’t being handed out, but they are becoming easier to secure. Consumer sentiment measures have bounced around, but the data is encouraging in aggregate. Consumer balance sheets are strengthening, as measured by a steep decline in debt as a percentage of disposable income, for example. A recovering housing market, rising equity market and increased access to low borrowing rates have contributed to a wealth effect that has carried through to better retail and auto sales.
U.S. Growth Headwinds Remain
There are potential headwinds to the U.S. recovery. GDP growth is estimated at 2% to 2.5% for 2013, but this annual expansion is likely front-ended. The impacts of sequestration have been relatively mild so far but could potentially deepen and lead to markedly lower GDP for the year. We are also watching corporate profit growth closely. Market participants are too, as evidenced by recent echoes of last year’s “April Swoon.” On the employment front, it’s a few steps forward and a few steps back, underscored by March’s steep hiring slowdown. We expect the Federal Reserve to continue to keep its bond buying program in place and do not expect to see any change until we see monthly jobs numbers to start to run above 200,000 per month. The Fed has set a target of 2% inflation and 6.5% unemployment which gives the market a fairly clear understanding of what they are doing. This should provide some buffer from any major market swings that could result if any sudden shift in Fed policy is made.
Emerging Market Improvement would help carry the rally in Equities
As we noted in our quarterly commentary, emerging market equities lagged during the first quarter, as concerns grew surrounding the potential for a shift away from more accommodative monetary policies and potential vulnerability to events in Europe. Of course, tighter policy could create headwinds for economic growth but, at this point, we believe that the emerging market economies are in good shape on the whole and can continue to contribute to global expansion. Inflation remains a concern in some emerging economies, particularly given its relationship to social unrest. Overall, the constructive long-term investment thesis is intact. The stronger balance sheets that many emerging market countries still possess provide flexibility in managing policy, and secular consumer trends provide powerful tailwinds for growth. Economic growth targets remain competitive relative to developed markets, but countries will likely have varying success in reaching them. China looks relatively well positioned to achieve its growth objectives as data suggests a broad-based recovery is underway. In particular, construction has benefited as massive government infrastructure projects continue. Business confidence has also been on the upswing, and manufacturing PMI data indicates expansion, albeit mild. Inflation in China has remained largely contained as input prices have declined. Meanwhile, India has put forth a growth projection above 6% for 2013, but relatively higher inflation pressures—including food inflation—creates some added hurdles for growth as well as for economic reform issues. Brazil is edging close to its target for inflation, and has seen slowing industrial production.
While we do expect some short term volatility over the summer, longer term we think equities are very likely to perform well due to low valuations and the eventual rotation out of bonds in anticipation of higher interest rates. We will continue to monitor earnings over the next few weeks and provide updates on anything significant with the investments we own. Apple and other technology stocks as well as Bank earnings will have a significant impact on investor sentiment.