The rally in U.S. equities resumed last week with the S&P 500 Index climbing 1.8%. Although expectations for the upcoming corporate earnings season are low, investors have instead focused on the positives. Specifically, investors reacted to dovish comments made by Federal Reserve Chair Janet Yellen which counteracted some more hawkish comments made by Fed officials the previous week. Other asset classes came under pressure, including commodities and oil, causing some skepticism about the recent rebound. The oil sell-off was due to heightened doubts about the ability of major producers to formalize a production freeze agreement. The market falsely still believes that the oil supply/demand equation is dependent upon OPEC cutting production. OPEC has basically succeeded in their goal of putting pressure on U.S. shale producers to reduce the historic increase in production which we have seen over the past ten years due to new technology allowing companies to more efficiently extract oil and gas. OPEC kept prices low for a sustained period of time to make it very difficult for U.S. oil producers to make money. OPEC knows that the supply/demand equation is likely already going to reverse because they have forced over 1,000 U.S. and global Rigs to be taken offline and that will likely take care of the supply glut over the next 6-18 months . Oil drilling and exploration investment in the U.S. is down by nearly $100 Billion over the past two years and future investment will also be impacted by this historic drop in oil prices due to the fact that new investors may not be willing to invest due to uncertainty of oil prices. This in effect is what OPEC also is trying to accomplish because it may help keep the average price of oil in the $60’s or $70’s over the next decade instead of possibly watching it fall much lower if U.S. oil production continued to grow at the same pace as the last ten years. Our basic point here is that OPEC is not worried about production cuts by OPEC members – they got all the cuts they needed from the U.S. producers! They will likely say whatever is needed to get the sentiment to change on oil so that prices in the futures markets start to rise again soon…
Weekly Top Themes:
- Strength in the labor market reinforces our view that the economy remains in solid shape.The March jobs report was mostly good news. Payrolls increased by 215,000 last month, and the unemployment rate ticked up to 5.0%. The data suggest more Americans are entering the labor force. Average hourly earnings were better than expected, climbing 0.3%, although they are only up 2.3% for the quarter on an annualized rate. Overall, the data suggest that while the economy may not be accelerating rapidly, it is growing.
- Manufacturing may be finally shifting into a higher gear.The March ISM Manufacturing Index beat expectations by rising from 49.5 in February to 51.8 in March (any number above 50 indicates growth). This was the highest level since last July. The details within the report were strong, with new orders showing a particularly large increase. It appears to us that the recent stabilization in oil prices and the decline in the dollar are improving prospects for the manufacturing sector.
- The Fed is likely to remain cautious in its rate increase efforts.Janet Yellen’s comments indicated that while she acknowledges improvements in the economy, she is also focused on weaker international growth. The Fed is clearly in no hurry to raise rates again. We expect to see one increase this summer and probably one additional increase later in the year.
- We expect first quarter real gross domestic product to be about 2.0%.The economy is enjoying a number of tailwinds, including low mortgage rates, healthy consumer income growth and low energy prices. Weak growth overseas is a drag, however. Although we have a positive view toward the consumer sector, real consumer spending levels have sagged a bit in recent months.
- Near-term weakness in corporate earnings may persist, but results should improve later this year.First quarter earnings results will be released soon, and we anticipate the numbers will show a year-over-year decline. We believe corporate profits are bottoming, and expect to see better results in the second half of 2016 as headwinds fade from the “oil down/dollar up” dynamic.
U.S. equities have rebounded sharply over the past couple of months, with the S&P 500 rising by an impressive double-digit rate. The gains are partly due to investors covering short positions as they have apparently recognized that the economy is in better shape than was feared in January. The rebound in oil prices has also reduced worries over deflation and provided support to risk assets, including equities and high yield bonds.
In our view, the global economy remains rocky and is still dependent on supportive monetary policy in some regions. In the near term, equities may experience some consolidation given the extreme pace of recent gains. We don’t expect to see a sustained uptrend in equity prices until investors grow more confident in the global economy and become convinced that oil prices won’t experience a renewed rout.
Nevertheless, we believe global growth conditions will improve as the year progresses, which should provide more support for corporate earnings and allow equity prices to rise. As such, we continue to have a moderately constructive outlook and a favorable view toward risk assets on a six- to twelve-month basis.
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