Despite Volatility, Global Economy Looks Stronger
Despite volatility, global economy looks stronger
So far this year, the financial markets have given us a volatile ride. But it’s a ride that has left us just about where we started. It’s not exactly that nothing happened, of course, but the S&P 500 Index ended the first quarter essentially flat. The volatility stems largely from two things: since January we’ve seen a steep decline in energy prices and a sharp rally in the dollar.
While those two factors have roiled the markets, there remains enough good news related to economic fundamentals that stocks generally bounced back from intermittent losses. Yet while the S&P 500 Index hit record highs at times during the quarter, investors haven’t been able to capture much gain given the volatility. Overseas, the news is a bit better as easy money policies from major central banks and signs of stability in some economies helped lift stock prices. Here are my key thoughts as we look out over 2015:
- There is a stronger economic backdrop in Europe and Japan, thanks to quantitative easing measures that are pushing down interest rates and in effect pulling up financial asset prices. The stronger U.S. dollar has helped as well, as European exports have become cheaper. The jury is still out, but we are likely to see improving gross domestic product (GDP) in the Eurozone this year. We are seeing financial asset prices rising in Europe and in Japan, in both in local currency and dollar-denominated terms.
- GDP growth in the U.S. in the first quarter was slower than anticipated, due primarily to harsh winter weather and the appreciation of the dollar. Housing hasn’t been as strong as projected, and capital spending is lagging. But the U.S. economy is expanding, and we believe GDP will rise about 2.5% to 3% over this year.
- U.S. stock valuations remain fair. We’ve talked in the past about the “rule of 20” as a means to judge stock valuation: Take 20 minus the current inflation rate and the result is usually a good guide to the potential price-earnings (P/E) ratio. With P/E ratios currently at about 18 times and inflation at about 2.0%, we’re right at fair valuation.
- The current driver of U.S. growth is stronger job creation. A lower unemployment rate, combined with low inflation and low interest rates are positives. Corporate earnings should improve from here if GDP growth normalizes further. Though we expect continued volatility, we see S&P 500 Index returns somewhere between 5% and 7% this year.
- Federal Reserve (Fed) policy and when it might raise interest rates continues to be a point of focus, but the Fed has been very clear in its statements: Rates will rise slowly and the timing of a decision on an increase will be data dependent, meaning driven by an increase in the rate of inflation and by job growth. We don’t expect a rate increase until maybe this fall, and then at only about 25 basis points.
- Here are key areas we currently think are driving potential growth or impacted by change:
- The technologysector is seeing a number of exciting developments driven by innovation and new products. Research and development is creating investment opportunities in companies around the world related to software, integrated controls, remote connectivity, among other ideas.
- Health care, pharmaceuticals and bio technology are seeing growth and change related to medical advances, innovative products and services.
- Consumer discretionarycompanies may see growth as consumer spending improves with support from improved job growth and lower energy prices.
- Energy is an area we continue to monitor. Prices continue to be held down thanks to significant excess supply of oil and natural gas. This provides a boost to consumer spending and confidence, as noted above. But it is not helpful to industrial companies, transportation companies, exploration and related industries. We remain less certain about an extended period of low prices, given tension in the Mideast. Military conflicts or terrorist activity can bring production disruptions that drive prices up quickly.
- Given the uncertainty and volatility, we believe investors need active investment managers who conduct global research and have independent, differentiated investment ideas. An understanding of the market and the implications of ongoing activity can make a meaningful difference when selecting investments and specific allocations.
Past performance is no guarantee of future results. The opinions expressed in this article are those of Mr. Herrmann and are current through April 2015. Mr. Herrmann’s views are subject to change at any time based on market and other current conditions, and no forecasts can be guaranteed. Waddell & Reed Financial, Inc. is the ultimate parent company of Waddell & Reed, Inc. and of Ivy Funds Distributor, Inc.
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