Avalon produces a variety of investment commentaries.
Our perspectives and quarterly commentary are issued throughout the year and cover a range of investment-related topics.
TPP Is Dead. What Now?
January 25, 2017
The Possibilities of Trump's U.S.
December 9, 2016
Reversal Rates Are the Next Big Challenge for Central Banks
November 23, 2016
The Good Ole Days Aren't Coming Back
October 13, 2016
The Federal Reserve's Anti-Volcker Inflation Revolt
August 24, 2016
Why the Fed Needs to Raise its Inflation Target
August 18, 2016
Is the Rest of the World Ditching America to Trade with China?
August 3, 2016
Has the Federal Reserve Become Congress's Golden Goose?
July 20, 2016
The Fed Must Avoid the 'Credibility Trap'
June 21, 2016
Why the Fed Needs to Make a Policy Error
May 18, 2016
The Fed Faces Its 'Anti-Volcker Moment'
May 9, 2016
The Fed's Critical Global Mandate
April 29, 2016
Why the Federal Reserve Is All Talk
April 26, 2016
Is the Global Middle Class Really Here to Stay?
April 12, 2016
Quarterly and Monthly Notes
Fourth Quarter, 2016
Third Quarter, 2016
Second Quarter, 2016
News | Press
Avalon Advisors Announces San Antonio Expansion
December 21, 2016
Avalon Advisors Announcement
December 16, 2016
April 11, 2016
Avalon Advisors Announcement
October 1, 2015
March 1, 2014
Fourth Quarter, 2015
Second Quarter, 2015
First Quarter, 2015
Fourth Quarter, 2014
Third Quarter, 2014
Second Quarter, 2014
Despite being down in both January (-3%) and March (-1.5%), the S&P 500 was slightly positive for the quarter as a result of a nearly 6% total return during February. After significant underperformance last year, small cap stocks did better than their large cap counterparts, with the Russell 2000 up 4.3%. Within the S&P, the best performing sectors were Health Care (up 6.5%) and Consumer Discretionary (up 4.8%) and the worst performing sectors were Utilities (down 5.2%) and Energy (down 2.9%). International stocks outperformed the S&P 500, with the MSCI All Country World ex U.S. index returning 3.6%. Japan was particularly strong, up 10.8% in local currency and 10.4% in dollars. Most European equity markets performed extremely well in the quarter, helped by the start of quantitative easing and increasing signs of improving economic growth, although returns to U.S. investors in these markets were muted by the dollar’s strengthening against the Euro. For example, Germany returned 22% in Euros, but only 7.7% in dollars.
U.S. bond indices generally had positive returns in the quarter, due to some disappointing economic releases, falling rates abroad, and signs that the Fed may be slower to raise rates than previously expected. However, interest rates were highly volatile over the period. The 10-year treasury traded in a 60 basis point range, touching a low of 1.64% on 1/30/2015 and a high of 2.24% on 3/6/2015, before ending the quarter down 25 basis points at 1.92%.
In our Fourth Quarter Commentary, we discussed the effect on global equity markets of changes in growth expectations. As we pointed out, expectations for U.S. economic growth rose last year while those for Europe fell. So far this year, economic indicators have tended to surprise on the upside for Europe and on the downside for the U.S. The graph below shows Citigroup’s Economic Surprise indices for the U.S. and Europe. These indices attempt to capture how actual economic data is coming in relative to expectations. As the graph illustrates, U.S. economic data in the first quarter, while still strong, was on average disappointing. Conversely, European data, while still weak, was on average better than expected. This shift in economic surprise trends partially explains the weaker relative performance of the U.S. equity market. A look at corporate earnings and equity valuations should also shed more light on where we are in the U.S. equity market and what we can expect going forward.
The near-term earnings picture for companies in the S&P 500 Index has been deteriorating significantly since the fall of last year. According to Factset, which aggregates the earnings estimates made by Wall Street analysts, expectations for first quarter earnings growth as of March 31 were a minus 4.6%, with earnings growth for 2015 expected to be up only 2.4%. As recently as September 30 of last year, analysts were forecasting 2015 earnings growth of over 11%. The primary factors pressuring earnings have been the rising dollar and falling energy prices.
As shown in the chart below, the U.S. dollar has been on a tear since mid-2014, up about 9% in the first quarter, and about 14% percent from its 2014 lows. The rising dollar coupled with relatively slower growth abroad has had a negative effect on earnings for U.S. companies that do a significant portion of their business abroad. Factset estimates that S&P 500 companies in aggregate generate about 30% of their sales outside of the U.S.
After declining 46% in 2014, oil prices fell another 10% in the first quarter. As of April 24, according to Factset, analysts are expecting Energy sector earnings to decline almost 59% in 2015. Despite the poor near-term outlook, there are some positives. First, the aggregate earnings numbers have been dragged down significantly by the Energy sector. Within the S&P, 2015 earnings growth expectations for the Financials, Consumer Discretionary and Health Care sectors are all above 10% and the Technology sector’s earnings are expected to be up over 7%. Second, we believe we are not going to see the large moves in the dollar and oil prices repeated in 2016 and by mid-2015 investors will start focusing more on next year. Currently, energy earnings are expected to rebound significantly in 2016 and S&P earnings are forecasted to be up over 12%.
U.S. equity valuations have been getting more expensive, as the stock market has continued to rise and the rate of earnings growth has been slowing. As of March 31, the S&P 500 Price/Earnings ratio based on expected earnings growth over the next 12 months was 16.7 and it has since increased to just over 17. Although valuation does not appear to be extreme, especially considering our low inflation and interest rates, this P/E is well above the 5-year average of 13.7 and the 10-year average of 14.1. It is worth noting that the P/E for the Index has been inflated by the Energy sector P/E. Earnings estimates for this sector (about 8% of the Index) have fallen much further than stock prices, causing P/E’s to expand, and this sector is now selling at over 30 times forward earnings.
Despite some first quarter weakness, some of which was weather-related, we believe the U.S. economy can continue to grow at a moderate pace over the near-term. However, long-term economic growth depends on employment growth and productivity, and both of these variables are facing some headwinds. Employment growth has been strong for many months now; even more impressive, the last few years of employment growth have been achieved despite a decline in the number of government workers. Now, however, our unemployment rate is relatively low. As the graph below illustrates; the 50-year average is 6.0%. In addition, our labor force participation rate, while low, is constrained by demographic factors and unlikely to rise significantly anytime soon. Productivity growth remains well below its historical average. Hopefully, these growth headwinds will be addressed in future policy initiatives, such as immigration policy reform or efforts to increase capital investment. While risks remain to higher rates, renewed skepticism of economic growth after disappointing initial Q1 results, continued deflationary pressures and global quantitative easing point toward a cap on rates, with a bias toward current levels or lower, depending on economic results. Inflation is not an imminent problem; however, we are closely monitoring wages and energy prices.
Turning to international markets, we believe both Japan and Europe have the potential to deliver better than expected earnings growth in 2015. Companies in these markets should continue to benefit from the stronger dollar. In contrast, emerging markets, which are struggling with slower growth, continue to be hurt by the stronger dollar. However, both developed and emerging market countries, many of which are more dependent on imported oil than the U.S., benefit more from lower oil prices.
The opinions expressed herein are those of Avalon Advisors, LLC investment professionals at the time the comments were made and may not be reflective of their current opinions. Nothing herein shall be construed as investment advice or a solicitation or offer to purchase or sell any securities.
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