Market Commentary: April 2015

Equities have bounced around in recent weeks amid a slowdown in the U.S. economy, drama over Greece’s debt negotiations and lingering concerns about pockets of deflation and increased geopolitical tensions. Under the surface, however, it looks to us like the global economy may be gradually recovering.

In the United States, the twin drags of lower oil prices and a stronger dollar appear to be pausing – though there are prognosticators out there calling those drags to fade – and the outlook is brightening. Europe, which has long been a source of risk, looks to be stabilizing, with increased monetary policy support helping to combat deflation. While a potential messy exit of Greece from the Eurozone is a key source of risk holding back investor confidence; our view is that we should see at least a temporary deal to prevent that from happening.

Despite an abundance of negative factors, U.S. equities appear to have held their ground so far this year. The main headwind for stock prices has been the deteriorating earnings environment, and while we expect a period of soft earnings to persist, the longer term outlook does look brighter. Equity valuations may look a bit stretched, but we believe that they look attractive compared to government bond markets. Assuming global economic activity continues to improve, we believe there should be further room for equities to advance.

The first few months of the year were marked by disappointing economic data and deteriorating earnings expectations that put U.S. equities into a choppy holding pattern. In fact, it wasn’t just the investors that were choppy, but also the news.

During the course of the last two weeks of April, investors focused on the negative and then positive news of the week, respectively. During the penultimate week, there was some disappointing US economic data and growing concerns over what would happen with Greece’s debt problems. As such equities fell, with most of the damage coming on Friday amid a global risk-off trade, wherein the S&P500 fell 1% on that day alone.

Outside of the US, during that week, Chinese stocks continued to soar as weak economic data sparked expectation for additional policy support. Over the interim weekend, those expectations came to fruition when the People’s Bank of China announced a cut in bank reserve requirements, a move designed to boost lending (remember, GDP = Consumer Spending + Business Spending + Investments, and buying a home is an investment).

The good news is that the markets did finish the month off focusing on the positive. Primarily the focus was on corporate earnings beating expectations and the volume of M&A announced activity. Despite the disappointing economic data (as previously mentioned), the trend of focusing on the positive news reinforced the perception that the Federal Reserve would hold off on rate hikes for the time being. While the turmoil in Greece continued to rattle investors, it did remain relatively contained. In fact, during the last full week of the month, there was a huge surge in a risk-on mentality (piling into risky equities), leading to a 1.8% rise in the S&P500 just on the week alone.

Specific to the Fed, we believe they will likely acknowledge a first-quarter slowdown in economic growth and the labor market. However, with core inflation starting to creep higher and financial conditions looking good, the Fed should still be on track to raise rates later this year. When it does so, we think the central bank will be slow and deliberative, as the fed funds rate climbs gradually to 1% or slightly higher, we’re targeting around the September 2015 time-frame.

From the domestic standpoint, we expect economic growth to improve from here as the temporary effects of a harsh winter fade and consumer spending gradually accelerates. Earnings have been hit by the precipitous drop in oil prices and pressure from the rising U.S. dollar. In our view, profit growth should begin to improve as stabilizing oil prices settle the energy sector and non-energy earnings reflect the delayed benefit of cheaper oil.

Assuming the advance in the dollar levels off and global growth continues to firm, we forecast a brighter environment for earnings in the coming months. The pending start of the Fed’s rate hike cycle is likely to result in increased bond yields and heightened volatility in the equity market. But we don’t believe this shift will derail the bull market given a healing economy and an accommodative global monetary policy environment. We think the balance of risks remain favorable for equities and continue to advocate a pro-equity, pro-growth investment stance.

More globally, we believe a backdrop is in place to allow equity prices to advance, but the road ahead may be rocky and not without risks. The threat of a Greek debt default and a messy exit from the Eurozone is much in the minds of investors right now. The ongoing negotiations may cause market turmoil, but we believe the most likely outcome is some sort of compromise that leaves the Eurozone intact. Additionally, outside of the United States, policy easing continues with the impact varying by country. In China, for example, we do not believe policy support will accelerate growth, but it should moderate the slowdown. In Europe, the massive quantitative easing program should boost growth

Finally, looking forward, we see a combination of significant deleveraging and a global collapse in productivity has limited economic growth over the past several years despite unprecedented stimulus. Nevertheless, equities have enjoyed an extended bull market mainly because slow wage growth pushed earnings higher and an abundance of liquidity propelled investors into higher risk assets. While there is no magic number of years at which bull markets end, fundamentals, the economic backdrop, and investor sentiment all matter far more than an arbitrary age. We believe these factors point to more time and more price advances for this bull market.

The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Any opinions are those of David Abuaf and not necessarily those of RJFS or Raymond James.

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