Equities Post Gains Amid Mixed Economic Backdrop

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Includes: DWLV
by: Invesco PowerShares

Summary

An improved economy and strengthening earnings picture has supported US equity returns.

Export-dependent emerging markets are showing renewed strength, boosted by rising commodity prices.

The developed world outside the US is still fraught with risk, including Britain’s exit from the EU and political unease in Turkey.

By Nick Kalivas, Senior Equity Product Strategist

Earnings season is upon us, when companies reflect on the past quarter and fine tune guidance based on their outlook for the rest of the year. So, it seems an appropriate time to take stock of some of the larger economic trends we're seeing, both stateside and abroad.

As we move into late summer, investors face a mixed landscape of opportunity and hard-to-quantify risks. While there are signs of economic revival in the US and emerging world, historically low global interest rates are a reminder of persistent risks - including geopolitical instability, monetary policy, the US elections, "Brexit" and unstable European banks. Nonetheless, strong year-to-date equity performance in many parts of the world could make the case for equity exposure, even in the face of global uncertainty.

Source: Bloomberg L.P., July 22, 2016

Source: Bloomberg L.P., July 22, 2016

Slow-growth US economy shows signs of firming

In the US, decelerating economic growth is showing signs of abating and a trough may finally be forming. Industrial production growth reached a high of 3.9% on a year-over-year basis in July 2014, before falling to a low of -2.3% in December 2014. This decelerating industrial growth was driven in part by a drop in commodity prices, the strength of the US dollar and inventory imbalances.

These trends are showing signs of reversing, with US industrial production falling by 0.7% on a year-over-year basis in June 2016.1 In addition, commodity prices have been rising since November, the US dollar is moving sideways and the inventory-to-sales ratio may be peaking.1 When overlaid by three straight months of robust retail sales, a steady recovery in the housing market and a strengthening labor market, the chances for improved corporate profits have increased.2 In fact, there is hard evidence of economic firming in the form of the economy-weighted ISM Manufacturing Index, which rose to 56.1 in June - its highest level since October 2015.1 Nonetheless, signs of rising inflation within the core consumer price index (CPI) and its impact on monetary policy generate some risk to the investment landscape and economic revival. The core CPI stood at 2.3% year-over-year in June - up from a recent trough of 1.6% in July of 2015.1

Source: Bloomberg L.P., June 30, 2016

Source: Bloomberg L.P., June 30, 2016

Mixed outlook for the developed world ex-US

Outside the United States, the outlook for economic growth is less constructive. Japan is discussing the issuance of perpetual bonds and fiscal expansion, while desiring a weaker yen to boost export growth. The three-month average of Japan's industrial production has contracted on a year-over-year basis since September 2015.1 Meantime, Europe is working through the impact of "Brexit" - the populist backlash toward EU leadership.

Poorly capitalized European banks compound existing risk and generate headwinds to profit growth, despite ultra-accommodative European Central Bank (ECB) policy. However, negative interest rates in Germany and the ECB's move to buy corporate debt have helped underpin European equities in non-financial sectors. Industrial output in the United Kingdom had showed signs of improving in the late spring, but the Brexit vote and a recent PMI reading of 47.7 argue against expansion, creating more economic uncertainty.1 Moreover, political instability in Turkey is creating a new level of geopolitical risk.

Industrial production in the eurozone has decelerated since the summer of 2015, with the three-month average easing from 2.2% to 1.0% at the last reading in May.1 The bright spot may rest in Canada, where a rally in commodity prices could boost economic growth, although a pick-up has yet to be reflected in vibrant industrial activity.

Source: Bloomberg L.P., May 30, 2016

Source: Bloomberg L.P., May 30, 2016

Emerging market prospects brightening

The economic picture has potentially brightened in the emerging world, as rising commodity prices boost the outlook for commodity-producing countries like Russia, Brazil and South Africa. There is also hope for economic reforms in Brazil under a new government, while India is expecting a favorable monsoon season and fiscal changes that could boost economic growth. China is working to mitigate the fallout from excessive debt and the drag of zombie state-owned enterprises. A 9.5% increase in June auto sales, a solid 55.5 reading for the July Westpac MNI China Consumer Sentiment Indicator and a 2.1% jump in electricity output in June suggest economic stability.1 As seen in the chart below, the June Markit Emerging Market Composite PMI rose slowly off its recent low of 48.8 in September 2015 to 50.1.1

Source: Bloomberg L.P., July 22, 2016. Data as of June 30, 2016

Source: Bloomberg L.P., July 22, 2016. Data as of June 30, 2016

A global, multi-factor investment solution

An option to consider for investors looking for a tactical global equity solution: PowerShares DWA Momentum & Low Volatility Rotation Portfolio (NASDAQ:DWLV).

  • DWLV's underlying index allocates to both global and US equities markets using the momentum and low volatility factors.
  • The portfolio's underlying index can also partially or fully convert to cash, depending on the relative strength of equities.

The ability to rotate between momentum, low volatility and cash provides investors the potential for equity exposure and risk mitigation. Dorsey Wright's proven relative strength methodology uses the forces of supply and demand to determine exposure and may help overcome or balance some of the uncertainties found in fundamental analysis.

Sources

  1. Bloomberg L.P., July 25, 2016
  2. Bloomberg L.P., July 25, 2016. Retail sales ex-food, auto dealers and gas stations have risen 1.1%, 0.5%, and 0.5% in April, May and June 2016, respectively. The Commodity Research Bureau BLS Raw Industrials Sub-Index hit a low of 397.31 on November 24, 2015 and has since risen to 459.70 as of July 22, 2016.

Important information

The Russell 2000® Index, a trademark/service mark of the Frank Russell Co.®, is an unmanaged index considered representative of small-cap stocks.

The MSCI EAFE Index is an unmanaged index considered representative of stocks of Europe, Australasia and the Far East.

The MSCI All Country World Index is an unmanaged index considered representative of stocks of developed countries.

The MSCI Emerging Markets Index is an unmanaged index considered representative of stocks of developing countries.

The ISM Manufacturing Index, which is based on Institute of Supply Management surveys of more than 300 manufacturing firms, monitors employment, production inventories, new orders and supplier deliveries.

The consumer price index measures change in consumer prices as determined by the US Bureau of Labor Statistics.

The Commodity Research Bureau BLS Raw Industrials Sub-Index of 13 markets measures daily prices of the 13 raw industrials components of the CRB BLS Spot Index.

The PMI (formerly the Purchasing Managers Index), a commonly cited indictor of the manufacturing sectors' economic health, is calculated by the Institute of Supply Management.

The Westpac MNI China Consumer Sentiment Indicator tracks large consumer consumption patterns in China with more than 100,000 data points, including housing, durable goods and savings and investment. Typically, security classifications used in calculating allocation tables are as of the last trading day of the previous month.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: This article was posted on the Invesco PowerShares' blog by an Invesco PowerShares' employee on July 29, 2016: https://www.blog.invesco.us.com/equities-post-gains-amid-mixed-economic-backdrop