The first quarter of 2015 officially ended March 31st and the results are disappointingly lackluster. Data is often revised backwards to adjust for new information, but it would take a huge revision to change the outlook most economists have for the 1st quarter.
GDP growth is expected be between zero and 2% with many firms predicting growth of less than 1%. The Federal Reserve Bank of Atlanta lowered its estimate from 0.3% to 0.2% following a weaker-than-expected report on business spending and investment.
The markets haven't given investors a lot to be confident of either. The S&P 500 ended the quarter slightly ahead having gained 8.99 from 2,058.90 to 2,067.89. The NASDAQ fared better, up +3.48%, while the Dow suffered a very small loss of -0.26%.
Orders for durable goods fell a seasonably adjusted 1.4% in February from January while business spending and investment dropped for the sixth straight month, likely caused by the resilient strength of the U.S. dollar which is hurting domestic manufacturers.
Unseasonably cold weather was partially blamed for the weak quarter, reminiscent of last year's first quarter weakness. Still, consumer confidence is on a downtrend falling for the last two months from a high of 98.1 in January to 93 for March. The jobs number has been similarly disappointing with March only adding 126,000 new jobs and averaging just 197,000 new jobs per month over the past three months.
However, the second quarter doesn't appear to be shaping up to deliver the same results.
Taking a sneak peak at what's ahead
The removal of weather related risks means that there should be more growth for the second quarter. The average estimate by economists for the next quarter is GDP growth of 3.5% - less than last year's 4.6% but still well ahead of this year's first quarter stagnation.
Housing prices have been on the uptrend, rising 10% year-over-year and helping to sustain the long bull market. Housing starts fell 17% for February, but bad weather was also the reason many builders decided not to break ground. The real estate market still has plenty of room to grow which should boost consumer confidence and drive further growth.
Cheaper gas prices and low interest rates will also give a boost to the consumer and cause an increase in spending throughout the next quarter and the rest of the year. With interest rates on the verge of beginning a long journey of hikes, new loans and financing should take place while rates are still relatively low. The increased activity should translate into better corporate earnings and an improving confidence in the economy's strength.
The Fed is going to be a key figure over the next three months as the exact timing of the widely expected interest rate hike has yet to be established. Still, a modest bump of 0.10% in interest rates won't negatively impact the economy and might actually do more good than harm. If the Fed is confident enough in the economy to warrant increasing interest rates, this should send a signal to the markets that positive growth is still the direction in which we are headed.
Consumer spending will likely be another key element to next quarter's success. DPI (disposable personal income) rose 0.4% in February and has been gaining strength for the last couple of months. That's good news and it means that incomes nationwide are rising. Combined with the fact that most consumers have been paying off debt obligations post-recession, a standard action that occurs following an economic pull-back, then we have a case where consumers are able to take on new debt and bolster economic growth.
If the jobs number can improve, then the second quarter should be a turnaround for the financial markets this year. As income levels rise along with spending, then more employed persons would directly benefit the economy. Aside from Russia and Brazil, emerging market economies look undervalued as well. Tailwinds like low oil prices and a cheap currency will help these markets outperform not only for the second quarter, but likely for the rest of 2015.
Asset performance for the second quarter
Equities are in a vulnerable state right now. Valuations are well above norms as evidenced by the current P/E ratio of 20.44 versus the historical median of 14.57. Low inflation and interest rates might be some of the causes for equities performing so strongly even with higher multiples attached, but they face a challenge in the next quarter.
A rising rate environment has a mixed impact on equities, although it seems safe to say that stocks could take a slight hit once the first rate hike goes into effect without impacting the stronger long term fundamentals. At this point, the Fed is in the driver's seat and controls investor sentiment with every statement made. Fed guidance leading up to the rate increase will lead stocks as much as the actual rate hike will.
Corporate earnings are an indicator of economic strength and the first quarter results were anything but impressive. Out of the 101 companies that issued guidance during first quarter earnings results, 85 were negative while only 16 had positive guidance. The aggregate EPS estimate for the first quarter dropped 8.2% led by severe declines in the energy sector and marked the largest drop seen since the first quarter of 2009 where earnings fell a staggering 26.8%.
The lowered expectations might serve the second quarter well though. Companies that have lowered guidance will find it easier to meet or beat estimates which should translate into higher gains for stocks across all sectors.
The technology sector looks to offer investors the most growth for the next quarter. It trades at a multiple just under its historical average while rising investment in the technology industry should fuel further gains. The weakest sector looks to be utilities. Multiples are well above average thanks to investors paying a premium for dividend paying stocks but face pressure from a rising rate environment. Most utility companies are highly leveraged and extremely sensitive to interest rate fluctuations.
Internationally, emerging markets along with Japan and Europe look attractive based on their lower relative P/E values to domestic stocks. Data like the PMI points to a real recovery in Europe and indices like the FTSE and DAX are climbing. As an economy that relies heavily on oil importing, Japan should similarly thrive throughout the next quarter. The declining values of the euro and yen well help manufacturing and lead to higher corporate earnings.
Oil has been the bane of economic growth for more than six months now. Prices are hovering in $45 to $50 per barrel range and could face further pressure from oversupply concerns and an Iran deal. Rig stacking will help to put a bottom on oil, although the effects could take several months to be realized.
Lower oil could help to lift corporate earnings and consumer spending, however, this in turn will cause oil prices to rise again. In addition to the macroeconomic reasons resulting in oil's plunge, the strength of the U.S. dollar has also been a major headwind. Until the dollar begins to retreat from its highs, oil isn't likely to recover to the $100 range before the end of the year. However, in the long term, global demand is still rising, albeit weakly. Oil should begin tracking higher in the next few months and we could see it end the quarter about $50/barrel.
Precious metals have suffered at the hands of the dollar as well. Gold briefly touched above $1,300 in January but has since pulled back to around the $1,200 range. A lack of inflation is the primary reason for gold's weakness along with the dollar, although a spike in volatility might been a benefit for the shiny metal. Weak jobs reports have been helping gold rise over the past month and could track even higher to touch its earlier January highs sometime during the second quarter.
The currency market has seen some wild swings in the past year. The end of QE and the introduction of easing programs by the BOJ and ECB has lifted the dollar to new highs relative to other currencies. The euro looks to be well on its way to parity as well - something that investors haven't seen in over a decade.
An increase in U.S. treasury rates is expected to increase this next quarter as the inevitable rate hike draws closer, although inflation will play a large role in how much rates actually go up. The dollar could continue to gain strength over the next quarter although it faces pressure from a moderating Fed rate hike. An increase of 0.10% instead of 0.25% will cause the dollar to retract from its highs.
The second quarter is shaping up to be a positive one for both domestic and foreign markets. The absence of weather-related slowdowns will help grow overall GDP and lowered earnings expectations could allow companies to surprise on the upside and renew the bull market.
Equities in emerging markets look the most promising given the relative value compared to domestic markets. These stocks have lagged for the past several months but have begun to make a strong comeback that should continue well into the 2nd quarter. If the dollar shows any weakness, that should only further boost emerging market values as well.
European and Japanese markets should also expand on its 1st quarter strength. As the ECB pumps liquidity back into the Eurozone and interest rates stay low, manufacturing should rise and corporate earnings will improve over the next quarter. The Nikkei is on track to hit 20,000 and could smash through that barrier in the 2nd quarter.
For domestic stocks, investors should concentrate on the technology sector. The NASDAQ is the only index that has shown strength so far this year and should outpace the Dow and S&P 500 for the next quarter as well. Strong companies like Apple (NASDAQ:AAPL) and Intel (NASDAQ:INTC) will lead the tech space while a healthy private investment base is fueling M&A activity. If oil shows a real bottom this quarter, energy stocks could be an undervalued sector that will provide plenty of opportunities for value investors. Look for companies with a strong balance sheet and high dividend yields like Helmerich & Payne (NYSE:HP) that are able to withstand the downturn and weather the temporary weakness.
Commodities are still experiencing a lot of volatility to accurately predict any given direction. Oil might track higher as the quarter progresses but there are still headwinds that could drag the price down even further before it starts to rise. For gold, there are neither headwinds nor tailwinds. Until inflation begins to impact financial markets, there isn't any real fundamental reason gold should go higher. As it stands, the precious metal will likely trade at the $1,100 to $1,200 range for the next quarter, if not the rest of 2015.
The Fed remains the biggest driving force in the market this quarter and investors should pay close attention to what actions it might take. A rate hike isn't expected until at least June, but the actual timing of the increase will ultimately say a lot about the strength of the economy.
CEO, Elite Wealth Management
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This article is not intended as investment advice. Elite Wealth Management or its subsidiaries may hold long or short positions in the companies mentioned through stocks, options or other securities.
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