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Bullish Signals Outweigh Bearish Obstacles 

Kristina Hooper 

The Upshot 

4/21/2014 

Stronger-than-expected economic data on the heels of a harsh winter and anecdotal evidence of improving conditions have bolstered the case for further stock-market upside, overshadowing potential headwinds, writes Kristina Hooper.
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Kristina Hooper, US investment strategist and head of US Capital Markets Research & Strategy for Allianz Global Investors. She has a B.A. from Wellesley College, a J.D. from Pace Law and an M.B.A. in finance from NYU, where she was a teaching fellow in macroeconomics.

The reasons to stay upbeat on the stock market outnumber the reasons we’re due for a downturn.

Stocks bounced back last week from a sharp selloff the week before. It seems that the long-awaited correction was just a head fake. There are simply more tailwinds than headwinds for the stock market right now, as the economy rebounds from a winter depressed by uncharacteristically bad weather.

Let’s start with retail sales. March retail sales rose 1.1%, beating estimates and easily besting the February reading. March industrial production rose 0.7%, also better than expected. And the Beige Book—the Fed’s anecdotal report on the economy—confirmed the recent improvement in economic conditions, showing that most districts have seen marked improvement in growth after a harsh winter. These encouraging developments follow improved consumer sentiment and further labor-market strides.

So what could throw the US stock market off the rails? Three headwinds come to my mind: Housing, earnings and a lack of broad participation in the economic recovery.

1
Housing doesn’t heat up. We haven’t seen the post-snowpocalypse recovery in housing that we’ve seen in other areas of the economy. Housing starts in March disappointed while the Housing Market Index, which measures demand for new homes, showed a reading of 47 for April, below consensus expectations. But housing data may improve as the job situation improves, especially given that lenders are reducing their down-payment requirements and slightly easing their credit standards for some homebuyers. It will also help if mortgage rates remain relatively low. Last week, refinancing applications actually increased as mortgage rates ticked lower.
2
Earnings can’t keep pace with stock prices. Among the 82 companies that have reported earnings for the first quarter of 2014, 66% have reported earnings above the mean estimate, according to FactSet. That’s below the S&P 500’s one- and four-year averages. And only half of those companies have reported sales above the mean estimate, well below what we saw in the fourth quarter.
Weather Woes Chart

However, investors may overlook a potentially disappointing first-quarter earnings season, given that most market watchers believe weather played a significant role in the results. Instead, they’re more likely to focus on second-quarter earnings and beyond.

With a much improved job market and short-term unemployment close to historical norms, more Americans should begin to experience better labor conditions, such as more full-time positions and higher-paying jobs.”
3
More Americans don’t participate in the recovery. Fed Chair Janet Yellen continues to beat the drum on the dangers of income inequality, pointing out that when wealth is concentrated among a small group of people, it often doesn’t make its way back into the economy in the form of consumer spending as robustly as it does when wealth is distributed more broadly. We’ve seen this issue become a much bigger problem during the Great Recession recovery: stock prices rose dramatically in the past five years but that growth was concentrated among investors with stocks to appreciate in value. As a result, we didn’t see the big bounce in consumer spending we would normally expect.

We’ve seen a similar phenomenon in the jobs recovery. With a much improved job market and short-term unemployment close to historical norms, more Americans should begin to experience better labor conditions, such as more full-time positions and higher-paying jobs.
But we just haven’t seen that happen yet. While the unemployment rate has decreased substantially, wage growth remains anemic with the exception of specific industries and skilled occupations. Indeed, the April Beige Book reported that six districts experienced difficulty finding skilled workers, especially in the information technology sector. However, because wage pressures were isolated, they were characterized as “contained to minimal.”

Looking ahead, the recovery will need to be more inclusive if we want to see economic growth rise to historical norms. Additionally, more Americans earning higher income will likely benefit the housing sector more than looser lending standards would. And more people getting higher-paying jobs will likely mean increased consumer spending, which should boost earnings. Finally, a broadening of participation in the recovery is likely part of the prescription for another leg up in the stock market.


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Past performance of the markets is no guarantee of future results. This is not an offer or solicitation for the purchase or sale of any financial instrument. It is presented only to provide information on investment strategies and opportunities.


A Word About Risk
: Equities have tended to be volatile, involve risk to principal and, unlike bonds, do not offer a fixed rate of return. Foreign markets may be more volatile, less liquid, less transparent and subject to less oversight, and values may fluctuate with currency exchange rates; these risks may be greater in emerging markets.
 
The material contains the current opinions of the author, which are subject to change without notice. Statements concerning financial market trends are based on current market conditions, which will fluctuate. References to specific securities and issuers are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Forecasts and estimates have certain inherent limitations, and are not intended to be relied upon as advice or interpreted as a recommendation.

 

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