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Economic Outlook | Summer 2015

Central Banks Stabilizing Global Recovery

Summary

Since the onset of the financial crisis seven years ago, the actions of global central bank policies are being felt worldwide. While there are critics of economic stimulus policies, it’s hard to argue with the central banks’ success. Their policies are not only working to stabilize global financial markets, they’re acting as a catalyst to help economic recovery move forward in many parts of the world.

Following the U.S. lead, Japan’s version of quantitative easing is helping its economy get back on track. And, after struggling with austerity, Europe is growing again thanks to the European Central Bank’s bond-buying program that is expected to last through September 2016.

Though the People’s Bank of China has not implemented quantitative easing policies, per se, it has repeatedly lowered interest rates and has reduced reserve requirements for banks there in an attempt to stimulate its economy.

Only time will reveal the long-term implications of these policies on global financial markets. Still, in a slowly recovering global economy, an increase in economic activity and growth, even if it is moderate, is a positive for global equities.

U.S. expansion continues

Despite a weaker-than-expected first half, the U.S. economic expansion continues. Several economic indicators signal that growth will catch up through the balance of the year, and we expect U.S. growth to be slightly stronger in 2015 compared with 2014, as investors adjust to a more moderate but sustainable annual growth rate.

U.S. stimulus policies helping stabilize financial markets

Federal Reserve efforts have helped dampen larger price swings and extend the run of the current bull market. Since the bull market began in March 2009, the U.S. has experienced approximately two market corrections (a price decline of 10% or more) and twice the average number of “mini corrections” (stock market declines greater than 3% but less than 10%).

Over the past six years, every time the equity market declined a bit, Federal Reserve officials made encouraging remarks that caused these corrections to not become normal-sized corrections. It is reasonable to believe that without the Federal Reserve’s intervention, markets would have been far less tame.

A stronger labor market

Unemployment claims fell to their lowest level in over 14 years and the unemployment rate has fallen from 10% to 5.4% — its lowest rate in seven years through April. We expect unemployment to inch even lower through 2015.

In conjunction with more jobs, we are also seeing evidence that wages are improving. For example, Wal-Mart, the nation’s largest private employer, increased the minimum wage for its employees in January. Their announcement was followed by other retailers. In a healthy economy, wages typically rise 3%–4%; and while we haven’t achieved that level yet, both wages and benefits (Employment Cost Index) are moving up and rising by 2.6% on a year-over-year basis.

The push and pull of other market forces: Oil and the U.S. dollar

While oil prices have rebounded from last summer’s bottom, they are still low enough to benefit consumers. Over the past year, we have seen oil prices fall from over $100 a barrel to around $60 a barrel. The “bonus” of falling gasoline prices — along with heating oil and natural gas — should have a positive impact on U.S. consumer spending. But we expect lower energy prices to be a negative headwind for energy-related companies, which we believe will earn 60%–65% less this year due to lower energy prices. In contrast, lower energy prices will be a positive development for earnings of non-energy companies, which are consumers of energy and comprise 90% of U.S. companies listed on the Standard & Poor’s 500 Index.

The rise of the U.S. dollar relative to other global currencies has been dramatic. Between July 2014 and mid-March 2015, the major currency trade-weighted dollar index rose more than 20%. This will impact the profits of U.S. exporters, since a stronger dollar makes U.S. manufactured goods more expensive than they were a year ago. While it isn’t the goal of monetary policy, per se, the effect of a lower euro against the U.S. dollar gives European manufacturers a competitive advantage over U.S. multinational companies. Since we expect the U.S. dollar to remain strong, we will want to focus a little bit more on those companies that have less exposure and less competition with their multinational counterparts.

Other signs of U.S. economic expansion

Consumer confidence is on the rise. In addition to an improving labor market, we are seeing other examples of economic growth. While businesses remain somewhat guarded, consumer confidence is on the rise in 2015 and Americans are buying cars and houses again. Auto sales at the tail end of the first quarter, for example, have risen 2.6% year over year through April, the fastest pace in eight years. In addition, existing home sales — the largest component of the housing market — grew at twice the pace of expectations in the first half of 2015. Housing prices are on the rise, suggesting greater confidence in the homebuilding industry, and another positive contributor to economic growth.

"We expect U.S. growth to be slightly stronger in 2015... as investors adjust to a more moderate but sustainable annual growth rate."

A much-anticipated interest rate increase

A delay in raising interest rates is helping stimulate economic growth. For the past 18 months, we have advised investors to prepare for a rising interest rate environment. Slower-than-expected economic growth in the first half of the year persuaded the Federal Reserve to postpone its decision to raise the Fed Funds rate (the short-term interest rate at which banks lend balances to each other overnight). When it does begin to raise rates, we expect the move to be slow and gradual so as not to interrupt the economic expansion. That is a positive for U.S. investors because it will mean that the economic expansion will face less or lower risk. Another positive for consumers and investors is that inflation remains unchanged. That means that if you are earning middle to high single-digit rates of return in an environment where there is no inflation, you are able to preserve and grow your wealth.

Developed international markets picking up steam

The response to the European Central Bank’s quantitative easing program has been positive. The region’s economy is finally growing and equity markets have outperformed thanks to both stimulus efforts and a lower euro. We remain cautiously optimistic as deflationary concerns have subsided and a weaker euro is supporting manufacturing and exports.

Still, political uncertainty continues. Greece remains a challenging investment theme for 2015, but our view is that cooler heads will prevail and the Greek government will negotiate its debt obligations. We do not expect the ongoing headlines about Greece to interrupt Europe’s current economic expansion.

We are bullish on Japan, and believe its quantitative easing program, significantly larger than that implemented in the United States, has achieved many of its economic goals. Economic activity is up and wages are improving. In fact, through the first half of 2015, the Japanese equity market has been one of the best developed-market performers.

An improving but mixed view on emerging markets

Among global emerging markets, Asia remains the brightest region in terms of economic growth and recovery. Like China, central banks in India, Thailand, South Korea, and Singapore are also stimulating their economies. Many Asian markets will benefit from the monetary easing that’s taking place in China, but will also benefit from their own central banks’ actions to lower interest rates.

We see diverging paths in Latin America. The economies of Chile, Peru, Colombia and Mexico are experiencing positive growth. Mexico, especially, is benefiting from the U.S. recovery and growing at an annual rate of about 2%. However, the central bank in Brazil, the largest economy in the region, is moving against the tide. It has been raising short-term interest rates and will likely continue to do so to manage high inflation that now exceeds 8% on a year-over-year basis. A much more serious situation plagues Venezuela and Argentina, where 2015 inflation estimates could approach levels as high as 125% and 40% respectively, contributing to investment challenges in these markets. In summary, our broad views on emerging markets are mostly unchanged. We continue to favor select Asian markets and remain cautiously optimistic.

What this means to you

In the seven years since the financial crisis started, the world’s central banks have facilitated a dauntless recovery — and the United States continues to lead by example to help this recovery last. As investors, it’s important to remember just how far the global economy has come. One of the lessons that we have learned through the recovery process is that global diversification is the best defense.

Take the next step

As global markets recover and the interest rate cycle in the U.S. shifts, work with our Advisors to review your objectives and make sure you are positioned to stay on track.

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