2015 Q2 Economic Update from Transition Financial Advisors, Inc.
Global stocks advanced in the first quarter of 2015 amid rising mergers & acquisition activity, escalating central bank stimulus overseas, and signs of renewed economic growth in Europe and Japan. Health care stocks around the world enjoyed a strong rally, driven by several large acquisitions, while the energy sector lagged as oil prices continued to weaken.
U.S. stocks posted modest returns despite hitting record highs in March as the S&P 500 rose just under 1% while the Dow Jones Industrial Average was basically flat. Several companies warned that the headwinds created by the soaring U.S. dollar were taking a toll on international sales and revenues. This helped keep a lid on U.S. share prices as the strong dollar hurt U.S. exports.
European stocks powered ahead, supported by improving economic data, falling oil prices, and an aggressive new stimulus program launched by the European Central Bank (ECB). Despite renewed concerns that Greece might exit the euro zone, most European stock markets enjoyed double-digit gains, notching the best quarterly returns in years. The euro tumbled to multi-year lows against the U.S. dollar reducing European stock returns when translated into U.S. dollars. Although our crystal ball is often cloudy, we did foresee the euro continuing its fall against the U.S. dollar and to that end, we took positions in a fund that invests in a basket of European stocks and hedges away all currency risk. That fund gained more than 18% for the quarter.
Japanese equities also rose amid strong corporate earnings and optimism that companies may begin to raise dividends. Further boosted by data showing Japan had exited recession, the MSCI Japan index gained 10% for the quarter, the best performer of all countries in the MSCI EAFE developed markets index.
Emerging market stocks under-performed developed market equities as the MSCI Emerging Markets index rose 2.2% amid hopes of continued stimulative fiscal and monetary policies from governments and central banks around the world. Brazil continues to be one of the worst countries for investment losing almost 15% for the quarter, while China and Russia gained 8.1% and 17.5% respectively.
Global real estate securities advanced in the first quarter following the outstanding performance in 2014. U.S. REIT’s put in nice returns, with the Dow Jones U.S. Real Estate Index up 4.27% for the quarter, as demand for commercial rental property continued to strengthen across most U.S. cities, while new supply remained limited. Low oil prices, along with strong job growth, should keep demand for real estate strong. International real estate also had a strong first quarter, benefitting from better economic data and continued momentum from the January announcement regarding QE in Europe.
MLP’s and midstream-energy focused companies declined in the first quarter, underperforming most equity and fixed income investments. Sentiment towards the asset class weakened with the continued slide in the price of crude oil. Those companies with a higher sensitivity to oil prices, such as exploration and production (E&P) companies, tended to do the worst. Companies with more fee-based cash flows as well as those with more defensive qualities tended to outperform. Although the recent decline in crude oil and natural gas has had a material impact on the short and medium-term growth rates for the midstream energy sector, we remain firm believers in the long-term investment opportunities that are developing in this current volatile environment.
Bonds rallied, with investors favoring U.S. issues over Europe and Japan because of higher yields. The yield on the 10-yr Treasury note declined 25 basis points to 1.92%. Higher income securities like high yield bonds and preferred stocks notched nice returns for the first quarter gaining 2.08% and 2.77% respectively.
Arguably, the most important economic event of the quarter was the European Central Bank’s announcement that it would initiate Quantitative Easing (QE) for the euro zone. In January, the ECB stated that it intended to buy 50 to 60 billion euros of sovereign European bonds every month for the next 18 months. This would result in a 1.1 trillion euro liquidity injection into the European financial system. While market participants were already expecting QE in Europe, the announced plan was larger than anticipated. As a result, European stocks did extremely well for the quarter.
In contrast, the U.S. economy started strong but lost steam as the quarter progressed, dampening U.S. equity returns. Looking at the job growth numbers in November and December 2014, along with those in January 2015, the U.S. economy created more than 1 million jobs, truly a historic number. This level of job creation is rare; the last time it happened was in 1997. However, the robust job growth faded as the quarter went on. We believe the central causes for the backslide in job numbers were the strong dollar, which hurt U.S. exports, and lower oil prices leading to continued job losses and capital expenditure cutbacks in the energy sector.
U.S. corporate earnings have also taken a hit from the combination of lower oil prices and a higher dollar. For the first time since September of 2012, earnings per share growth on the S&P 500 index will likely contract for the second consecutive quarter. We have seen episodes like this before, when lower oil prices and unfavorable currency translation due to the higher dollar have combined to create an earnings slump. Typically, about 12 months after such slowdowns, lower oil prices and the stronger dollar boost U.S. consumer spending giving rise to higher levels of economy activity. Consequently, S&P 500 company revenues increase, and the market follows.
Looking forward, we believe the global economy remains on generally firm footing, with lower oil prices and continued monetary stimulus providing a boost to growth. We also believe the global economy will continue to benefit from the tailwinds emanating from the long-term structural growth story in developing markets. At the end of 2014, companies in developed nations generated nearly 30% of their total income from emerging market consumption – a similar percentage to the revenue generated from developed Europe and Asia combined. And not only are emerging markets expected to continue to grow at a faster pace than the mature economies, composition of that growth is changing in meaningful ways. It is not just important what emerging consumers will buy, but how they will buy it. People in developing markets are now increasingly using smart-phones to purchase household products and services, as well as to access health care and banking information. This trend has been facilitated by e-commerce marketplaces, like Alibaba and JD, and has allowed new opportunities for companies all over the world to reach customers without having to build costly infrastructure. Furthermore, online shopping appears to boost overall consumption, not merely replace traditional purchases. In China, for example, studies have shown that a dollar spent online replaces roughly 60 cents of sales in traditional stores.
We are just completing our 2nd quarter portfolio reviews and we have lightened up a bit on U.S. equities, mostly due to valuation concerns. As forward earnings estimates have come down with virtually no change in stock prices, valuations look relatively expensive to those in cheaper international markets like Europe and Japan. Although the outlook for REIT’s is generally positive, we have also reduced that position due to valuation concerns as well.
The warmer weather has arrived for most of us and we wish everyone the best of luck with all your summer plans. As always, please call us with any questions.
Transition Financial Advisors Group, Inc.
Mitch Marenus, Chief Investment Officer
MBA, CFP® (US), CFA®
Brian Wruk, President
MBA, CFP® (US), CFP® (Canada), CIM, TEP