Wednesday’s Fed press conference was the highlight of last week – a week in which the S&P 500 finished up 0.8%, led by a comeback in defensive sectors including consumer goods, utilities and telecommunications. Janet Yellen’s carefully crafted address was undoubtedly the catalyst as she set the stage for interest rate hikes later this year, but at a more gradual, accommodative pace than the market had factored in. With US economic data continuing to show solid strengthening, Europe on the mend, and a rising interest rate theme ahead, all eyes over the weekend have been on Greece, where the last straws seem to be getting clutched to avoid running out of funds. Monday’s European markets will undoutably take center stage and set the tone for Wall Street next week as a result of the ongoing EU leadership meetings. All we, as investors, can do is wait and watch. With that backdrop, here are the two regions worth highlighting this week.
Europe: European markets find themselves at an interesting juncture. With a strong economic healing under way, the Stoxx 600 index is up over 12.5% YTD – far outperforming the S&P 500’s 2.5% gain so far – proving wrong much of the consensus forecast that expected the US to pull ahead this year. The weak euro, cheap oil, quantitative easing as well as local reforms have all aided recovery efforts; even Spain and Portugal’s markets are YTD by 6.5% and over 17% respectively. Even Italy – possibly the most tuned-in observer of Greece’s debt negotiations due to its own debt obligation, is on the mend – for example, according to the WSJ, Italy’s ‘recovery has so far been driven by investment rather than consumption, reflecting business confidence’. Local labor statistics show decreasing unemployment, and PM Renzi has promised several reforms in insolvency rules, infrastructure, and administration that have been needed for years, but haven’t been delivered. Our point is that at such a critical recovery juncture for the entire region, it’s hard to think that European leaders would willingly throw a wrench into the whole process by cutting off Greece. More importantly, our interactions with business owners in Germany last week highlighted a significant geopolitical aspect to the Greek negotiations – that being Russia’s involvement. Russian support to Greece would have far reaching consequences for NATO as well as the EU – well described by political analysts including Eurasia Group’s Ian Bremmer earlier this year – and, needless to say, ones that western leaders would want to avoid at all cost. Therefore, the calculations involved in keeping Greece go far beyond finance and economics – geopolitics is set to play a major role. Keeping a close eye on the outcome is all investors can do – as in case any bets are placed, the payoffs would be quite binary, as described in our May 31st column.
The United States: Main Street can breathe a sigh of relief – economic data shows wages slowly growing, inflation rising, labor markets tightening, and gas prices holding steady. The past 6 years’ economic recovery has been a polarizing one – one in which the top 10 percent of the United States (coincidentally owning 80% of the stock market) effectively saw their market wealth more than double, while the middle and lower class got sorely left behind due to their limited exposure to assets such as stocks. Recent data shows that we’ve finally reached a point where most of America should start reaping the recovery benefits as well; with consumption driving the US economy, things are looking promising. As stated by the Bank Of America’s Capital Market Outlook last week, ‘the US economy is moving confidently into the middle of what should be its longest expansion ever’. This, of course, doesn’t mean that a good cleansing for overvalued stocks isn’t due later this year (when rates rise, in our opinion) – it just means that with economic fundamentals looking solid, pullbacks should be viewed as buying opportunities for investors. Car sales reached their highest levels in a decade in May, gas prices continue to stay relatively low, small business optimism is increasing, and the S&P 500 consumer discretionary sector is seeing the benefits – it’s the 2nd highest performer in the market, up 7.5% YTD (behind healthcare, at 10.5%). However, there are a couple of themes we believe the market is overlooking. Student loans are at more than $1.2 trillion – steadily increasing from around $0.3 trillion back in the early 2000s, according to data from the New York Fed. With 40 million borrowers having an average balance of $29,000 (according to CNBC), we’re looking at a changed landscape for the US economic engine. The homeownership rate, at 63.7%, is at the lowest in 25 years, and is projected to continue declining, according to Bloomberg. In our opinion, the reason is that millennials have a new idea of the American dream. It involves smaller, compact – potentially multifamily homes, downtowns, craft beers, and a more entrepreneurial spirit – which means they’re busy investing in ideas rather than single family homes. Multifamily houses and – more importantly – renting – seems to be much more in vogue in the generation that’s having kids now. Housing has led the US economy for decades now – it may be time to rethink this philosophy. Companies smartly combining consumer services and technology – such as Netflix, Google (via Nest), Apple, and other new age firms such as iRobot catch our attention – and while we’re not saying go buy them all immediately, these are the type of companies that should do well as the US consumer paves a new lifestyle.
What it means for you: Economic drivers change with time, and finding the themes early can pay off in the long run. The US housing model has changed post-2008, and is one that we’ll be paying careful attention to. Meanwhile, in the short term, the global economy finds itself in a waiting game in which Eurozone leaders and the Federal Reserve hold the cards to the market’s next moves. Timing your buys and sells, as we’ve mentioned before, is a risky game. Stay invested with the rising interest rate theme and a US economic recovery, remain diversified, and keep looking into the details on Wall Street as Greece’s outcome defines the markets next week.
