The overall market strength has been quite impressive. In spite of some less than stellar international economic data coming out and the near complete shutdown of the 2nd largest economy in the world due to a viral outbreak, the S&P 500 has managed to gain 3.6% this year with all of those gains coming in the last 4 days. After last year’s impressive move up, driven mainly by multiple expansion, one would think a pause or correction would finally occur. The bond and commodities markets are pricing in a much less rosy economic scenario.
However, domestic data continues to chug along, slowly improving. In previous notes, the concern was in the jobs market as the US consumer drives GDP. Data this week completely reversed those concerns with the jobless claims report coming in near record lows. Wages also improved 3.3% during the fourth quarter. Today’s January employment report was well ahead of expectations with 225,000 new jobs added versus expectations of 160,000. Average hourly earnings are up 3.1% as well. The only real issue is running out of talented workers. Domestic manufacturing data has been mixed depending on location but generally positive and confirming an industrial bottom.
Further, we have seen 79 central banks easing moves over the past six months alone. Money supply is increasing. More importantly it is looking for a home. Many investors ponder the question, am I better served buying a 10-year corporate bond with a 2.7% coupon and holding to maturity, or buy a stock like Coca Cola# with a near 3% dividend yield and possible price appreciation over the next decade. Day to day volatility aside, most would presume Coca Cola would generate a far better return over the next decade while providing similar income from growing dividends.
With rates as low as they are, investors are being pushed into the equity markets in a battle to keep pace with inflation and desired spending rates. This helps elevate the overall P/E of the market as well. Previous market peaks were accompanied by 20+ P/E’s but they also had bond yields over 6%. This is not 1999. Not yet anyway.
One of the biggest beneficiaries of low interest rates is the housing market. The 30-year mortgage rate declined again this week to 3.45%. It was nearly 100bps higher at this time last year. 15-year mortgages are below 3% again. If you haven’t refinanced and have a high rate on your property, it would be prudent to check your markets. This may not be the bottom, but those who wait are taking the risk that economic data improves, post-virus, and yields rise from here. From a stock perspective, home-building stocks have nearly doubled over the past 15 months, pricing in a lot of good news for the market. Ditto for suppliers in the industry.
Another major piece of the investment puzzle is capital expenditures. This cycle has seen CapEx spending well below norms. Healthier spending levels improve productivity, produce jobs and boosts GDP. With rates low, tariff wars off the table for now and a bottoming in manufacturing data, we should start to see expansion in expenditures. Software CapEx is poised to overtake hardware this year and is the leading driver of productivity gains. Cloud adoption, blockchain technology, 5G expansions and shifting to digital innovations should keep this bull market alive as software enhancements have positive returns on their investments.
Even with the lag in CapEx for much of the past decade and slowness in top line growth last year, US productivity finally showed signs of life. 2019 yielded a 1.7% rise. The 2000 – 2007 period was 2.7%. From 2007 – 2018, it was only 1.3%. If CapEx increases from here, driven by software, hopefully we can get productivity moving toward the historic norm over 2% and finally see a 3% GDP run rate. As corporations cut costs and utilize more technology, more revenue will flow to the bottom line leading to lower P/E’s.
On the global front, China has decided to not release January trade data and will combine it with the February release. There is no question the data was dreadful with much of the country shut down. When the SARS outbreak occurred, China accounted for 4.2% of the global economy. Today that number is over 16%. Supply chains will be disrupted. Foxconn, a major manufacturer and maker of the iPhone, already told employees to not come back on February 10th when the country is supposed to “re-open”. Others will follow. Restaurants are reporting a 50% drop in traffic. Cruise lines will certainly see a hiccup in demand. Many areas will see a near-term effect. Some are losing sales forever, while some will see a pickup later in 2020.
However, with optimism around a cure, quick containment policies and a slight slowdown in the growth rate of the virus this week, there is optimism this will be a minor blip. Hopefully that is the case for all involved. If you look at a long-term chart of equities, you can hardly notice the 2003 decline from SARS. Some are looking well ahead to better data in the second half of 2020 and beyond. However, investors may raise some cash prior to the weekend when anything can happen from this outbreak.
Today, actors Ashton Kutcher and Chris Rock turn 42 and 55, respectively. Country singer Garth Brooks is also 55.
James Vogt, 610-260-2214