Markets are discounting any permanent weather related lost revenues in sales and a much lower than originally forecast level of real GDP. We anticipate that 1Q2014 earnings’ growth forecast for the S&P 500, now at 2.4%, will also get a pass for the weather. Energy sector earnings are expected to decline 5.8% and the weakened Consumer Discretionary sector will rise only 6%. Financial sector earnings growth, which rose year-over-year 25% in 4Q2013 is projected to increase only 3.4% in 1Q2014. Overall 1Q2014 is forecast to be the lowest rate of growth since 3Q2012. Consensus real GDP first quarter growth is estimated at less than 1%.
Many market strategists calling for a definable correction (10-15%) have thus far proven wrong on Fed tapering, Emerging Market meltdown, and a decline in corporate earnings. The recent sell-off on the Ukraine crisis lasted one day as it became evident that no military action would take place. Ukraine is not a country of particular interest to the US and Europe, or for that matter, Russia. In fact, the annexation of Crimea may ultimately prove especially painful to Russia’s finances. While Europe fears a potential energy cutback, this is highly unlikely as it is the source of 42% of Russia’s total revenues. Just as we dismissed a contagion from the Emerging Market sell-off (Compass 2/11), so too the Ukraine crisis.
The general consensus is that the effect of severe weather has pushed back economic growth until later in the year along with back-loaded earnings’ gains. As mentioned, the consumer slowdown began prior to the severe weather as inventory sales ratios began to rise to uncomfortable levels. In addition, credit expansion remained low throughout 2013, and Capex was nowhere near historical levels. Despite the surprise in February employment, the overall trend remains weak. However, all these negatives are already priced into equities. Notwithstanding is the possibility that weather is being used as an excuse for a bigger problem. We do not subscribe to this thinking and believe that equities, particularly growth stocks, will outperform fixed income as economic and earnings data begin to surprise.
Fundamental to our reasoning for equities is the following:
The return to the traditional business cycle after the adjustments to the economy necessitated by the 2007-2008 financial crisis is underway. The completion of the Fed tapering will mark the end of government direct emergency involvement.
The fiscal drag from new regulatory legislation, tax increases, and the sequester have lessened and the deficit buoyed by increasing tax revenues, is slowing. State and local governments’
Both corporate and individual balance sheets are healthier than ever. Corporate cash is over $3 trillion and pension plan funding is being restored. Individual wealth has benefitted from equity portfolios and rising home prices.
Our investment strategy remains long-term optimistic on corporate equities. With all the discussion of the five-year anniversary of the 2009 market bottom, which has seen the S&P 500 rise 178% and the Nasdaq, 242%, the implication is a correction is imminent and necessary. Bull markets have no time limit. Contrary to most strategists, we believe that continued economic growth, accompanied by rising real interest rates, will result in a multiple expansion for equities.
Hutchens Investment Management
Hutchens Investment Management