Fragile World No Bar to S&P 500 Rally as Economy DeliversJoseph Ciolli and Christopher Condon
The rally that has sent U.S. stocks to records for seven straight quarters is holding up as signs of an expanding economy and bolder consumers drown out the stress of sinking oil prices and debt worries from Venezuela to Greece.
The Standard & Poor’s 500 Index is up 10 percent this year and climb another 10 percent in 2015, JPMorgan Chase & Co. strategists led by Dubravko Lakos-Bujas wrote in a client note. The S&P 500 advanced 0.5 percent today even as concern grew about Venezuela, Russia’s fifth interest-rate increase failed to stem the ruble’s worst rout since 1998 and Greek stocks capped a three-day retreat in which they lost 20 percent.
Divergences among markets in the U.S. and elsewhere highlight the challenge facing the Federal Reserve in its quest to move beyond crisis-fighting mode and raise rates for the first time since 2006. While the U.S. economy appears livelier with every jobs report, the rest of the the world’s largest economies are slowing, shrinking or sitting still. Benchmark U.S. oil prices dropped below $60 a barrel today for the first time since July 2009.
The U.S. “went into the recession and financial crisis first, and we’re coming out of it first,” Alan Gayle, who helps oversee about $50 billion as a senior strategist at RidgeWorth Capital Management, said by phone. “The Fed wants to raise interest rates, but the pace at which they go about doing that is very much in question. The international situation is going to be a factor.”
Retail sales rose 0.7 percent in November, the most in eight months, as consumers bought electronics, clothing and furniture, according to Commerce Department figures issued today in Washington. The report added to optimism in an economy that has already added 2.65 million jobs this year, the most since 1999.
The upbeat outlook is why the Fed is likely to be the only major central bank raising rates next year. Unemployment has dropped to 5.8 percent, the lowest since 2008, and close to the Fed’s estimates for full employment.
Most Fed officials expect next year to begin increasing rates held near zero since December 2008. They will update their forecasts when the policy-setting Federal Open Market Committee meets on Dec. 16-17. Investors are betting on liftoff around August or September, and several policy makers have signaled their comfort with a mid-year move.
“The hurdle is high for them to deviate from a June liftoff,” said Joe Davis, chief economist at Vanguard Group Inc., the biggest mutual fund manager, based in Valley Forge, Pennsylvania.
The JPMorgan team led by Lakos-Bujos sees the rally in equities weathering rate increases that start in mid-2015. Stocks measured by the S&P 500 will climb 9.7 percent from last week’s close to 2,250 by the end of 2015 on an 8 percent gain in earnings, they said.
“The economy, despite all the grumbling, is getting better, and it’s getting better because the single most powerful factor in the world is the U.S. consumer,” John Manley, who helps oversee about $233 billion as chief equity strategist for Wells Fargo Funds Management in New York, said in a phone interview. “There’s always something that can pop up. but I don’t see anything over the next six months that would make me want to get out of the stock market.”
In contrast to the U.S., the outlook for other big economies has darkened. Economists surveyed by Bloomberg expect China to grow 7.4 percent this year, the weakest since 1990, as the country’s real estate and construction boom falters.
In Japan, government figures this week showed the economy contracted 1.9 percent in the third quarter, worse than preliminary data. For the euro area, forecasters don’t see quarterly growth exceeding an annual rate of 1 percent until the second half of 2015.
John Bellows, who helps manage more than $100 billion of fixed-income investments at Western Asset Management Co. in Pasadena, California, believes it’s unwise to dismiss the international risks.
“The trade channel probably underestimates the impact of the global economy on the U.S.,” Bellows said. The mismatch in growth, among other factors, could push up the value of the dollar, putting unwelcome downward pressure on U.S. inflation when the Fed wants to see prices rise more quickly, he said.
Inflation, as measured by the Fed’s preferred gauge, was 1.4 percent in October, the 30th consecutive month below its 2 percent target.
Beyond any direct impact, weak global conditions also heighten the risk that at least one struggling economy tips toward crisis. In that case, a financial shock could spread very quickly through global markets.
“A large blowup somewhere, say China has a hard landing, I think that’s a huge risk,” Gennadiy Goldberg, U.S. strategist at TD Securities USA LLC in New York. “If that goes sour, that could drag us down with it.”
Vanguard’s Davis and other economists stressed the U.S. can continue to grow amid a cool global environment. The U.S. is a “relatively closed economy,” said Paul Ashworth, chief U.S. economist at Capital Economics NA Ltd. in Toronto. Exports accounts for about 14 percent of gross domestic product, compared to 51 percent in Germany and 26 percent in China, according to World Bank data.
Thus, lower demand from abroad has a limited impact on overall GDP. Moreover, lower oil prices provide a boost to energy importers like the U.S., although its reliance on foreign oil has declined in recent years.
While all the economists interviewed said it would take a substantial external shock to disrupt markets enough to knock the Fed off track from raising rates in 2015, several also noted the unpredictable nature of financial shocks.
In the case of a China crash, “U.S. banks have very little exposure to China, and no one owns Chinese equities apart from the Chinese,” Capital Economics’ Ashworth said. “But who would have thought that a Russian default would push Long-Term Capital Management over the edge,” he said, recalling the 1998 hedge fund implosion.
So far, the effect on U.S. stocks have proven transitory. Declines in the benchmark gauge have lasted an average of 1.4 days in 2014, the shortest since at least 2009, according to data compiled by Bloomberg. Starting last year, returns on days after the index fell have averaged 0.13 percent, the highest since they were 0.38 percent in 2009.
The S&P 500 hasn’t had a decline of more than three days in a row this year and hasn’t fallen 10 percent or more over any period since October 2011. It came close in October amid signs of slowing global economic growth, sliding as much as 9.9 percent through the middle of the month before retracing to reach an all-time high two weeks later.
Corporate earnings that have exceeded analyst expectations have also provided a boost to U.S. stocks. For the third-quarter earnings season, 80 percent of the S&P 500 beat profit estimates and 60 percent surpassed revenue projections, according to data compiled by Bloomberg.
Meanwhile, American consumer confidence reached a seven-year high last week as job gains and plunging fuel costs propelled the U.S. economy and boosted spirits in the midst of the holiday-shopping season, according to a survey conducted by Bloomberg. Shoppers have benefited from oil prices at five-year lows as Brent crude prices plummeted 32 percent since the start of the fourth quarter.
“The market has been pretty resilient in the wake of oil getting crushed and amid the news overseas in Greece and China,” Todd Salamone, senior vice president at Cincinnati-based Schaeffer’s Investment Research Inc., said in a phone interview. “That suggests that some of these growth concerns might be misplaced. Expectations for earnings and economic data have been brought down and if we continue to meet or exceed those expectations it will be supportive of stocks.”