Brouwer & JanachowskiOctober 30, 2015
Three things this week.
1. The world’s most watched central banker: Janet Yellen of the Federal Reserve, followed last week’s most persuasive Mario Draghi of the ECB. Unlike last week, there were no surprises and little market reaction. Unsurprisingly, the FOMC decided not to raise rates. Three points arose. One, they dropped references to external concerns. Two, they relegated job growth from “improving” to steady. Three, they said they would determine whether to raise rates rather than how long they would keep the current range. The market took this as hawkish. But we see it differently. Any December move will be data driven. That means two solid employment numbers and growth. And the first numbers on growth came the next day.
2. GDP: the BEA released third quarter GDP estimates. Growth came in at a disappointing 1.5%. We tend to look at current or nominal GDP these days. Low inflation, caused by the energy sector’s near $100bn decline in production over the last year, flatters real growth. And on that metric, it’s a bit disconcerting. A year ago, the Fed estimated 2015 nominal GDP at 4%. Last summer it was down to 2.8%. It now looks like 2.3%. This time the biggest drag was inventories, the most volatile and unpredictable of GDP components. It was down $65bn and reduced growth by 1.4%.
We view inventories simply. If businesses have too much, either through overstocking or low demand, they cut them. It’s a business confidence gauge. And right now, it has taken a hit. Investment in structures also fell 4.7% led by the 55% decline in oil and gas drilling. Personal consumption contributed 2.2% to growth, lower than last quarter and last year. So, it’s not a great report and does not support a December hike.
3. Earnings: the story is weak sales growth. This is important. Earnings, unlike sales, can for a time be managed. Taxes, expenses, foreign exchange and buybacks can all help the bottom line. So far in this earnings season, 77% of companies reported earnings above estimates but only 43% reported sales above estimates. Energy has not helped of course, but sales are slowing. Here are the numbers so far, about halfway through the season:
|S&P 500||S&P 500 ex-Energy||Energy|
|Year on Year Sales||-3.5%||+2.0%||-38.0%|
|Year on Year Earnings||-3.8%||+3.9%||-65.0%|
Even technology is taking a bruising. Tech earnings are up 2.0%, but exclude Apple and that number drops to -3.0%. What’s going on? Well, as we said, companies are citing four major themes: 1) Slower China and 2) Europe 3) a stronger dollar and 4) lower oil and gas. The good news is that equity and bond markets anticipated this and are taking it in their stride. There is little price action and equities are up 9% from quarter end.
Bottom Line: We’ve said this many times before, but this is a good time to remember diversification. Here is a simple chart that plots equities and bonds over the last five years. Equities have won hands down. But whenever you see the line fall, bonds outperformed equities, as indeed they did in August. So keep invested in fixed income.
--Christian Thwaites, Brouwer & Janachowski, LLC
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