So far it appears that the “sell in May and go away” crowd got it wrong as the S&P 500 Index (SPX) climbed 2.1% in that month with positive momentum continuing into the early weeks of June.
The European Central Bank’s base interest rate cut to 0.15% (and a cut to -0.10% on bank deposit facilities) along with strong recent U.S. non-farm payroll report were sufficient to keep the rally in global stocks and bonds intact.
But as we’ve noted previously, much of the gain in European bonds and stocks over the past two years has come on investors’ faith in Mario Draghi’s assurance that the ECB would do whatever it takes to preserve the euro.
That assurance is now finally going to be tested as the economic benefit, if any, of last the recent announcement will take months to be seen. We suspect that investor patience may also be tested before the final evidence is in.
Most other economic data releases signaled that the domestic economy is gaining strength, albeit at levels that still allow the vigor of such recovery to be questioned. Accordingly, the pattern of the past several weeks should continue: market averages grinding higher on light trading volume.
Although, as the weather warms up and we push deeper into the summer doldrums, the market may soon find itself lacking a catalyst to push it to new highs. Since 1950, June has been the second worst performing month for the S&P 500 Index and the Dow Jones Industrial Average (DJIA). (September is the worst).
In spite of the ascent of the major market averages and lack of identifiable near-term catalysts to propel markets higher, we remain fully invested and optimistic about world equity markets because global monetary policy is accommodative and likely to remain so:
- The Fed is still buying bonds under its quantitative easing program and rolling over maturities of those bonds already in its portfolio. In my opinion, interest rates are likely to stay low for a very, very long time.
- The Bank of Japan has unleashed a proportionately large quantitative easing program that is destined to get even bigger.
- The European Central Bank, in my opinion, is moving closer to full blown quantitative easing, ending sterilization of its asset purchases, and encouraging more bank lending and lowering interest rates.
- China’s recent tightening from more restrictive credit and currency appreciation is beginning to ease as the government moves to become more modestly stimulative to achieve its growth targets. Interest rates will shift lower as 2015 approaches.
Deflation is still the biggest threat to global growth, which is why monetary policy stays accommodative and interest rates remain low.
U.S. and European economic data have been on an improving trend, helping to bolster the outlook for the global economy. As output accelerates in advanced economies, countries around the world should benefit from increasing demand for manufacturing inputs.
With the investment cycle turning in the United States and Europe, global trade should accelerate in the near term, helping kick-start growth in some struggling emerging market economies.
The underlying strength of the U.S. economy continues to be unappreciated and largely unrecognized in my opinion. U.S. headline GDP, which declined by 1% in the first quarter, in particular has given a disproportionately large false sense of weakness in my view.
We constantly hear about the economy limping along at 2%. Less appreciated is that the private sector has actually been growing in excess of 3% since 2009. The decline in government spending that has weighed on the numbers but will now begin to contribute positively to growth as those spending cuts end.
Meanwhile, the private sector is re-accelerating as business spending has finally begun to trend higher. I have no way of knowing for sure, but these positive forces may push real GDP growth above 3% in the second half of this year.
DISCLAIMER: The reader should not assume that any investments identified were or will be profitable or that any investment recommendations or investment decisions we make in the future will be profitable. Past performance is no guarantee of future results.
