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|Thursday, April 17, 2014|
BY JASON NORRIS | OB BLOGGER
A Hazy Shade of Winter
The “polar vortex” of 2014 seems to have finally thawed and we believe this change in weather will bring more sunshine to the U.S. economy as well. Economic growth hit a speed bump in the first quarter as much of the U.S. experienced severe winter conditions. This resulted in lower-than-expected economic activity, which in turn led investors to reduce risk in their portfolios and bid up bonds, leading to a decline in interest rates. We believe this “soft patch” is a short-term phenomenon and have already started to see a pick-up in retail sales and manufacturing activity, as seen in the Purchasing Managers Index (PMI) data in the chart below.
What is PMI and Why Does it Matter?
The Purchasing Managers Index (PMI) is an indicator of the vitality of the manufacturing sector. The PMI Index is based on five major indicators: new orders, inventory levels, production, supplier deliveries and employment. Historically this has proved to be a good leading indicator for future unemployment rates, consumer confidence and the direction of the economy.
In last month’s blog posting, we made mention of the impact of the NCAA basketball tournament on worker productivity. As the polar vortex melts away, there is a new weather-related phenomenon across the U.S. that is making headlines – the pollen vortex. According to the Asthma and Allergy Foundation of America (AAFA), 70 million people suffer from nasal allergies and asthma in the U.S., resulting in $18 billion in hospital visits and lost workdays annually. Although we think the polar vortex will have packed a bigger punch to the economy than pollen, we do empathize with those who are sneezing and wheezing this spring.
While stock market volatility hasn’t hurt consumer confidence, the price of gas may do so in the near future. We have seen a 10 percent increase in gas prices the last two months. Of course commodity prices can be volatile, but if there is a persistent trend higher, it will present an impediment to our bullish view of the U.S. consumer.
This improvement in economic activity has also resulted in more lending from financial institutions. However, there is a bifurcation in lending activity as smaller banks have shown an increased propensity to increase loans (up over 13 percent), while larger institutions have shown muted growth (up 5 percent). The main differential is coming from real estate lending, with smaller banks growing their loan books, while larger banks are still showing declines. Commercial lending for both segments has shown very healthy growth of late. Some of the hesitation from larger institutions may be coming from the increased capital requirements the Federal Reserve has mandated. Fed Chairwoman Yellen has even stated that larger financial Institutions may want to reserve more than the regulators require.
We believe that spring will show a thaw in economic activity, thus we favor equity exposure to the U.S. consumer and financials, especially regional banks and select life insurance companies.
April 15 has come and gone, bringing increased revenues to the U.S. Treasury. On the expenditure side of the ledger, we are also seeing reductions in deficit projections as a result of lower-than-anticipated spending on healthcare and defense. While the U.S. is still spending more than it takes in, at least that difference is declining. For those taxpayers who have a big heart and want “make a difference,” the IRS includes a box on tax forms for filers to check should they want to make a donation to the Treasury. Remember, tax rates are just a minimum requirement! Over the last 15 years, the average annual donation has been around $2 million; however, 2014 has already eclipsed this amount with $2.7 million in additional support to the Treasury. With the strength in equity markets over the last few years, will there be more “giving” to the U.S. government, or will increased capital gains taxes eat into this philanthropic endeavor? We’ll see.
Show Me the Money
April kicks off the first quarter earnings season for 2014 and expectations are for earnings growth of 3 percent (year-over-year). This is down from expectations of 10 percent growth three months ago. We believe this negative revision is a result of extreme weather in the first quarter. We expect second quarter growth to reaccelerate to 9 percent. Though this may prove to be somewhat optimistic, we believe we will see greater-than-5-percent growth in second quarter.
As we move into spring, we would expect U.S. economic growth to continue to pick up, which will be positive for corporate earnings but also result in higher interest rates. That would present a headwind to bond investors.
Jason Norris, CFA, is executive vice president of research at Ferguson Wellman Capital Management. Ferguson Wellman analysts blog on the financial markets for Oregon Business.
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