Is the Glass Half Full or Empty in the Second Half
It’s that time of year. The time when we arrange our tea leaves and dig out our Ouija boards to make our bold second half of the year predictions. So, what are we seeing? Will the economy gain steam in the second half of this year after the woeful first quarter or will it fall flat before the finish line exhausted and played out? What are the overriding factors that will drive the final six months? We see three broad movers of markets:
1. Will Gross Domestic Production be closer to 2% or 3% growth? 2. What will the Fed’s exit from Quantitative Easing (QE) and 0% interest rates do to markets? 3. Can corporate earnings increase to appropriate levels to sustain this bull market?
Markets survived a woeful 0.7% first quarter GDP report when our economy was hampered by one of the worst winters in US history and West Coast dock strikes. However, we believe that GDP expansion will be closer to 3% by year’s end. Three percent growth is the historical average growth rate over the last 50 years. Because of higher than normal expectations for consumer spending, housing, and business capital spending, the outlook is positive for growth for the remainder of 2015.
Markets seem to be resigned to the fact that the Fed will act this year. The “when” of interest rate hikes seems to be contingent upon maximum employment (250k jobs created every month); inflation moves above 2%, and a jobless rate of 5.4%. Most Fed watchers expect the first hike to be in September or December with a movement of 25 basis points and only to be 2% total by 2018.
We believe that corporate earnings will expand equity markets in the second half. Why? There are 5 reasons:
a. First and foremost, we must see increased GDP growth or these predictions are as worthless as Presidential promises. b. Stabilization of oil prices which will help mitigate losses to energy companies and help prices in this sector of the S&P 500. c. A pause in the dollar rally is expected and will also help the majority of S&P 500 exporters. d. Corporate profit margins will continue to hold steady because of only modest pressure coming from wage increases, historical low borrowing rates and low commodity prices. e. Corporations will continue to purchase large blocks of their own stocks which will help their balance sheets and boost the prices.
If this optimism comes to fruition, what does it mean for your portfolio? As we predicted at the beginning of the year, we feel the S&P 500 will be up between 5-9%. Currently, that index is up slightly more than 3% for the year. We seem to be tracking well with those predictions.
Arriving in good shape at the finish line in 2015 means that we will arrive with different running shoes than the ones we wore in 2014. In our portfolios this year, we maintain more emerging market, developed international investments alternative strategies than we did last year. With QE programs in full swing in Europe and Japan, we believe the valuations of some of these investments seem to indicate that foreign investments are needed in portfolios. Also, with bond prices under pressure, we feel it has become very difficult to find areas where historical fixed income returns are available. Alternative strategies offer a low correlation to both bond and equity markets with capital preservation and moderate returns as the driver.
We believe we’ll cross the finish with less defensive types of investments including equities, long-term high quality defensive investments, International developed foreign investments and commodities than years past. However, we’ll have more cyclical growth investments that are US-centric in our equities while providing more high yield and alternative strategies in our fixed income space.
We think we are entering a time when volatility will return to markets. You should be prepared for louder and more frequent noise from market watchers. However, I think we should raise our half-full glass and toast a decent first half of the year. We believe we have more to be excited about in upcoming months.
Source: LPL Financial Research: 2015 Midyear Outlook* *Some Assembly Required. #1-388787 exp 06/16