The markets have been volatile to start the year, but no real headway has been made in either direction. The weather and issues in Ukraine have caused investors to take a step back.
The recent economic news flow has been encouraging, led by upside surprises from the April flash manufacturing PMI surveys. Global PMI appears on track to hold stable in April at a level consistent with a strong 4% underlying pace of growth in factory output. Taken together with the latest reading from GDP growth, which is running above 3% in March, top-down indicators are aligned with our forecast for global growth to rebound to an above-trend pace this quarter. The bigger question is whether recent positive news coming from the US and Western Europe can sustain strength beyond this quarter. We believe it will.
In the US, growth has been quite volatile in recent quarters, but much of the volatility can be explained by our unpredictable weather. As this drag fades, we think a bounce-back is likely and our March/April data appear to be showing the beginning of an acceleration. Several of our key upcoming releases should reinforce this message with strong gains expected in real consumption (0.4%), April employment (220,000), and a sustained high level of April auto sales (16.0 million). It is too early to confirm that the US economy has transitioned to the 3% growth pace we expect to be sustained in the coming quarters. But through the latest growth bounce, we see encouraging signals from business confidence and financial market supports. The failure of housing indicators to join in the spring lift is the one notable disappointment.
While the US economy is volatile, the improvement underway in Europe seems more solid. This is important, because we expect Europe to provide a complementary engine for global growth. The UK economy is now completing a year of above-3% growth and is certainly the leader in the region. However, we are seeing significant improvement in some of Europe’s “problem children”, with Spain and Portugal experiencing strong improvements.
The wild card is Ukraine. We believe ongoing tensions surrounding the Russia/Ukraine crisis are a threat to the projected pickup in global economic activity this quarter. In response to a perceived failure of Russia to act in either the “spirit or letter” of the Geneva agreement struck just one week ago, G-7 leaders have indicated additional sanctions are ready to be implemented. Sanctions could include restrictions on additional individuals, defense firms, and another bank.
The direct impact on Western European growth of reduced exports or capital flows to Russia is likely to be small. We believe that even in the event of some additional sanctions, European growth can still run above-trend in the coming quarters. We also believe the biggest concern is the potential for a curtailment of Russian energy exports that is amplified by a sharp hit to global confidence and risk appetite.
The calendar flipped and the personality of the markets also turned. We started the year with minor losses, but the markets have flipped those losses to small gains. In reality, we have been in a trading range for the last four months and it’s been nothing more than chop.
The recent choppiness in equities, while disappointing, is not altering our positive stance for equities in 2014. In our view, equities are supported by the positive combination of:
1. Strong corporate fundamentals
2. Strengthening US consumers
3. Pent-up demand for durables investment and improving global growth
4. Attractive relative value
Additionally, in the short-term, the low beta of mutual fund managers and high short-interest ratios should fuel for an eventual rally for the year.
Trading ranges, like the one we are in now, tend to be frustrating, but they are necessary.
The market made a big run last year and investors are now taking time to evaluate earnings, the economy and geopolitical events. In other words, our recent market movements are normal.