economic & financial market outlook - idob · economic & financial market outlook ......

Economic & Financial Market Outlook

WELLS CAPITAL MANAGEMENT

James W. Paulsen, Ph.D. Chief Investment Strategist

2WELLS CAPITAL MANAGEMENT

U.S. faces “supply-side” economic challenges!!!

Annualized U.S. working age population growth by economic recovery

Annualized U.S. productivity growth by economic recovery


Demand-side policies for supply-side problems!?!

Annualized U.S. real GDP growth vs. U.S. supply growth

by economic recovery


U.S. productivity needs to be rescued!?!

Detrended U.S. Productivity Index**Percent by which U.S. productivity index is above or below its post-war trend line average


The problem is lack of INVESTMENT!!?

Productivity vs. public sector

real investment spending Left scale – Detrended U.S. Productivity Index (Solid)

Right scale – Detrended U.S. Real Government Investment Spending

(i.e., percent above or below its post-war trend line average) (Dotted)

Productivity vs. private sector real investment spending

Left scale – Detrended U.S. Productivity Index (Solid)Right scale – Detrended U.S. Real Private Sector Investment Spending (i.e., percent above or below its post-war trend line average) (Dotted)


Ample capability to drive investment!!?

Public sector investment spending as a percent of real GDP

U.S. corporate net cash flow as a percent of nominal GDP


Demand-led recovery???

U.S. demand/supply ratio


Adjusting to a demand-led economy???

U.S. demand/supply ratio

S&P 500 Composite Stock Price Index U.S. 10-year Treasury bond yield


U.S. growth sustaining near 2.75%!!

Annual U.S. real GDP growth 4-Quarter Moving Average


Five forces for U.S. growth!!!

Finally … some credit creation

Better household world

Capital spending cycle still coming

Housing starts rise another 50%

Better growth abroad


Synchronized global policy accommodation!!?

WTI crude oil spot price U.S. 10-year Treasury bond yield


A synchronized global economic growth bounce???

Eurozone 10-year sovereign bond yield Bank of Japan monetary base reserve balances

Chinese 10-year sovereign bond yieldU.S. real broad trade weighted dollar index


Chinese policy officials have only recently began easing!!??

Chinese one year benchmark lending rate Annual Chinese M2 money supply growth

Shanghai Stock Exchange Composite IndexNatural Log

Chinese – U.S. exchange rate Price of one U.S. dollar per yuan


Eurozone showing signs of life!?!

Euro area real gross domestic product annual growth

Euro area real household consumption expenditure annual growth

Eurozone foreign trade balanceTrailing 12-month average trade balance

European business and consumer surveysEurozone economic sentiment and Eurozone retail trade confidence

Solid(left Scale) – Eurozone economic sentiment

Dotted(right scale) – Eurozone retail trade confidence


Eurozone following U.S. economy?!?

Unemployment rates Eurozone vs. U.S.

Solid – Eurozone unemployment rateDotted – U.S. unemployment rate


U.S. Ex-Mfg is stronger than perceived!!!

U.S. ISM services sector company survey U.S. annual non farm payroll employment growth

Total annual U.S. housing startsTotal annualized U.S. auto sales

Three-month moving average


Commodity price collapse is stimulative!!?

S&P GSCI Spot Commodity Price Index

Annual core consumer price inflation rate U.S. 10-year Treasury bond yield


$65.00 crude oil within a year??!

Crude oil price *Dark circles represents crude oil price one-year after each major bottom since 1980


When will commodity prices bottom?

U.S. commodity prices vs. U.S. Dollar IndexSolid Line (left scale) – S&P GCSI Spot Commodity Price Index, natural log scale

Dotted Line (right scale) – U.S. Real Broad Trade-Weighted Dollar Index, inverted natural log scale


U.S. Dollar Index vs. Fed funds rateSolid – Trade weighted U.S. Dollar Index

Dotted – Fed funds target interest rate

Higher interest rates = a lower dollar!!?


Is U.S. dollar peaking??!?

U.S. Major World Currency Index (DXY Index) JP Morgan Emerging Market Currency Index


A bull, a bear, or a bunny?

S&P 500 Composite Stock Price Index Natural log scale with recessions in grey


Good news becoming bad news for stock market?

U.S. initial jobless claims Four-week moving average

S&P 500 Composite Stock Price IndexShown on a natural log scale


Wall Street crossroad …… Slack to tightness??

Full employment

Economic power switches to labor owner

Cost push pressures/wages & price pressures/margin erosion

Forced to realign interest rates

Unfriendly policy officials

Capital spending leads

Reliance on productivity


Wage pressures finally rising!?!

U.S. wage inflation 3-month average of annual inflation rate in average hourly earnings

NFIB Small Business Compensation Plans Index3-month moving average


Core Inflation a change in tone???

Japan annual core consumer price inflation rate

U.S. annual core consumer price inflation rate

U.S. annual core PCE deflator inflation rate**Assuming the PCE core deflator rose in January

(reported later this month) by the same amount as the Core CPI Index rose as reported this morning (i.e., by 0.3%).

Eurozone annual core consumer price inflation rate

U.S. Annual core services inflation rate


Crossing the threshold of full employment ?!?When unemployment rate reaches 5% or less …

Stock returns are about 45% lower and bond returns are

about 70% lower

Stock falls 20% more frequently and bond yields rise about

60% of the time

Bonds provide less diversification benefits

On average, a recession is only 1.77 years away versus 4.18

years when unemployment rate is above 5%


Repricing bond yields post Armageddon fears!!!

Real 10-year Treasury bond yield**10-year bond yield less core consumer price inflation rate


Buy some JUNK???

U.S. Junk Bond Yield Spread**Chase High Yield Bond Spread


Buy some TIPS???

U.S. 10-year TIPS embedded expected inflation rate


Bond yields can move fast!?!

10-year Treasury bond yield


Does this make sense … ???

U.S. government bond yield


Stock market vulnerabilities?!?

Investor sentiment too calm and complacent

Valuation too high for crossroads

Interest rate structure “below” equilibrium

Losing the Fed friend

Thinning participation/concentrated leadership

Pumped-up by M&As, IPOs & Buybacks

An aging EPS cycle


An aging U.S. EPS cycle

S&P 500 trailing 12-month earnings per share


Record profit margins and cost-push pressures?!?

U.S. corporate profit margin vs. U.S. labor income share Solid (left scale) – U.S. corporate NIPA profits as a percent of nominal GDP.

Dotted (right inverted scale) – U.S. total labor compensation as a percent of nominal GDP.


Investor sentiment has been adjusted!!?

Investor sentiment AAII Bull less Bear (4-week moving average)


Median P/E = 14.5 and seldom above 20 P/E !?!

U.S. stock market trailing 12-month price-earnings ratio


Rule of 20!!?!

P/E Multiple vs. Rule of 20Solid – S&P 500 P/E multiple on trailing 12-month earnings per share

Dotted – 20 less the annual rate of core consumer price inflation Natural log scales


A market catalyst??!

Atlanta Fed GDPNow GDP Forecast*This concept provides an estimate of overall economic activity. It is an estimate of

current quarterly GDP growth updated daily as information is released during the quarter.


How to play coming year?

Invest to a year-end target of 2050

Maximize overweight to international stocks

Overweight mid and small caps

Add some real asset exposure

Emphasize manufacturing, commodity, energy, technology and financials

Raise proceeds on rallies from consumer discretionary, consumer staples, utilities, and health care


Overweight overseas!?!

Under owned

Better relative values

Hospitable policy officials

No negative full employment fallout

Companies in younger part of earnings cycle


Stock market leadership shift??!

Core consumer prices vs. core crude producer pricesNatural log scale

Solid: Core Consumer Price IndexDotted: Core Crude Producer Price Index(Crude non food materials less energy)


Go international and industrial!?!

U.S. / ex-U.S. total return stock performance vs.CPI/PPI Ratio

Consumer / industrial total return stock Performance vs. CPI/PPI Ratio

Solid (left natural log scale): MSCI relative total stock market return:U.S. stock market vs. global ex-U.S. stock market in U.S. dollars

Dotted (right natural log scale): Ratio of Core Consumer Price Index divided by Core PPI Index for crude non food materials less energy

Solid (left natural log scale): Relative total return performance of consumersectors vs. industrial sectors. Data from Kenneth French 12 sector U.S. universe.Consumer sectors include consumer non durables, consumer durables, telecom, utilities and shops (retail). Industrial sectors include manufacturing, energy and

chemicals. Sectors are equal weighted. Dotted (right natural log scale): Ratio of Core Consumer Price Index divided

by Core PPI Index for crude non food materials less energy


A cascade of change?!?

Relative S&P 500 dividend Aristocrat stock performance and commodity prices

Relative foreign stock performance and commodity prices

Relative small cap to large cap stock performance and commodity prices

Relative producer to consumer stock performance and commodity prices

Solid (left scale) – Relative stock price performance. S&P 500 Dividend Aristocrat Index compared to S&P 500 Composite Index.

Dotted (right scale) – S&P GCSI Spot Commodity Price Index, natural log scale.

Solid (left scale) – Performance of transports, materials, energy, and industrial sectors relative to consumer discretionary, consumer staples, and health care sectors.

Dotted (right scale, log) – SPGS Commodity Price Index

Solid (left scale) – MSCI World Ex. U.S. Stock Price Index relative to S&P 500 Index.Dotted (right scale, log) – SPGS Commodity Price Index.

Solid (left scale) – Relative small cap (Russell 2000 Index) to large cap (S&P 500 Index) performance

Dotted (right scale, log) – SPGS Commodity Price Index.


U.S. productivity and the stock market?

Detrended productivity vs. S&P 500 Stock Price IndexLeft scale – Detrended U.S. productivity index (solid)

Right scale – S&P 500 Stock Price Index, natural log scale (dotted)


10-year needs to reprice to between 4% to 5%

Bullet now & barbell as Fed gets in game

Stay below average duration

Overweight lower quality (junk)

Buy some TIPS

Investment themes—BONDS?


Investment themes—STOCKS?

Maintain secular overweight to stocks

Manage 2016 to a 2050 S&P target

Expect 5% to 7% buy and hold returns for balance of bull market

Diversify away from U.S.A.

• To a different policy cycle … Japan & eurozone

• To resource-based economics … Canada & Australia

• To emerging world

In U.S. market …

• Long term emphasize, manufacturing, commodity, energy, technology,

and financials

• Overweight small and mid caps

• Underweight consumer discretionary, consumer staples, utilities, and health care


Questions?


Disclosures

Wells Fargo Asset Management (WFAM) is a trade name used by the asset management businesses of Wells Fargo & Company. WFAM includes Affiliated Managers (Galliard Capital Management, Inc.; Golden Capital Management, LLC; Nelson Capital Management; Peregrine Capital Management; and The Rock Creek Group); Wells Capital Management, Inc. (Metropolitan West Capital Management, LLC; First International Advisors, LLC; and ECM Asset Management Ltd.); Wells Fargo Funds Distributor, LLC; Wells Fargo Asset Management Luxembourg S.A.; and Wells Fargo Funds Management, LLC.

Wells Capital Management (WellsCap) is a registered investment adviser and a wholly owned subsidiary of Wells Fargo Bank, N.A. WellsCap provides investment management services for a variety of institutions. The views expressed are those of the author at the time of writing and are subject to change. This material has been distributed for educational/informational purposes only, and should not be considered as investment advice or a recommendation for any particular security, strategy orinvestment product. The material is based upon information we consider reliable, but its accuracy and completeness cannot be guaranteed. Past performance is not a guarantee of future returns. As with any investment vehicle, there is a potential for profit as well as the possibility of loss. For additional information on Wells Capital Management and its advisory services, please view our web site at www.wellscap.com, or refer to our Form ADV Part II, which is available upon request by calling 415.396.8000.

http://www.wellscap.com/

economic & financial market outlook - idob · economic & financial market outlook ......

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