Market Sets New Records (More Are Coming)
After three weeks of consecutive gains, both the S&P 500 and the Nasdaq closed at record highs on Friday, buoyed by signs of a stronger US economy and loosening gridlock, perhaps, in Washington. The domestic gains are being reinforced by a better economic outlook overseas and some favorable political developments. Gains in European growth, especially if reinforced by some labor market reform, will provide incremental demand for domestic exports and add to corporate profitably. As a consequence, the outlook for domestic equities has improved.
The US payroll report revealed 211,000 new hires last month, which dispelled nascent fears of a slowdown following the weak March job formation number (even though Friday’s report revised downward that surprising 98,000 figure to 79,000). And while firm outlays on capital equipment remain weak, as compared to other recoveries, they have been picking up lately and are likely to gain further strength as firms run out of options to expand production through new hires alone, given a 4.4% unemployment rate.
Despite solid economic underpinnings, many investors remain nervous at the record levels now being reached by various market indices and the above-average multiples at which those markets are trading. After all, last year the US economy was showing similar signs of strength in hiring, job openings, low unemployment, and a positive outlook for US company earnings growth, and yet multiples are now higher than they were then. This year, investors are looking at continued economic expansion and a resumption of growth in corporate earnings growth. Adding some potential for fiscal reform provides an excellent environment for stocks, even though those tax reform expectations have been tempered.
The improving outlook for Europe aids domestic growth prospects. It isn’t very often that European elections capture as much attention in the US as the Macron-Le Pen battle has. But after the Brexit vote and the Trump win, investors have been on edge about the possibility of additional populist waves rolling across supposedly stable economies. Many had feared further disruption to the European Union following the Brexit vote, and Emmanuel Macron’s decisive win should lessen those fears. This is good news, and comes on top of other developments in Europe that are pointing to continuing recovery and dampening sources of economic upheaval.
Europe, which lagged the US in recovering from global recession, is showing further signs that growth is improving. Last week, we learned that the Eurozone expanded by 2% in the first quarter, on an annualized basis, and this strength is expected to continue in the quarters ahead. Moreover, the unemployment rate in the EU is at its lowest level since April 2009, led by gains in the EU’s growth engine, Germany, where unemployment fell below 6%. While this is high relative to the US, Europe has greater structural challenges in its labor market and Europe is also lagging the US in its recovery. That, combined with the win for Macron, suggests that further recovery in Europe, and hence greater demand for US exports, may very well be in the cards.
Even the UK, where many feared an immediate slowdown in economic activity following Brexit, is showing signs of strength. The UK Manufacturing Purchasing Managers Index (PMI) increased in March to 57.3 from 54.2, which surprised forecasters who had expected a drop in activity. Britain looks to be benefitting both from a weaker pound and from strengthening demand from consumers in the EU.
Most surprisingly, Greece’s debt problems, which disrupted markets in 2015, now appear to be headed for calm resolution after more than six months of discussions with creditors. The Greek government has agreed to implement further reforms in exchange for the cash it needs to meet its upcoming debt obligations. The yield on Greek government debt dropped to a two-and-a-half year low as investors reacted to the decline in the risk of a default.
Strength in Europe is good news for companies in the US that sell into international markets. Last year, US firms exported over $500 billion in goods and services to the European Union, led by sales in aerospace, machinery, pharmaceuticals, and medical devices. US companies with operations and sales within Europe are not captured by that export figure, but clearly stand to benefit even more from a healthier Europe. Macron’s win eases fears of a breakup of the EU and may even lead to labor market improvements in France, which are badly needed. It also makes it more likely that Europe will continue on its current path of economic progress. If the political winds in Europe continue to blow in the direction of market reform, we may very well see additional expansion in spending from a major US trade partner, which would help to boost sales and earnings for US companies well into the future.
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