Excerpted from Provident Investment’s May Investment Comments
In early April, the market reached its highest levels of 2016 (so far) as signs of economic stability and delayed interest rate hikes encouraged investors. There may be a bit more negative news ahead, but indicators of the future are starting to point in the right direction.
Earnings per share (EPS) for the companies comprising the S&P 500 fell 4% in the fourth quarter. Looking at the first quarter, estimates call for an 8% drop in EPS. Growth rates slowed and then turned negative over the past couple of years resulting from modest economic growth, adverse foreign currency translation due to the strong dollar, and falling commodity prices, especially for energy.
After hitting new lows early in the year, commodity prices have risen, although they remain well below the highs of several years ago. The dollar recently hit its lowest point of the past ten months. Both of these developments suggest commodity prices and currency translation should have less impact on corporate profits in coming quarters.
Economic growth appears stable to improving. European factory output is rising with significant help from the weak euro in 2015. China’s factory sector rebounded in March, although one good month doesn’t yet make a convincing trend.
U.S. economic growth remains modest, but stable. Capital spending was weak throughout 2015 due to the double-pronged effect of the plunge in commodity prices and the strong dollar. Early results in 2016 point to a rebound, but a soft February partially offset stronger growth in January. Recent improvements in commodity prices and the lower value of the U.S. dollar should help U.S. capital spending recover or at least stabilize.
Growth in consumer spending remains puzzlingly, but consistently, lower than growth in personal income. The important takeaway, though, is that growth in both measures continues to rise month after month. As most investors realize, consumer spending powers 70% of the U.S. economy. It is the continued growth in this measure that led us to remain cautiously optimistic over the past nine months as the market wobbled and investors became concerned about renewed recession.
The Bureau of Economic Analysis has not yet released first quarter economic growth as of this writing, but we expect it to be quite modest based on statistics released for the first 2-3 months of the year. However, the precursors of stability and growth remain intact.…
…The net result of the various inputs is that we continue to project modest, but positive, economic growth and returns for U.S. stock investors this year. We have to caution that volatility is likely to remain elevated resulting from uncertainties over the modest rate of economic growth, the U.S. presidential election, and unpredictable regulatory pronouncements. Selection of good growth stocks with an eye on valuation will continue to be important to investors’ success.