“We must free ourselves of the hope that the sea will ever rest.
We must learn to sail in high winds.” - Aristotle Onassis
This quote from Mr. Onassis, a famous Greek shipping tycoon, is valuable advice not only for sailors, but also for equity investors as they contemplate the future.
Looking back on the first half of 2015, there were notable events in many regions of the world that resulted in choppy seas and volatile crosscurrents. For example, in the U.S., severe winter weather, the lengthy West Coast port strike, a rising dollar, and weak consumer and business spending led to a surprising decline in first-quarter GDP. These cold winds subsided as the spring unfolded, the weather improved, and the consumer got back to doing what consumers do best – spending money. In contrast, the winds of optimism were blowing strongly on the European continent in response to quantitative easing by the European Central Bank, and there was evidence of a modest pickup in economic activity relative to diminished expectations. This momentum was reversed in the second quarter as attention turned to the unfolding drama in Greece and its impact on the rest of the Eurozone.
As we look out over the horizon for the balance of 2015, we continue to see a tug of war between powerful crosscurrents that are likely to continue to create turbulence and investor anxiety, some of which are illustrated in the grid to the right. In the U.S., increasing evidence of spending by consumers and businesses, coupled with a benign inflation environment, is likely to bolster confidence in the outlook for profits. Corporations are likely to see upward pressure on wages in coming months and will have to grapple with continued volatility in currency markets. However, in our view, the benefits from lower commodity prices and operating leverage from solid cost control are likely to offset a good amount of the pressure from higher wages.
We believe all of these factors are supportive of higher stock prices. The flip side of this good news is that the Federal Reserve is likely to be pushing interest rates higher by year end, which historically has lowered the price-earnings (PE) multiple of the stock market. The two countervailing forces are likely to keep investors on high alert and contribute to the choppy seas we have been calling for in 2015.
In Europe, the crisis in Greece has drifted the Eurozone into uncharted waters. While Greece is a minor player economically (its GDP is approximately the same as Louisiana’s), a “Grexit,” or a resolution that is suboptimal, will serve to increase overall uncertainty, dampen economic activity, and raise risk levels. The resultant downward pressure on PEs could be exacerbated by increased geopolitical tensions in Eastern Europe or the Middle East, which would be an unwelcome development that would offset the nascent signs of economic and profit improvements evidenced in the first half of the year in Europe.
In assessing the conditions that lie ahead, we continue to prefer the relative certainty of the improving economic backdrop of the U.S., despite headwinds posed by higher wages and the threat of higher interest rates. If the Fed’s moves are gradual, and are reflective of an improving pace of economic growth in the U.S., the environment should be conducive to higher stock prices. In contrast, we believe that continued structural problems in Europe are likely to hamper any cyclical rebound in European economic growth. As a result, we reiterate our overweight in U.S. equities.
City National Rochdale, LLC is a Registered Investment Advisor and wholly owned subsidiary of City National Bank.
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