From ISM numbers to jobs reports, last week’s US economic data was disappointing and showed that the US economy, though it’s getting better, isn’t recovering as fast as some had hoped.
The downbeat data quickly translated into US stock market weakness and begs the question: “What does this mean for the US economy and market going forward?”
While I don’t believe the reports suggest a recession, they do point toward a tougher US economic environment in the second quarter than in the first quarter, in line with what I’ve been discussing in my recent blog posts and weekly market commentary. Why? Just consider two particularly troubling numbers in the reports:
- Hourly wages are now growing at less than 2% year over year, below the rate of inflation. This means that unless consumers are willing to dip further into their already low savings, either wages need to start picking up or consumption will probably fall. As I mentioned in a post last week, a pickup in wages isn’t likely, meaning there’s some downside risk to US consumption.
- The percentage of the population engaged in the workforce keeps dropping. All else equal, a falling participation rate lowers US growth potential.
As for what the weak numbers mean for the US market and investors, there are three implications:
- Expect more market volatility. Markets were unusually quiet in the first quarter, with the VIX – or fear index – dropping to its lowest level since early 2007. Though last week’s data pushed the VIX up significantly, volatility still remains low and likely has further to rise.
- Be cautious on small caps. Though I do still expect the broad US market to finish higher in 2013, small caps discounted too much good news and more dramatically pulled back last week than their larger counterparts, which I prefer and which are accessible through the iShares S&P 100 Fund (OEF).
- Overweight municipals. While yields are likely to rise in 2013, the rise will be a slow and erratic process. And while I prefer equities, investors shouldn’t abandon bonds. Instead, they should focus on those parts of the fixed income space that offer some relative value- like municipals, accessible through the iShares National AMT-Free Muni Bond Fund (MUB).
And finally, it’s worth remembering that the big risk to the US market isn’t Washington or an existential crisis in Europe but rather a more mundane problem: disappointing economic growth.
Russ Koesterich, CFA, is the iShares Global Chief Investment Strategist.
Author is long MUB.