As Head of Research for State Street Global Advisors’ ETF and mutual fund businesses, part of my job focuses on helping investment professionals parse through market movements to make sense of the implications that shifting markets may have for portfolios.
To do this well, my team and I spend a lot of time speaking with clients about their perspectives on the market and how these views impact their decision-making and investment strategies.
This new blog series, Market Musings, will give me a chance to share what I’m hearing from clients while providing guidance on how investors may be able to navigate and identify opportunities in today’s market environment.
I wanted to kick off this series by talking about a sense of cautious optimism that is emerging among investment professionals. While investors are holding higher amounts of cash, they are interested in putting that cash to work instead of keeping it on the sidelines.
What I’m hearing is that most investors are not looking to make quite as many directional bets in the current environment. Instead, investors are looking for pockets of opportunity that might emerge in a volatile market that’s largely driven by macroeconomic forces, rather than fundamentals.
Frustration with the Federal Reserve waiting game
Many investors wish the Federal Reserve (Fed) had put an end to the waiting game and raised the federal funds rate in September. As we now know, they chose not to do so, and again they left rates unchanged at their policy meeting this week.
It shouldn’t be much of a surprise then that markets have gyrated as the members of the Federal Open Market Committee (FOMC) have decided to hold rates steady. Investors are now contending with what my colleague Dan Farley has referred to as “policy purgatory,” where uncertainty over rates will keep the stock and bond markets on edge in the fourth quarter.
One constant in the midst of this market uncertainty is that extraordinary monetary policy is not going away anytime soon. Even if the FOMC decides to raise interest rates in December, our expectation is that any future rate increases will be slow and gradual, with the bank carefully evaluating a potential increase against new economic data. While we wait for liftoff, investors should expect more of the same: navigating a macro-driven world where central banks matter more than fundamentals and market volatility is here to stay.
Where does that leave investors?
Concerns over China’s economic slowdown and its impact on global growth will continue to weigh on the markets. There is also the downside risk that deflationary forces will persist for some time and weaken a US recovery.
While these forces are worrisome, it’s also the case that there has never been a global recession without a US recession and US data is generally trending in the right direction. Second-quarter real GDP rose at a 3.9% annual growth rate, surpassing estimates for a 3.7% rise. Consumption was the largest contributor, accounting for 2.4% of the 3.9% growth.1
For investors who are cautiously optimistic and want to use some of the cash they’ve been holding on the sidelines, consumer discretionary stocks may represent a pocket of opportunity. We are witnessing a consumer-led economic recovery as recent data, including household spending, paints the picture of a resilient US consumer. This means consumers may have ample spending power heading into the year-end holiday shopping season.
Within consumer discretionary, US homebuilders stand to benefit from a robust consumer profile and a domestically-oriented revenue stream that is somewhat insulated from a rising US dollar.
While earnings season is still in the early stages, initial results have been positive for discretionary stocks. So far, consumer discretionary companies have reported a 21.8% year-over-year increase in quarterly earnings, beating estimates by 10.0%, with expected earnings of 11.8% (including those that have not yet reported). That is the largest surprise rate among all S&P 500® sectors that have reported results.2
The remainder of the fourth quarter could be marked by continued volatility and persistent speculation over the fate of rates. However, it’s encouraging to see investors showing signs of cautious optimism in this time of limbo. At State Street Global Advisors, we believe pockets of opportunity will continue to emerge that investors can use to navigate today’s macro-driven market.
1Bureau of Economic Analysis, as of 9/25/2015
2RBC Capital Markets, as of 10/26/2015