QE: The silver lining of slower growth
Stocks struggled last week amid more evidence that economic growth is not accelerating as expected. In the United States, the S&P 500 Index fell 0.99% to 2,081, the Dow Jones Industrial Average dropped 1.28% to 17,826, and the Nasdaq Composite Index lost 1.30% to close the week at 4,931. As for bonds, the yield on the 10-year Treasury fell from 1.95% to 1.87% as its price correspondingly rose.
Renewed worries over the future of Greece also contributed to last week’s market action. But sluggish global growth represents the nagging headwind for stocks, particularly in the United States where expectations remain high. However, as has been the case for most of the past six years, slow growth and the monetary stimulus intended to combat it are benefiting some markets—and hurting others.
Consumers saving, not spending
Last week brought more evidence of what is shaping up to be a very soft start to the year for the US economy. Despite a sharp advance in consumer sentiment, retail sales in March once again disappointed, leaving adjusted retail sales up just 1.3% year-over-year, the slowest rate of increase since 2009.
Rising wages and cheaper oil prices should be supporting sales, but Americans are being more conservative than in past cycles; instead of spending more, they are saving more. In February, the savings rate rose to 5.8%, the highest since 2012.
And the softness was not limited to the consumer. Both industrial production, which contracted by 0.6% in March, and housing starts were below estimates. The persistent softness in U.S. economic data has led economists to lower their estimates for first quarter gross domestic product (GDP) growth to 1.4%, down from 3% as recently as November. Growth should rebound in the second quarter, but the United States will struggle to hit the 3% growth rate that investors expected at the beginning of the year. Another implication of the slowing growth: It suggests that earnings estimates for the year may still be too high.
The situation in the world’s second-largest economy, China, is also one of diminished expectations. First quarter growth in China decelerated to 7%, the slowest pace in six years. And in many ways, that statistic understates the slowdown. Fixed asset investment slowed to a 14-year low, while retail sales, which are expected to compensate for a slower rate of investment, fell to a nine-year low.
The comfort of quantitative easing
In the case of China, however, lower growth has a silver lining: greater monetary and fiscal stimulus. To be sure, investors there are hoping slower growth will lead to stimulus by the government. And we see investors being similarly consoled in Europe. Last week, European Central Bank (ECB) President Mario Draghi reiterated his commitment to Europe’s quantitative easing program. The 60-billion-euro-a-month bond-buying spree has pushed 10-year German Bund yields down to nearly 0%.
Even in the United States, the weak pace of global growth has reassured investors that a potential interest rate hike by the Federal Reserve does not represent a near-term threat. Last week, US rates fell toward their April lows. At the same time, interest rate volatility has also dropped, with the MOVE Index, which measures volatility in the US Treasury market, recently hitting its lowest level in months.
Among the beneficiaries of this environment are many, although not all, financial companies. With interest rates low and most central banks stuck in a position of near-permanent easing, it should come as little surprise that many large financial firms are seeing a benefit.
It is true that traditional banks are struggling with low rates and declining net interest margins. Wells Fargo reported that its net interest margin fell below 3% for the first time in at least a decade.
However, financial firms with large capital market operations and merger-and-acquisition desks are thriving. Low rates have translated into a surge in mergers and an increase in currency trading, both big moneymakers for investment banks. Last week, JP Morgan and Goldman Sachs reported strong numbers, with Goldman’s profits at a five-year high. We see the favorable environment for this sector continuing, and accordingly, we would remain overweight large, global financial firms.
Russ Koesterich is BlackRock’s global chief investment strategist