The “Goldilocks” economy continues, says BlackRock’s Koesterich
US labour market is still not strong enough to produce a pickup in wages, Russ Koesterich, chief investment strategist at BlackRock, says.
Economy: Two Steps Forward, One Step Back
There was a great deal of economic data for investors to digest last week. One of the highlights was the first estimate of second-quarter gross domestic product growth-a better-than-expected 1.7% rate. The good news came with a few caveats, however. Most significantly, we learned that first-quarter growth was quite a bit worse than had been previously thought, with the original 1.8% pace being downgraded to 1.1%. Additionally, the second-quarter GDP reading also indicated that consumer spending has been weakening.
Economic data from July was also mixed. On the positive side, we saw a significant rebound in US manufacturing activity, a trend that was confirmed by multiple surveys. This improvement was not limited to the United States, as we also witnessed stronger manufacturing data from Europe and China.
In contrast, July’s employment data was less rosy. Last month, the United States produced 162,000 new jobs, well below expectations and the slowest rate of growth in four months. Additionally, the data showed that the average work week shrank and that hourly earnings fell for the first time since last October-an important point since it shows that the labour market is still not strong enough to produce a pickup in wages. Finally, we would point out that even the headline improvement in the unemployment rate (which fell from 7.6% to 7.4%) was actually a sign of weakness. A close look at the numbers shows that the decline can be partially attributed to the fact that more and more Americans have dropping out of the labour force and are no longer seeking employment.
The Backdrop has Been “Good Enough,” but Caution is Warranted
On the whole, we would say the data continues to paint a picture of an economy that is exhibiting gradual and grudging improvements. So far, this environment has translated into what is often referred to as a “Goldilocks scenario” for stocks. The economic data is just strong enough to support earnings, but also still weak enough that the Federal Reserve is not being forced into aggressive tightening.
That said, however, we believe investors are likely to witness more volatility when we get into the fall. In our view, September is likely to provide three challenges for equity markets. First, September is a month when the calendar has traditionally mattered-it has historically been the worst month for stock prices. Second, we expect anxiety over the direction of monetary policy to rise in advance of the Fed’s mid-September policy meeting. And third, we expect Europe to re-emerge as a source of volatility as investors focus their attention on next month’s federal election in Germany.
Overall, we still believe that equity valuations are reasonable and that prices can continue to advance over the next year, but we would also advocate a more defensive posture going into the fall. In particular, we would suggest lightening up on those segments of the market that look the most extended. These would include smallcap companies and areas of the market most exposed to weakness in consumer spending-such as retailers and other consumer discretionary companies.