As we observe U.S. stocks down roughly 5 percent in the first week of 2016, we are reminded of what occurred last fall when Chinese growth concerns and a strong dollar reverberated around the globe. While China accounts for only 1 percent of U.S. economic output and its stock market is of limited heft compared to the value of global equities, the slowing of China’s economic growth continues to put pressure on its state-managed currency the renminbi. In turn, policy makers adjusted the “fixing” of China’s currency downward once again this week, and while a 0.5 percent midweek adjustment downward doesn’t seem like a big deal, it highlights the challenge that China’s government authorities have in managing a currency against the pressure of continued outbound investment flows. As foreign investors repatriate their renminbi into home market currencies “hard” script like the dollar tend to appreciate, creating economic headwinds for U.S. manufacturers attempting to export products rendered more expensive by a stronger greenback. As well, multinational corporations suffer as the earnings they generate overseas are worth less translated back into the dollar.
Service with a Smile
While the leadership of China’s state-controlled economy struggles to manage the country’s transition to a slower growth, more consumer-led economy, U.S. data out this week reminds us again of our economy’s resilience to overseas turbulence. First off, investors witnessed the dichotomy between domestic manufacturing, which accounts for just 12 percent of GDP, and the rest of our services led economy. The latter’s strength was again confirmed in a report that typically receives little attention: the ISM nonmanufacturing release for December. Growth signaled by this diffusion index highlights that our services-driven economy continues to benefit from healthy levels of discretionary income that consumers are spending in restaurants, on air travel for vacations, and in their investment accounts. The latter observation may seem unusual, but as today’s “smarter consumer” chastised by the financial crisis rebuilds savings, this creates demand for investment advisory services such as Ferguson Wellman’s, as well as additional brokerage, tax and accounting services.
U.S. Economic Expansion
Indeed, as we digest today’s much stronger than expected jobs report, investors will observe that professional services like those alluded to above helped drive the healthy 292,000 increase in December net-job gains. Accompanying the payroll growth is an unemployment rate that stayed stable at 5 percent last month, with a small uptick in the labor force participation rate indicating that a healthy job market may be luring some disaffected job seekers back into the labor force. So while the strong dollar is a hindrance to manufacturing, a headwind to the earnings of U.S. multinational companies, and a negative for commodities like oil that are priced in the currency, it helps boost the disposable income of domestic consumers who, at the end of the day, are the long pole in the tent for the U.S. economy.
Earnings Are the Key
As our 2016 Investment Outlook entitled, “Groundhog Day” highlights, the strong dollar and weak oil price environment are being revisited again. Aside from the potential for these factors to again hinder the forward progress of corporate earnings, we see nothing more sinister at play in the underlying economy. We reiterate our expectation for gains in the trade-weighted dollar to moderate and for oil prices to rise this year. In contrast to the flat earnings of 2015 that not surprisingly produced roughly flat equity prices last year, we foresee forward progress on the corporate earnings front driving positive returns for equity investors in 2016.
Our Takeaways from the Week
- Developments in China are once again reverberating globally
- Key factors underlying last fall’s equity correction are resurfacing