Managing Risk Key To Volatility

Brian Selzer

OCEAN CITY — With earnings season essentially over, U.S. corporations delivered yet another positive surprise versus analyst expectations at the beginning of the quarter. While earnings for the S&P 500 companies are still down from a year ago, the headline decline masks bright spots in several consumer related industries. By the same token, recent economic data have highlighted positive trends for U.S. households.

Going forward, we expect the consumer to continue to drive growth in the U.S. and abroad and advise investors to look to select services-driven economies and industries to capture these positive trends.

Third-quarter earnings for the S&P 500 companies are down 2% from a year ago, according to FactSet. However, this is significantly better than the 5% decline expected at the end of September. Furthermore, the decline masks a large divergence among sectors. Excluding Energy, earnings are up more than 4% year-over-year, and certain sectors and industries are exhibiting double-digit growth despite concerns over slowing global economic growth. Health Care and Consumer Discretionary contributed the most to earnings, with industries such as autos, internet retailing and biotechnology posting especially impressive profit growth. We expect these trends to persist, as consumer spending is supported by improving labor markets and wages, rising household wealth and persistently low energy prices. The October U.S. employment report underscores the upward trend in the labor market, particularly in the last year and a half, when monthly nonfarm payrolls consistently averaged more than 200,000 on a six-month basis.

Some 71,000 jobs were added to the economy in October, above even the highest expectations and the most in 2015. Another bright spot in the report was wage growth, rising to 2.5% annually—the most since 2009. Low inflation and labor market slack have kept a lid on salaries since the 2008-2009 recession, but as more people enter the workforce and the labor market tightens, wages are likely to rise at a faster pace.

Roughly 70% of U.S. gross domestic product (GDP) growth is driven by consumer spending, more than in all other major economies. This perhaps helps to explain why S&P 500 companies with a majority of sales in the U.S. posted 5% earnings growth in the third quarter, while those with a majority of international sales saw their earnings decline more than 10%, according to FactSet. Last week, October retail sales came out below expectations, rising only 1.7% from a year earlier. However, headline growth has been weighed down over the past year by the continued decline of gasoline prices.

With better economic data in the past few months, especially on the employment front, expectations for the Federal Reserve (Fed) to finally hike interest rates at its December meeting are beginning to mount. Bond yields and the U.S. dollar have started to rise in anticipation. Following the positive October jobs report, for example, Treasury yields across the maturity spectrum rose 5-10 basis points, and the DXY U.S. Dollar Index rose over 1%. While we believe markets are correctly pricing in a hike in December, we believe the more important function is the pace of rate hikes thereafter. Global factors such as slowing growth in Emerging Markets, declining commodity prices and ultra-low interest rates in other major economies should keep the Fed patient and U.S. interest rates anchored.

(A Merrill Lynch Wealth Management Advisor who can be reached at 410-213-8520.)

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