Aided By Weather, Economy Showing Signs Of Striking Back

OCEAN CITY — After a slow start to 2014 impacted by the weather — and epitomized by the incredibly low 0.1% initial estimate of first quarter annualized growth in U.S. GDP — we see signs that economic momentum is picking up.

Although the headline 0.1% print for U.S. GDP was well below downwardly revised expectations, looking through the detail brings to light the role that weather played. Capital spending, especially residential investment, was particularly soft, likely a function of the cold winter. More recently capex data has picked up, a development necessary for the better growth we expect.

Although consumer spending rose 3.0%, much of that gain is attributable to utility bills resulting from the cold winter and health insurance enrollments under the Affordable Care Act.

Spending on goods grew much more slowly — a trend we expect to see reversed in the coming months as the weather effects fade. There are already signs of a rebound in a 0.9% month-on-month (MoM) rise in personal spending in March, three times the expected rate. Within that growth, auto sales surprised to the upside.

We feel comfortable about the U.S. consumer sector remaining resilient throughout 2014 and providing a good foundation for economic activity more broadly. One reason for this confidence is the ongoing recovery of the labor market. U.S. nonfarm payrolls grew by 288,000 in April, the highest monthly change since January 2012, continuing the acceleration seen in the prior three months following a low of 84,000 last December.

Although the unemployment rate is still elevated, the direction continues to be downward, a trend that in the past has coincided with equities outperforming bonds. In addition, the U.S. Institute of Supply Management’s Purchasing Managers Index (PMI), an indicator that has historically provided a great read on the direction of the economy, picked up again in April, rising to 54.9 from a low of 51.3 in January. All in all, from labor to spending to manufacturing, there is a growing body of evidence that the U.S. economy has taken a noticeable turn for the better in recent weeks.

This perception of economic acceleration is shared by the Fed. At its April policy meeting, the central bank elected to taper its monthly bond purchases by another $10 billion, noting that “information received since the Federal Open Market Committee met in March indicates that growth in economic activity has picked up recently, after having slowed sharply during the winter in part because of adverse weather conditions.”

Going forward, we believe these markets are more likely to respond to the progression of economic data, with the Fed taking a back seat. With the data improving, this shift should support equities and put bonds more at risk in the coming quarters, although we do not expect yields to spike up.

Corporate earnings support this optimistic view. With nearly 60% of the S&P 500 having reported for the first quarter, two trends stand out. First, earnings have surprised to the upside and analysts have in turn raised estimates. These surprises have occurred across sectors with evidence of resiliency in profit margins – a trend we have persistently anticipated.

Second, as noted by Bank of America Merrill Lynch (BofAML) Global Research Chief U.S. Equity Strategist Savita Subramanian, reports of the weather hurting earnings are dissipating. In addition, companies continue to lift their capex intentions, which should translate to better investment spending as the year progresses.

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