Waddell & Reed

Market Perspectives


Spotting some longer-term growth signals

Story Highlights

  • Japan, Europe and the U.S. all have undertaken aggressive monetary easing.
  • That means the economies responsible for about 70% of the world's GDP are in the mode of potential acceleration.
  • The Chinese government will for some time be confronted with the difficult task of balancing inflation versus growth.
  • In the U.S., the three legs keep running: we are likely to see positve growth in GDP driven by three sectors of the economy, housing, energy and industrials.
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Investment Team

Manager Name

Hank Herrmann

CEO

We’ve seen a strong start to the equity markets this year, although, as occurred in the past two years, that strength moderated some toward quarter end. By early March this year, market sentiment had become quite ebullient, buoyed by economic data in the U.S. that was better than expected. By early April, however, the data, particularly on the jobs front, softened. Financial markets have come back to reality a bit in reaction to the data. We still believe there remains good reason for optimism on the economy and equity markets over the course of this year, but some time might be required until the data becomes convincing enough to allow for meaningful upside.

We’ll get into the reasons for optimism in a moment, but first let’s look at what brought on the early ebullience.

Numerous special dividends were paid by companies in the fourth quarter of 2012, in part to avoid increases in taxes scheduled for 2013. This of course put more money in consumers’ pockets, pushing up consumer spending and creating premature thoughts of sustainable economic growth. While very early estimates for first quarter gross domestic product (GDP) growth were just 1%, growth is in fact very likely to come in around the 2.5% to 3% range. However, much of the GDP growth during the first quarter was from inventory building, rather than strong final demand.

Why haven’t consumers followed through with stronger spending? Taxes have risen, as the temporary payroll tax deduction expired in January, and the extension on unemployment benefits expired as well, both of which have impacted consumer sentiment, increasing a focus on savings and budgeting. Also, gasoline prices rose sharply, and the government’s broad budget cuts mandated by the sequester caused some to be concerned for their jobs.

Now, where does the optimism come from? Two primary reasons.

First, Japan has pledged to undertake an aggressive easing campaign, setting an inflation target of 2%, doubling the amount of money in circulation. Combine that with the aggressive monetary policy in place in the U.S., along with that of the European Central Bank’s, and we have the economies that are responsible for approximately 70% of the world’s gross domestic product (GDP) all in the mode of potential acceleration.

That is a significant push toward growth around the world, which over time should allow equities to enjoy superior performance, relative to bonds.

Second, the three legs keep running. As we entered 2013, I suggested 13 points that could make a difference over the course of the year. Among them was the idea that we are likely to see positive real growth in GDP in the U.S. this year, primarily driven by three sectors of the economy: housing, energy and industrials. Currently, the housing market is accelerating. The energy patch is also, and industry is being dragged along by the other two. Consumers’ focus on durable goods spending, notably automobiles, also is helping.

Home sales continue at a good pace, thanks to low mortgage rates, and houses remain affordable, even as prices now are rising after several years of steep falls. The pace of new home construction continues to be very favorable relative to the last couple of years. New housing is a very significant economic accelerator, because when people buy new houses they tend to hang curtains and buy new appliances, maybe new cars and, in some cases, the most expensive acquisition: new babies. While housing is only approximately 2.5% of the economy, with the multiplier effect, it’s a big positive. And it is important to point out that housing starts currently are not anywhere near catching up with new family formations growth over the last three years, so there is a lot of room for further expansion.

On the energy front, the fact that the U.S. is spending so much money extracting resources from the ground is leading to a surge in supply. The U.S. currently is producing more oil and gas than it has since 1997 and is now producing about as much oil as Saudi Arabia produces. That is huge, considering we were about half of the Saudi level just a few years ago.

The oil and the housing sectors bleed over into industrials, given the increased need for pipelines, truck and rail transport, storage, refineries, among other related areas.

Combined, these three legs remain poised to provide longer-term growth in the U.S., and the U.S. remains, in our opinion, the best house in a difficult neighborhood for investors. We project U.S. economic growth to show further improvement in the second half of this year, slightly better than first half, leading to about 2.5% expansion for the year.

Outside the U.S.

Three other key areas deserve mention as we review where 2013 started and where we are now. Events in China, Europe and Japan will continue to influence the global economy.

  • Earlier this year I noted that China’s growth would stop decelerating, which I still believe to be an accurate assessment. While it remains an important driver of global economic growth, China’s GDP expansion is likely to stay in the 7 to 7.5% range, rather than return to double digits. The Chinese government will for some time be confronted with the difficult task of balancing inflation versus growth. They just cannot step on the pedal too hard in the direction of monetary easing or tightening, so they are likely to experience a more moderate rate of growth, versus the growth rates seen in the 2000s.
  • Europe remains in a recession, and the southern periphery continues to be very challenged. I noted earlier this year that Europe had put a stopper in the bottle, meaning slowed its financial crisis, as the European Central Bank addressed the issues of capital flight. However, a lot of work on the fiscal side has to be accomplished before we can be enthusiastic about an improved economic environment in Europe.
  • We noted Japan’s intent to stimulate aggressively. Prime Minister Shinzo Abe has made it clear that he is going to initiate very aggressive fiscal stimulus and very aggressive monetary policy. Given the popularity and the response of the financial markets in Japan, it appears he’ll be able to put his policies in place, although it will take time to determine the results.

Investment return and principal value will fluctuate, and it is possible to lose money by investing. International investing is subject to additional risks, including currency fluctuations, political or economic conditions affecting the foreign country, and differences in accounting standards and foreign regulations. These risks are magnified in emerging markets.

Past performance is no guarantee of future results.The opinions expressed in this article are those of Mr. Herrmann and are current through April 2013. Mr. Herrmann’s views are subject to change at any time based on market and other current conditions, and no forecasts can be guaranteed. Waddell & Reed Financial, Inc. is the ultimate parent company of Waddell & Reed, Inc.

Investors should consider the investment objectives, risks, charges and expenses of a fund carefully before investing. For a prospectus, or if available, a summary prospectus, containing this and other information for the Waddell & Reed Advisors Funds or Ivy Funds, call your financial advisor or visit www.waddell.com. Please read the prospectus or summary prospectus carefully before investing.

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