The analogy may not be perfect, but "weather" is the best way to characterize the first quarter. With this winter being longer, colder and snowier than recent history, it is not surprising that weather did have a material impact on the North American economy. While some companies (notably retailers) frequently lean on adverse weather as an excuse for poor results, this is one quarter where the meteorological explanations are somewhat justified. The good news is that this economic rough patch will be followed by better times.
During the first quarter, cancelled air flights were at record levels. United Airlines alone cancelled four times as many flights in the first two months of the year as they did in the same period last year. In some parts of the country, construction crews lost over half their work days due to adverse weather conditions. The weather also played havoc with shipping schedules such that very little was arriving on time or with any sort of predictability. It is difficult to quantify lost productivity due to workers arriving late or their just staying home. Housing and car data was also less robust than last year. The inclement weather also impacted US regions that are typically insulated from winter, such as the South and Mid-Atlantic. Overall, investors were willing to accept management’s weather excuses at face value and thus maintained a positive attitude.
When companies report earnings in April, investors are likely to give them a "mulligan" or "pass" for sub-par results. Investors will overlook Q1 results in anticipation of better numbers for the rest of the year. US GDP growth estimates are starting to inch up closer to 3%.
A significant portion of the weather related economic activity that did not occur in the first quarter is not gone forever but just postponed. We anticipate that consumers who delayed major purchases, such as cars or homes, will for the most part proceed with these decisions. On a similar vein, consumers who stayed home to avoid the winter weather will purchase preplanned items in the electronic and clothing sectors. The same does not hold true for all expenditures as can be seen from restaurant visits. For example, if you did not go out for dinner in February due to weather, you are unlikely to make up for it by going out for dinner in a future month.
While weather remains an unpredictable element, demographics is more of a predictable quantity. Based on historical birth statistics, we can make reasonable predictions for future population numbers in various age groups. This is useful from an investing perspective due to its implications on economic growth. The future growth projections of the 30-39 age group are for a progressive rise over the next couple decades. The growth in this age group growth will have a long term positive impact on the economy and the stock market.
People in their thirties typically increase their spending levels more than any other age cohort relative to the prior decade of their lives. This is due to significant lifestyle changes experienced by this age group. This age group is more likely to get married and have children. These activities results in spending growth on houses, cars and all things kid related. As consumer spending accounts for 2/3 of economic activity, any sustainable increase in consumer spending is positive for the economy and the stock market. What's interesting about the chart is the contraction in the US population in this age group over the last fifteen years (due to the baby bust) and the corresponding sideways move in the market.
When companies report earnings in April, investors are likely to give them a "mulligan" or "pass" for sub-par results. Investors will overlook Q1 results in anticipation of better numbers for the rest of the year. US GDP growth estimates are starting to inch up closer to 3%.
A significant portion of the weather related economic activity that did not occur in the first quarter is not gone forever but just postponed. We anticipate that consumers who delayed major purchases, such as cars or homes, will for the most part proceed with these decisions. On a similar vein, consumers who stayed home to avoid the winter weather will purchase preplanned items in the electronic and clothing sectors. The same does not hold true for all expenditures as can be seen from restaurant visits. For example, if you did not go out for dinner in February due to weather, you are unlikely to make up for it by going out for dinner in a future month.
While weather remains an unpredictable element, demographics is more of a predictable quantity. Based on historical birth statistics, we can make reasonable predictions for future population numbers in various age groups. This is useful from an investing perspective due to its implications on economic growth. The future growth projections of the 30-39 age group are for a progressive rise over the next couple decades. The growth in this age group growth will have a long term positive impact on the economy and the stock market.
People in their thirties typically increase their spending levels more than any other age cohort relative to the prior decade of their lives. This is due to significant lifestyle changes experienced by this age group. This age group is more likely to get married and have children. These activities results in spending growth on houses, cars and all things kid related. As consumer spending accounts for 2/3 of economic activity, any sustainable increase in consumer spending is positive for the economy and the stock market. What's interesting about the chart is the contraction in the US population in this age group over the last fifteen years (due to the baby bust) and the corresponding sideways move in the market.
CHART 1: US POPULATION AGES 30—39 vs. S&P 500
Source: BMO Investment Strategy Group, Bloomberg, Census Bureau
Due to the recession and higher than normal unemployment rates for young people, household formations (marriages, people moving out of their parents homes etc) was below what it should have been. This pent up demand has potential to further boost housing and the economy over the next few years as housing demand moves closer to the long term trend.
Housing prices and home sales have rebounded sharply since the recession, but there still exists more upside. Chart 2 shows housing starts for the last twenty five years. Housing starts averaged 1.0 – 1.2 million per year pre-recession (ignoring the immediate lead up to the recession) versus four to eight hundred thousand since the end of the recession. New residential building activity has the potential to continue to increase without the risk overbuilding. Any increase in building activity would be incrementally positive for the economy.
CHART 2: US NEW RESIDENTIAL HOUSING STARTS
Source: Datastream
Assuming current economic forecasts of 2 – 3% growth are realistic, bond returns will approximate the current coupon rate of 2 – 4%. If the economy accelerates, interest rates will rise and bond returns will be less than 2 – 4%. The magnitude of the shortfall will be dependent on the strength of economic growth versus current expectations. The sluggish Q1 economy was primarily related to an unusually challenging winter. We believe that the economic rebound will continue and strengthen as it makes up for lost activity related to the large number of winter storms.
Based on the low single digit return potential for bonds, our preferred investment is in stocks. Stocks are reasonably valued and are poised to benefit from increasing economic momentum. Stocks are offering high single digit to low double digit (8-10%) returns based on current earnings estimates. Condor Asset Management has successfully positioned our client portfolios to take advantage of the opportunities in the stock market. If the economy accelerates as we expect it will, revenues and earnings will come in higher than current forecasts.
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