Job growth is replacing fiscal and monetary stimulus as the driver of the US economic recovery and will likely provide the catalyst for market direction over the months ahead, a conclusion reached in this month’s issue of MFS Global Perspectives.
While stocks and bonds fell on news earlier this month that US employment rose again in April, job growth must replace low interest rates and tax cuts as a primary factor supporting consumer spending and maintaining the economic recovery in the months ahead, according to the report.
Political uncertainty and oil prices are holding down stock prices, but corporate earnings are in a strong upward cycle, the report also said. US corporate earnings were up an average of 27.1% in the first quarter, compared to a year ago. The National Income And Product Accounts (NIPA) verifies the trend, showing profits in a broad spectrum of public and private companies at a 40-year high. Year-to-year comparisons will become less dramatic as the recovery continues but strong profit growth is expected to continue, the report said.
Moreover, higher yielding sectors of the US bond market will feel pressure as rising rates put the squeeze on speculative players such as hedge funds, which have profited by borrowing at low rates and investing in higher-yield sectors. This “carry trade” has started to unwind with the prospect of higher US short-term rates. As a result, emerging market and high-yield bonds are likely to be volatile in the near term, though over the longer term those sectors may also perform better in an improving economy, it said.
Meanwhile, in the Eurozone new EU members admitted this month will hasten the pace of labor and social reforms in older member nations over time by competing with lower wages, less restrictive labor laws, and less expansive social contracts, the MFS economists said. In the short run, however, the new members will slow EU action by increasing its bureaucracy. The EU’s chief economist blames lack of reforms, rather than the level of interest rates, for the EU’s slow growth compared to the US and UK, according to the report.
In the UK, the Bank of England made a pre-emptive strike on May 6, hiking its benchmark rate by a quarter point. The UK unemployment rate fell to 4.7% in April, the country’s lowest rate since records began in 1984 and the lowest among the G7 industrialized nations. But manufacturing remains a weak spot, with output down 0.5% in the first quarter over last year. Inflation, now at 1.1%, is forecast to exceed the bank’s 2% target rate within two years, and the BOE is attempting a “soft landing” for the UK economy, the report said.
Japan is coming out of its long slump, MFS economists said. Small and mid-sized firms are committed to increasing shareholder value, especially through dividend increases and share buybacks, which are signs that businesses are getting healthier, MFS said. Finally, concern about an overheating Chinese economy has been increasing in Japan and elsewhere. China is one of Japan’s largest export customers, and Japan would suffer if China is an economic bubble about to burst, the report predicted.