Reasons for Optimism in a Sloppy Third Quarter
Investors are anticipating the day that we transition from a market dominated by monetary stimulus to an earnings-driven market. The problem is that earnings aren’t cooperating — yet. In my view, we’ve still got a sloppy third and maybe fourth quarter to get through, but I think 2014 will likely be a much better earnings market.
Capex spending increasing
As we wind down the dog days of summer, investors should heed the caution sign of lagging earnings and brace for some choppiness during the transition from a stimulus market to an earnings market. Minus the financial sector, the S&P 500 Index earnings have been flat since the fourth quarter of 2012.
More optimistically, companies are increasing capital expenditures (capex), a good sign in a recovery that has been largely devoid of capex spending. Companies aren’t going to spend money unless they see demand for products. But once they do start spending, there’s a giant ripple effect on the economy that can actually lead to the higher nominal growth everyone wants. Despite month-to-month fluctuations, durable goods orders and factory orders — two of the most important monthly data points — have provided reasons to be more positive this year.
What should investors look for in a higher nominal growth environment? Companies that benefit from capex spending and also have good pricing power can be attractive opportunities. If inflation returns because of increased demand for labor or raw materials, these market-leading businesses can pass those costs on. In my view, industrials and technology are the sectors most likely to benefit from increased capex spending.
Glimmers of global optimism
The global economy is critical to US growth because we can’t sell everything we make only to US consumers. The buyers we need for these products populate the fastest-growing, emerging parts of the world, primarily China. While growth in China has been less than anticipated, it’s still significant. It’s important for that growth to continue, whether at current levels or, ideally, at higher rates. In addition, we have our fingers crossed that Europe has seen the worst days and is now on the upswing.
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