Q4 2015 Market and Economic Update

by Jeffrey Kravetz

Arizona’s economy continues to show solid but measured growth heading into the new year, according to the Arizona Economic Outlook from Eller College of Management’s Economic and Business Research Center. Job growth in the state is largely driven by improvements in the Phoenix area, while by the end of Q3, the Tucson metropolitan statistical area had generated basically no net job gains in the previous year.

According to the S&P/Case Shiller Phoenix Home Price Index, as of October 2015, home prices had increased 5.69 percent over the previous year, still well below 2006 highs but showing solid improvements over 2011 lows.

Economic Trends

2016 is shaping up to look much like 2015 as we assess prospects for the U.S. economy. As has been the case for some time, the key to ongoing growth is consumer spending.

We anticipate solid growth through 2016, averaging 2 to 3 percent. Improving employment, strong consumer balance sheets and likely rising incomes underpin the U.S. economy. Net exports may be a primary drag on the economy due to weight of a stronger U.S. dollar on trade.

The world is experiencing greater economic divergence. Among emerging markets, Russia and Brazil are mired in recession while growth in India remains strong. The European Central Bank quantitative easing measures are likely to continue to support economic growth, despite the headwind from bank deleveraging. However, we think growth in Europe is unlikely to exceed 2 percent due to deleveraging and demographic headwinds.

Equity Markets

With the start of 2016, U.S. equities are approaching a seven-year bull market anniversary amidst structural crosscurrents. Equity performance in 2015 was varied, volatile and lackluster, yet remarkably resilient on average. For 2016, we are maintaining our moderately constructive outlook, mindful that risks are elevated. We believe that key drivers remain in place that may support a higher grinding equity market. We also suspect volatility is likely to remain high, with overall performance lagging historical levels.

Overall equity performance in 2015 was below historical norms. Only four of 10 S&P 500 sectors posted positive returns in 2015 (Consumer Discretionary, Consumer Staples, Healthcare and Information Technology). The Energy sector led performance to the downside, retreating 23.6 percent for the year. However, on average, U.S. stocks outpaced both international developed and emerging markets.

Fixed Income Markets

Following the December rate hike, we believe that the Federal Open Market Committee’s (FOMC) trajectory of policy rate normalization in 2016 will be quite shallow relative to previous cycles. Any future increases in the Fed funds rate will be driven by the data dependent. Therefore, we would expect increased volatility around inflation and labor market data.

Policy rate normalization will put a disproportionate amount of pressure on the short end of the curve relative to the long end. There are three headwinds to substantially higher long-term interest rates: Diverging central bank policies should increase foreign interest in the U.S. debt market, many corporate pension plans have approached fully funded status and have begun to reduce equity positions in favor of longer-dates debt, and domestic demographics via the retiring baby boomers have led to increased interest in U.S. bonds.

Real Estate Markets

Nationally, real estate trends were not consistently positive from month to month, but the environment continues to improve into 2016 at a pace correlated to the overall economy, job creation, wage growth, household formation levels and consumer and builder confidence. Existing and new home sales in 2015 were at the best levels since 2008, though still below the peak levels reached in 2005. We believe that the 2016 outlook for existing home sales is positive, and new home sales may show volatility month to month, but will continue to pull out of recession lows.

At a macro level, U.S. commercial real estate should have continued occupancy gains and improving rental rates. New construction remains fairly constrained, yet increasing in some markets, but overall inventory of the best properties will remain tight.

Commodity Markets

In 2016, the commodity complex may start to level out after five years of decline. With current production reflecting more modest potential demand growth from China, markets should experience tightening of supply versus demand relationships.

Energy prices are likely to rise slightly as production slips, which will ease the current gap between supply and demand. Demand growth should remain solid, but inventories will remain an overhang to the markets for much of 2016.

Jeffrey Kravetz is Regional Investment Director for The Private Client Reserve of U.S. Bank in Phoenix.

Investment products and services are:

Not a Deposit Not FDIC Insured Not Guaranteed by the Bank
May Lose Value Not Insured by Any Federal Government Agency

This information represents the opinion of U.S. Bank and is not intended to be a forecast of future events or guarantee of future results. It is not intended to provide specific advice or to be construed as an offering of securities or recommendation to invest. Not for use as a primary basis of investment decisions. Not to be construed to meet the needs of any particular investor. Not a representation or solicitation or an offer to sell/buy any security. Investors should consult with their investment professional for advice concerning their particular situation. The factual information provided has been obtained from sources believed to be reliable, but is not guaranteed as to accuracy or completeness. The organizations mentioned in this publication are not affiliates or associated with U.S. Bank in any way.

Past performance is no guarantee of future results. All performance data, while deemed obtained from reliable sources, are not guaranteed for accuracy. Indexes shown are unmanaged and are not available for investment.

The S&P/Case Shiller Home Price Index is a group of indexes that track changes in home prices throughout the United States. In addition to a national index, they also produce indexes for certain metropolitan statistical areas.

Equity securities are subject to stock market fluctuations that occur in response to economic and business developments. Investing in fixed income securities are subject to various risks, including changes in interest rates, credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications, and other factors. Investment in debt securities typically decrease in value when interest rates rise. The risk is usually greater for longer term debt securities. Investments in lower rated and non-rated securities present a greater risk of loss to principal and interest than higher rated securities. There are special risks associated with an investment in commodities, including market price fluctuations, regulatory changes, interest rate changes, credit risk, economic changes, and the impact of adverse political or financial factors. Investments in real estate securities can be subject to fluctuations in the value of the underlying properties, the effect of economic conditions on real estate values, changes in interest rates, and risks related to renting properties (such as rental defaults).


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