Monthly Archives: March 2015

What Will Janet Do?

yellen4February payrolls announced today were well ahead of expectations, and BLS data continues to paint a picture of a labor market that is largely healed. The unemployment rate at 5.5% is now below historical average (5.7%) and in the range of the Fed’s NAIRU (non-accelerating inflation rate of unemployment, 5.2-5.5%). The underemployment rate at 11% is quickly improving, and average hourly earnings growth has been trending slightly above 2% annualized over the last several months — not inconsistent with the Fed’s 2% overall inflation rate target. As such, the Fed’s 0.25% policy rate and its $4.5 trillion/25% of GDP balance sheet is appearing increasingly at odds with economic conditions. FOMC “patience” with deferring a move to more normal policy may be shorter than general expectations.

Turns in the Fed monetary cycle toward tightening have historically meant higher volatility. The record also shows positive equity returns as the Fed begins tightening, with earnings growth more than offsetting a P/E headwind. We expect a variation to this historical pattern, a rhyme rather than a repeat. Earning matter a lot more now than in the last few years of P/E-expanding policy tailwind. Consensus expectations for 2015 S&P 500 earnings was $123.81 at the beginning of the year and are now $118.48, suggesting a near absence of growth.

With higher volatility approaching a market that trades at a premium to historical valuations, investors will be well served by a focus on stocks of quality companies that are poised to show an important but now rare trait — earnings growth.