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At present, the jury is still out on the direction of the US economy. The Q1 GDP reading went from bad to worse, as the number was revised down to a contraction of 1%, while Treasury yields remain stubbornly glued to the 2.5% level and seemingly unable to go higher. Low yields indicate a broadening pessimism about the US economy among investors, even if Q2 is expected to be much better given that the snow storms of winter will have disappeared from the scene.
May’s employment report could therefore be a key moment. US job numbers are always important, but with opinion divided the upcoming figure will be closely-watched. A strong update could suggest the spring rebound is intact, and that economic growth will pick up in the second quarter. However, if the number is below expectations this would reinforce perceptions that the weakness of Q1 is seeping into Q2 as well.
Recent data has certainly confounded the optimists, but in addition there is the Federal Reserve to consider. We are not yet in a position to think that the Fed will ease back on its current tapering efforts, since Janet Yellen and her committee still believe that the US economy is enjoying reasonable growth.
Markets have become accustomed to the taper, but that was because they too thought the situation was improving. Now, they are likely to become more nervous that the Fed is letting the situation get out of control, despite Ms Yellen’s assertions to the contrary.
Overall, however, there still seems to be a positive trend to the situation. Revisions to non-farm numbers have been almost entirely on the upside, with 19 out of the past 20 numbers lifted from the initial reading, and by an average of 36,000. Stock market gains have not been rapid, but there have been gains nonetheless, and a good number on Friday could provide a fresh positive catalyst.
Looking away from job numbers and towards markets, there is still a perception that stocks have become overvalued. That may not necessarily be the case. Using normalised earnings as a guide, as per Robert Shiller, then the market seems to be trading at 25 times earnings, which looks overvalued. However, if a forward operating earnings figure is used then the valuation drops to a more reasonable 16 times, just above the average and well below the level seen in previous market tops.
So long as Treasuries continue to offer low yields, equities will retain their attractiveness over bonds. Janet Yellen has kept her own counsel as to the timing of rate hikes, and I still think we will move into 2015 without a rate increase of any kind. Even in 2015, rate hikes are likely to come towards the latter half of the year and even then will only be done in small increments.
Friday’s number is therefore particularly important, and taken with the ECB meeting on Thursday, we are in for some exciting times in the week to come.