U.S. Gross Domestic Product grew at an annualized rate of 2.5% in the first quarter. The important consumer spending portion of GDP grew at a 3.2% rate. Meanwhile, in the "euro zone," consisting of the 17 countries that use the euro as their currency, GDP declined for the sixth straight quarter. Continued modest growth in the largest euro country, Germany, has not been enough to counteract profound weakness among the next three largest countries, France, Italy, and Spain.
Most of the companies we follow are not seeing any growth in their European business, which certainly weighs on overall sales and profits. China continues to grow, but growth in industrial production is moderating, perhaps due to weakness in Europe, the largest market for China’s exports. Japan is expected to return to growth in 2013, due to aggressive monetary policies similar to those implemented in the U.S.
Within the U.S., economic conditions can be broadly characterized as good, but not great. The unemployment rate is ticking down almost every month. However, half the improvement is due to job growth while the other half is simply due to people leaving the workforce. Employers seem to be hiring very slowly due to uncertainties over the global economy and implementation of the Affordable Care Act.
Industrial production remains uneven. The ISM's (Institute for Supply Management) Purchasing Managers Index remains slightly positive but well below the levels achieved in a robust manufacturing economy. We believe this largely reflects the broad impact of weak international economies.
Core retail sales have continued on a steady upward path even as personal income has gone on a roller-coaster ride after the 2% payroll tax holiday expired at the end of last year. One must give the U.S. consumer credit for maintaining a steady spending pattern even as their take-home pay dropped in January. Reported retail sales have fluctuated, particularly due to falling gas prices earlier in the year. Core retail sales exclude cars, gasoline, and building materials, all of which are subject to abrupt changes that can mask underlying trends.
The housing market is still rebounding strongly. The median sale price for a home rose 11% in the first quarter compared to a year earlier.
It is likely that rising home prices and strong equity markets are supporting growth in retail sales. The evidence for this "wealth effect" is that consumers have reduced their rate of saving in order to continue their spending pattern. Rising asset prices appear to have encouraged consumers to spend more than they earn, knowing that their overall wealth is still rising. This hints at the "virtuous cycle" the Federal Reserve Board envisioned when it embarked on its aggressive program known as "quantitative easing."
Stock prices have risen sharply in this "good, but not great" domestic economy. Investors have shown a renewed desire to own equities. There has been particular interest in companies producing steady dividends, leading to potential overpricing of some of these shares, in our opinion. This year, they have outpaced returns on growth companies that typically pay more modest dividends (if any at all) in favor of reinvesting their profits for more growth. We still see many growth companies available at reasonable prices, but strong equity markets do make it more challenging to find stocks with acceptable returns. In a surging market, it is important to not lose one’s pricing discipline and to avoid chasing cheap junk just because prices are low.