By Eddie Perkin
For those of us who like a little excitement in our lives, the first half of the year was quite dull. In the first six months of 2015 prior to the last Monday of June, there had not been a single daily move of greater than 2% in the S&P 500. There had also not been a move greater than 1% for nine straight weeks, the longest streak since 1993.
With the situation in Greece coming to a boil, one might have hoped for more dislocation in markets. In one sense, these past few weeks have had a 2008 feel with the major brokerage firms holding well-attended Sunday conference calls for nervous clients. However, come Monday morning, everyone had rolled out the “buy the dip” playbook and everything was very orderly.
With the Greek voters saying “No” to further austerity measures, and European policymakers planning next steps, one might be tempted to forecast a significant increase in volatility in the coming weeks. However, with quantitative easing (QE) now a part of the ECB tool kit, any bouts of volatility are likely to be short lived.
As Janet Yellen and the Fed study incoming economic data, they are likely to find a two-speed economy with the overall health of the consumer improving rapidly, while the industrial side of the economy continues to struggle.
One of the best places to look for an early read on the economy’s direction is the transportation industry. Whether it’s a consumer product headed for the store shelf, coal on its way to a power plant or steel mill, or other raw materials being taken to a factory for production of an intermediate good, a train or truck is usually involved.
One data source investors can see this trend from is the Association of American Railroads’ weekly data on rail car loadings, this data shows the volume of intermodal goods, those that are transported over two or more modes of transportation i.e., ship, rail, and road. These are typically finished goods, and are a good proxy for consumer merchandise. Another indicator produced by this weekly data is total ex coal & intermodal which is primarily bulk commodities and can be viewed as representing the industrial side of the economy. If you look at the data in recent weeks it shows the two types of transport volumes moving in opposite directions; effectively consumer traffic is increasing whilst bulk commodities traffic is decreasing.
Part of the explanation for this seeming disconnect in economic data lies with energy prices. Over the past 12 months, the price of a barrel of oil has fallen from $105 to $60, a 43% drop. This has led to a fall in average gasoline prices in the US from approximately $3.70/gallon to $2.75/gallon. With more money in his/her pocket, the US consumer is feeling better about things.
While the collapse in oil prices represents good news for the consumer, it is bad news for many industrial companies. Oil and gas is an important end market for capital goods and equipment manufacturers. We have been struck by how rapidly the energy sector cut expenses at the beginning of this year. North American exploration & production companies tell us they have cut capital spending by 35%. This has had a ripple effect throughout the supply chain, well beyond the direct exposure of oil and gas equipment.
Understanding the relative health of different segments of the economy is important, but for equity investors the key question is always, “What’s not priced in?” Looking at the trailing 12-month performance of the Consumer Discretionary and Industrials sectors within the S&P 500, it is clear that the equity market has begun to figure things out:
This divergence of performance has led to widening valuation differences. Consumer Discretionary stocks are valued at 19.5x forward EPS estimates, whereas Industrials stocks are valued at 16.3x. In our Value strategies, we have cut back our Consumer Discretionary exposure and have been adding to Industrials. Meanwhile, in our Growth strategies, we carry underweight positions in Industrials. Our Growth team continues to be optimistic about the outlook for companies benefitting from strong, secular growth trends in the areas of Consumer, Technology, and Health Care, among others.
Eddie Perkin is equity chief investment officer at Eaton Vance
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