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Q3 Playbook Supplement – Part 1

07/10/2013

Additional content support for the Q3 Playbook “State of Confusion” released the week of July 1.

Q3 Playbook: Introduction (page 1)

“However, in late May that all changed and, ever since, investors have been challenged and in a state of confusion.”

S&P 500® Index Year to Date

  • May 22 all-time high: 1687.18
  • June “30 days of frustration” troughs at 1560.33 on the 24th

fig1
Source: Bloomberg

For Q3 Playbook: Confusion or Clarity?

  1. IS U.S. ECONOMIC GROWTH ABOVE OR BELOW TREND? (pages 1-2)

“There have been seven confirmed U.S. recessions over the last 45 years, beginning with?the fiscal tightening-triggered recession of December 1969 to November 1970 and ending with the June 2009 end of the ‘Great Recession.’ In that timeframe, there has never been a post-recession period when annual GDP did not rebound back above 2.5% – until now.”

Recession Start

Recession End

1 Year After GDP

2 Years After GDP

3 Years After GDP

Dec. 1969

Nov. 1970

3.40%

5.30%

5.80%

Nov. 1973

March 1975

5.40%

4.60%

5.60%

Jan. 1980

July 1980

2.50%

(-1.90%)

4.50%

July 1981

Nov. 1982

4.50%

7.20%

4.10%

July 1990

March 1991

3.40%

2.90%

4.10%

March 2001

Nov. 2001

1.80%

2.50%

3.50%

Dec. 2007

June 2009

2.40%

1.80%

2.20%

Source: U.S. Bureau of Economic Analysis 

“In 2013, the U.S. economy has the tailwind of strong housing and services industries?while manufacturing remains a headwind. The Institute of Supply Management (ISM) Manufacturing Survey May print of 49.0 was the weakest reading since June 2009.”

U.S. ISM Manufacturing, June 2009 to July 2013fig2
Source: Bloomberg

“The unemployment rate has fallen from 8.2% last July to 7.6% now. However, much of that decline is related to a continuing contraction of the labor force participation rate which fell to 63.3% during Q2, nearly a 35-year low.”

U.S. Unemployment Rate, June 2009 to July 2013fig3
Source: Bloomberg

U.S. Labor Force Participation Rate, June 2009 to July 2013fig4
Source: Bloomberg

“Over the past three months, job gains have averaged 155,000 per month. Assume for a minute that the labor force participation rate downtrend remains intact. With that assumption and the current job gain pace, the FOMC’s 6.5% outcome-based employment guidance would be attained one year from today.”

U.S. Nonfarm Payrolls 2013: Average, last 4 months = +183,000fig5
Source: Bloomberg

“Core inflation continues to trend lower, toward 1%, well below FOMC target levels.”

“…[Bernanke] is quickly dismissive of the historically low inflation, citing ‘transitory influences,’ and attributing ‘the effects of sequester and medical payments’…”

“FOMC member James Bullard dissented at the June 20 meeting specifically because of his concern about such a low inflation environment. In fact, the actual FOMC voting, where one ‘dove’ dissented and one ‘hawk’ dissented, underscores how confusing an environment the current growth trend is.”

U.S. Core Inflation 2007 to 2013fig6
Source: Bloomberg

“Given such a meager recovery and current 2013 GDP tracking at 2.0%, why does the Federal Reserve currently maintain such a positive expectation for U.S. economic growth?

  • FOMC 2013 GDP projection of 2.3% to 2.6%
  • FOMC 2013 unemployment rate projection of 7.2% to 7.3%
  • FOMC 2013 core inflation projection of 1.2% to 1.3%”
  1. 2.    SHOULD, NOT WILL, THE FOMC MODERATE ITS MONTHLY ASSET PURCHASE PROGRAM? (pages 2-3)

“However, as recent inflation figures tilt toward deflationary, pricing power for corporations disappears. On July 8, earnings season for results achieved during the second calendar quarter will start. I would pay particular attention to CEO and CFO commentary on conference calls.”

  • The week of July 8, only seven S&P 500® Index (SPX) companies will report
  • The week of July 15, 85 companies will report
  • The week of July 22, 170 companies will report
  • The week of July 29, 122 companies will report

3. WILL CYCLICAL ASSETS OR BOND-LIKE DEFENSIVE ASSETS OUTPERFORM? (page 3)

“Consensus estimates for SPX earnings per share (EPS) growth for the upcoming earnings season are +5% with SPX revenue growth of +3%. Cyclical assets will look rather compelling in the second half of 2013 if the earnings growth for the next quarter meets expectations. Current estimates for the quarter after the one to be reported in July stand at +17% EPS growth and +6% revenue growth.”

Virtus Investment Partners provides this communication as a matter of general information. The opinions stated herein are those of the author and not necessarily the opinions of Virtus, its affiliates or its subadvisers. Portfolio managers at Virtus make investment decisions in accordance with specific client guidelines and restrictions. As a result, client accounts may differ in strategy and composition from the information presented herein. Any facts and statistics quoted are from sources believed to be reliable, but they may be incomplete or condensed and we do not guarantee their accuracy. This communication is not an offer or solicitation to purchase or sell any security, and it is not a research report. Individuals should consult with a qualified financial professional before making any investment decisions.