where economy headed

Last week, investors digested a slew of mixed economic data including a disappointing headline US fourth-quarter gross domestic product number and an upbeat manufacturing report.

It’s no wonder, then, that many investors are asking what the main takeaway is from all the confusing and seemingly contradictory information.

The bottom line, in my opinion: The data overall was modestly positive. Although last week’s numbers certainly don’t indicate an economy on the verge of taking off, they do suggest that the US and global economies should continue to improve, albeit slowly, and that the market should continue to advance, though volatility is likely to rise over the coming months.

  • Q4 GDP: While the headline number was weaker than expected thanks to drops in government spending and inventories, personal consumption, the big driver of the economy, actually rose, and business investment was healthy. These improvements suggest positive first-quarter growth.
  • January Employment Data: Though the report included signs of a still struggling labor market, it was respectable overall. For example, the report showed that the United States created around 157,000 net new jobs in January, a figure consistent with the average over the past two years.
  • Manufacturing: The best news of the week was on the manufacturing front. This sector is starting to improve in the United States, with companies seeing an increase in the pace of new orders, good news for future growth. Even more, the improvement in manufacturing is not limited to the United States. Reports also suggested that manufacturing is getting stronger in Germany and Brazil, and perhaps most importantly, in China.

While an improving global economy is good news for stocks, I continue to advocate that investors be selective about where they commit new capital. I particularly like certain market segments most poised to benefit from recent improvements in the global economy. These include emerging markets (like China, which is up around 7% year to date) and larger domestic companies. These segments are accessible through funds such as the iShares MSCI China Index Fund (MCHI) and the iShares S&P 100 Index Fund (OEF).

At the same time, I still advocate exercising more caution with US small cap and consumer names. Though small caps have done well so far this year and should do well as long as we remain in a liquidity driven market, the sector looks extended. For example, the Russell 2000 is currently trading at nearly 20x this year’s earnings while the S&P 500 is trading at 13.5x and the S&P 100 is trading at 13x. The sector is also vulnerable to any further pullback by the US consumer and considering that equity market flows are likely to moderate this month or next.

Source: Bloomberg

Russ Koesterich, CFA, is the iShares Global Chief Investment Strategist and a regular contributor to the iShares Blog.  You can find more of his posts here.

In addition to the normal risks associated with investing, international investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles or from economic or political instability in other nations. Emerging markets involve heightened risks related to the same factors as well as increased volatility and lower trading volume. Securities focusing on a single country may be subject to higher volatility.