The U.S. Recovery Has Lost Some Momentum.
With four consecutive quarters of expansion, the economy continues to improve, but the pace of the growth slowed throughout the first half of 2010. During the second quarter, U.S. gross domestic product (GDP) rose at a 1.6% annualized rate, down from a 3.7% annualized first-quarter gain. This deceleration primarily resulted from a smaller boost from inventory rebuilding and a large drag from the trade deficit, as a double-digit spike in imports outpaced the increase in exports. Accounting for a majority of the economy, consumption grew at a modest 2.0% pace over the quarter, not enough to drive a significant pickup in activity. Government spending contributed about 0.9% of the GDP growth, yet stimulus spending is expected to fade over the next few quarters. By far the most positive component was investment. Specifically, business investment spending soared by an annualized rate of 17%, residential investment jumped by nearly 28%, and even commercial real estate investment rallied. While such acceleration is noteworthy, investment represents a relatively small part of GDP, and the broad economic picture remains mixed and uncertain.
As we have repeatedly emphasized, the labor markets seem to be the key for stimulating a self-sustaining recovery. Substantial job gains are generally thought to help lift consumer confidence and spur more spending, thus creating a positive feedback loop. While businesses have been hiring, they have done so at a cautious pace that has not truly begun to replace the jobs lost since the recession began. Companies added 71,000 workers in July, but that was overshadowed by government census layoffs, which caused total non-farm payrolls to decline by 131,000. State and local governments also shed 48,000 jobs over the month, contributing to the headline decline. Meanwhile, the underlying details showed some progress. The average weekly hours worked ticked back up, and average hourly earnings increased by 0.2% as well, although this year-over-year earnings growth remains fairly low at 1.8%. In general, the job market appears set on a gradual healing process. Conditions have improved, but businesses remain hesitant to hire.
Despite heightened concern over the path of the U.S. recovery, there have been some encouraging developments recently. In particular, the Federal Reserve’s Senior Loan Officer Survey showed that banks marginally loosened their lending standards from April to July. In fact, big banks eased standards on small-business lending for the first time since late 2006, and standards for residential mortgages loosened for the first time in four years. That incremental improvement doesn’t nearly erase the more stringent standards that have been established over the past few years, but it does mark a step in the right direction for getting money flowing throughout the economy. Ultimately, the economy continues to work through major issues such as tight bank lending, a weak housing market, and high unemployment. As we continue to see both positive and negative economic reports, we believe it will be important to focus on company fundamentals and not become preoccupied with macro-economic swings in sentiment.
The Global Economy
Like the U.S., the rest of the world continues to make bumpy progress. Differentiated recoveries continue to play out across the globe, which is perhaps best epitomized by the recent growth in the Euro-zone. As a whole, the 16-nation Euro-zone collectively expanded at a 3.9% annualized rate in the second quarter. Such an impressive rebound could be cause for celebration, but a closer look shows mixed growth among member countries and the potential for a slowdown in the second half of the year. Much of the area’s GDP gain came from a 9% annualized surge in German growth, which comprises almost 30% of the bloc’s economy. Driven by soaring exports, which were likely boosted by the weaker Euro, Europe’s largest economy expanded at the fastest rate since East and West Germany were rejoined 20 years ago. Neighboring countries also fared well, with France and the Netherlands growing at 2.5% and 3.5% annualized rates, respectively. In contrast, weaker Southern European countries that have been plagued by sovereign debt issues did not experience such a rally. Greece contracted at a 5.8% annualized pace, and the divergence could become more pronounced as austerity measures in countries such as Greece and Spain fully come into effect. The inconsistent growth among Euro-zone nations presents a dilemma for setting the appropriate monetary policy for the union. Elsewhere, Japan has also benefited from soaring exports, but the country remains mired in deflation and is now fighting a strengthening yen that threatens the health of its exports. Fast-growing emerging markets remain the primary recipients of this accelerated global trade, and their rapid growth creates another set of issues. For instance, China has hiked its reserve requirement ratios three times this year in an attempt to restrict excess lending, which if allowed to continue, could fuel an overheating economy and lead to inflation. In short, economic recoveries continue to vary by country.
After three straight months of declines, the Consumer Price Index (CPI) inched higher in July, which is primarily a result of more expensive energy prices. On a year-over-year basis, the headline inflation rate ticked up to 1.2%, which still signifies low inflation. Setting aside volatile food and energy prices, the annual rate of core CPI remains at 0.9%; it has been at this 44-year low for four months. Overall, there are minimal if any inflationary forces currently in the U.S. given the high unemployment rate and substantial amount of slack left over from the recession despite the amount of fiscal and monetary stimulus that has been injected into the economy.
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Featured Fund: Manning & Napier Fund, Inc. International Series
For investors looking to add an international element to their portfolios, the
Manning & Napier Fund, Inc. International Series focuses on investment themes across the world and offers dedicated exposure to foreign equities.
The International Series uses a big-picture, “top-down” investment approach that emphasizes economic fundamentals as well as overarching industry trends. In such an approach, the manager, Manning & Napier Advisors, Inc. (“Manning & Napier”), evaluates countries and industries to identify areas that present attractive opportunities. These high-level overviews serve as guidelines for making investment decisions.
For example, Manning & Napier completes a thorough environmental profile checklist on many developed and emerging market countries. Analysts review a range of factors including political stability, demographics, work ethic, trade practices, business regulation, government finances, taxation, and innovation. These details shape the ultimate country overview, which influences whether the International Series invests in stocks from that country. If a country has a negative outlook, Manning & Napier generally seeks to avoid companies tied to that economy.
Because of the nature in which Manning & Napier manages the International Series, the fund’s holdings directly reflect how we see the world. In other words, the breakdown of country allocations gives an idea of the parts of the world we find favorable and those we find challenging (see chart to the right). These viewpoints are actively monitored and may fluctuate as various developments unfold.
Throughout 2010, the International Series has maintained a significant allocation to developed European countries such as France and Germany. Manning & Napier believes these economies have appealing growth prospects and high-quality companies that benefit from positive non cyclical trends. Admittedly, over the past several months, the news in the European region has been dominated by Greece’s sovereign debt crisis and the potential it could spread to neighboring Southern European countries. Such widespread negative sentiment has pulled down equity markets across Europe, yet the concerning issues do not necessarily apply to all European countries and companies. We believe this front-page bad news provides an opportunity to buy compelling long-term investments that have been knocked down because of unrelated market fears, particularly in countries with more promising outlooks.
In general, Manning & Napier has seen a fairly sluggish global recovery, with the exception of emerging markets. Emerging markets such as China, India, and Brazil have experienced a more rapid turnaround at this stage in the recovery, and have served as a source of growth for companies in different regions of the world. One way to gain exposure to emerging market growth is to invest in companies that sell into these areas. For instance, German exporters have received a significant boost from sending equipment and autos to Asia and other developing markets. The International Series also invests directly in emerging market companies, but in such cases Manning & Napier evaluates external factors such as accounting standards, the clarity of law, and business and investment practices. Taking all of this into consideration, the International Series currently has a relatively high allocation to companies in Brazil and India.
By seeking opportunities away from home, a foreign equity component can provide rewarding diversification within an investor’s overall portfolio. Manning & Napier’s International Series has delivered value-added results over the past decade. Our active and flexible investment approach has successfully navigated multiple bull and bear markets, and the International Series continues to provide strong absolute and relative returns over the current international stock market cycle.