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Market Updates
Your resource for the latest thinking from our experts on the markets and economy in the coming year and beyond
Bring It on Home
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As the U.S. economy nears an unprecedented 41st quarter of consecutive expansion, a very unusual thing is happening. Weakening inflation and a budding small business, investment and productivity renaissance are raising the potential growth rate and extending the expansion, making U.S. equities more attractive. |
The Case for a Fed Rate Cut
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From real GDP trend growth to productivity, employment, consumer confidence and inflation, incoming U.S. economic data have continued to track our expectations for a “Goldilocks” economic environment of robust growth and contained inflation. Still, while real GDP growth posted a strong 3.2% annualized pace in the first quarter and consumer spending rose back close to its 3% growth trend by March, a number of forward-looking cyclical indicators have softened, suggesting moderating pressures on growth as the year progresses. In addition, inflation expectations have continued to weaken, and the yield curve is flirting with inversion, suggesting downside risks to inflation and heightened risk of a premature recession in 2020. |
Questions and Answers on Housing
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Housing activity data have been mixed over the last few months, but housing equities have performed well. We turned bullish on housing equities in the fourth quarter of last year. The premise was that lower rates from a more dovish Federal Reserve and a better-than-expected macro backdrop would act as a catalyst for a rebound. While we still believe the fundamentals for the housing market at this point in time are solid and supportive of equities over the medium term, our tactical view is that we should not overstay our welcome in housing-related equities and will likely be turning less sanguine in the next few months. |
Maker, Meet Your Robot — The Future of Work
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With no human manipulation or generated data, AlphaZero, an artificial intelligence (AI) program, surpassed every chess player in history in just hours, knowing only the basic rules of the game. Unlike programs coded with thousands of rules to mimic human-created strategies, AlphaZero discovered its own tactics by accumulating self-generated data by way of playing the game a million times over, and using deductive analysis to make judgments on how to improve. AlphaZero represents how far technology has come, but also epitomizes the great risk to workers. |
Inflation Is the Key
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The key to the longevity of this current expansion is the trend in inflation. The disinflationary shock from 2018 tightening has caused the Federal Reserve’s preferred inflation measure to fall below the 2% target for the 11th straight year. Correcting this mistake requires accommodative policy for a couple more years, making a recession appear unlikely in 2020. This shift to more accommodative policy has set the stage for a reacceleration in U.S. and global growth that is apparent in rising leading indicators. The economy is entering a cyclical sweet spot where growth is currently rising and inflation is falling. |
More Signs of a Global Manufacturing and Trade Rebound
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The global economy was buffeted by powerful negative forces through the end of 2018, including mounting concerns about an overly aggressive Fed policy, growth-inhibiting policies and political disarray in the eurozone, a rapid Chinese slowdown, and an unexpected German manufacturing recession. Yet, the Fed’s about-face on monetary policy in light of slowing growth and inflation pressures breathed new life into U.S. and global growth prospects. |
Here We Go Again
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“Money for nothing” is a very strong human desire and, therefore, political force. However, the scope for “free money” is limited. The parameters that set the limits for fiscal and monetary expansion won’t change through the alchemy of Modern Monetary Theory (MMT). The Federal Reserve is already providing the money that is necessary to achieve its inflation target, and interest rates are the result of that liquidity provision given fiscal borrowing needs. |
Anatomy of a Fed Policy Mistake: Part 2, Yield Curve Confirms Excessive Tightening
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Yield-curve inversions share both common and distinct features. They always reflect tightening financial conditions and slowing nominal growth. Their recession message, however, depends a lot on the underlying longterm inflation trend. The brief inversion in late March prolonged the expansion, in our view, because it reflected falling inflation pressures. |
U.S. Energy Revival: Transformative and Unprecedented
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The United States energy resurgence has played a major role in taming energy prices over the past five years, enhancing the attractiveness of domestic petrochemical and other industrial sector investment and supporting the global expansion. According to the International Energy Agency’s (IEA’s) press release for the Oil Market Report 2019, “the story of how the United States transformed itself into a major exporter within less than a decade is unprecedented” and its effects are likely to be long-lasting. |
U.S. Economic Policy: Dovish Pivot, Deregulation, Deficits and Trade Wars
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U.S. economic policies broadly appear to be favorable for growth and risk assets in 2019. Fiscal policy remains stimulative, and the size of the deficit is far down our list of risks to the U.S. economy. Monetary policy is the biggest new tailwind, yet price inflation is likely going nowhere fast, putting little pressure on the Federal Reserve to raise rates again. |
Lessons from the 10-Year Bull Market
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March 9, 2019 marked the ten-year anniversary of the equity bull market. The climb has been challenging, with bouts of episodic volatility littered throughout, but ultimately investors have been treated to ten years of impressive gains. This bull market has demonstrated that global economic momentum ebbs and flows with trends in manufacturing and trade, leading to market corrections as valuations reset to reflect increased uncertainty about the future. |
A Mirror Image
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2019 is shaping up to be a mirror image of 2018, which began with widespread euphoria about a continuing synchronized global expansion. By the spring, however, aggressive Federal Reserve (Fed) rate-hike plans and trade-war concerns had sparked a global slowdown. In sharp contrast, this year has begun with widespread expectations of continued global slowing. Instead, with the Fed and trade concerns now becoming tailwinds, in our view, the global economy is on the cusp of a new upcycle, which should become apparent, likely by the second half. |
Soft Patch Should Be Short-Lived
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Although U.S. real GDP growth surprised the consensus to the upside in the fourth-quarter of 2018, economic data for December and January have come in on the weak side, consistent with excessive restraint from Fed rate hikes and the shock to confidence they imparted by the end of 2018. Still, there are reasons to remain optimistic about a continuation of the expansion this year and next. The sharp December decline in consumer spending followed two very strong months, and a sustained deterioration would be inconsistent with solid real-wage growth. Encouragingly, consumer expectations as measured by The Conference Board rose sharply in February following the Fed’s early-year U-turn on policy and the end of the government shutdown. |
Fixing the Damage
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The surge in equity prices so far in 2019 dates back to the January 4 about-face by Fed Chairman Powell, where he reversed his hawkish stance communicated after hiking rates at the December 18–19 Federal Open Market Committee (FOMC) meeting. At that time, the Fed chair was still signaling more rate hikes for 2019 and sustained Quantitative Easing (QT) on automatic pilot. Just two weeks later, a new dovish message was apparent. |
The Fiscal Bogeyman
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Fears of government deficits and debt have been a ubiquitous feature of the American political discourse since the days of the founding fathers. Indeed, the idea of a perpetual centralgovernment debt was a significant bone of contention between Alexander Hamilton and Thomas Jefferson that contributed to the creation of political parties and the bipartisan nature of the U.S. political system. Chronicles of the debates in the early days of the republic make it clear that the bitter animosities of today’s political scene are nothing new. |
Fed Gives Growth a Chance
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The FOMC has acknowledged the need for a pause in its tightening campaign given waning momentum in U.S. and global growth and inflation indicators, high financial-market volatility and elevated economic policy uncertainty. The restraining effect of its cumulative rate hikes to date has become increasingly clear and is likely to continue to reverberate throughout the U.S. and global economy, as is typical following a sharp flattening of the yield curve. |
Four Upcoming Market Catalysts
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Following a sanguine 2017, concerns last year ranging from Federal Reserve (Fed) actions to trade disputes, to slowing growth and geopolitical tensions contributed to higher volatility across financial markets. We believe 2019 should see no shortage of market-moving events either, amid U.S.-China trade negotiations, Fed meetings, debt ceiling debates, and deliberations over Brexit. In this week's Capital Market Outlook, we outline a few catalysts for investors to monitor in upcoming months. |
Elevated Global Policy Uncertainty Can Be a Good Thing for Long-Term Investors
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Global risk assets are pushing forward despite persistent policy-related stresses that appear to be gaining momentum. The list of stressors is not short: The U.S.-China trade war, Brexit, talks of a looming fiscal hangover, the government shutdown and tighter U.S. monetary policy are probably cited most often as risks to the outlook for the global economy and risk assets. Climate change/global warming is also a frequent contender. It is not surprising then that global economic policy uncertainty reached an all-time high in December. |
The Ball Remains in The Fed’s Court
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Weakening leading indicators of global growth combined with softer-than-expected incoming data from Europe and China and aggressive Fed tightening have created an explosive mix that culminated at the turn of the year with a surge in risk aversion and financial-market turmoil. Indeed, a hawkish Fed policy and rhetoric increasingly out of sync with the economic outlook predictably spurred a frantic market rush to translate shattered expectations of prudent Fed policy into growing expectations of recession by the end of 2019. |
Anatomy of a Monetary Policy Mistake
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Monetary policy mistakes are inevitable. The economic theory behind policy is far from perfect and often difficult to implement. As a result, tightening and easing cycles tend to go too far relative to policy objectives until it becomes apparent that enough is enough. At his appearance before the American Economic Association conference in Atlanta on January 4, Fed Chairman Powell essentially admitted that the Fed had reached such a point in its latest tightening cycle. This sparked a major risk-on rally in markets, typical of the end of bear markets when Fed policy finally stops tightening. |
Taking Account for Some Tail Risks
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As we look to 2019, the key risks we are monitoring continue to be a trade war between the U.S. and China, a rapid deceleration in U.S. and global growth and an overly aggressive Federal Reserve (Fed). But as we look below the surface, we also see a number of “tail risks” out there: low-probability but high-impact events that could be detrimental to the economic cycle. We emphasize that these are unlikely to materialize to create broad contagion for the economy and markets in 2019. Our view remains for above-trend gross domestic product (GDP) growth in the U.S. and modest equity returns, and we maintain our slightly pro-risk bias in portfolios. |
The Disruption of Traditional Market Structures
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It is well understood that sound financial markets are an important driver of economic growth and welfare. They enable corporations to raise capital, access a wide investor base and fund growth projects, thus contributing to innovation in the economy. They provide investment opportunities for families, both directly and through funds, 401(k)s, and pensions. Investors and savers alike can access more attractive investments from a return perspective than what can be achieved via traditional banking products like deposits. In addition, these holdings have the potential to diversify portfolios and help manage risks. |
A Liquidity Recession, Not an Economic One
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Clearly, the market was expecting the Federal Reserve’s comments to be more accommodative for 2019. Investors are not necessarily looking for fewer than two hikes next year; but rather they are looking for the Fed’s commentary to indicate an understanding that financial conditions are tighter than they realize. In addition, weakness overseas and inflation that has ticked below their own target rate, do not seem to be factored into their commentary about future policy in any meaningful way. |
Maintain a long term approach during this Buyer’s Strike
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As we move into the last two weeks of trade for 2018 and are just a few days away from the last Federal Open Market Committee (FOMC) meeting for the year, equity markets remain weak. Despite still-positive economic news in the U.S., the overseas environment continues to struggle, particularly in Europe and China. |
Rate Hikes Turn Reflation into Disinflation
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Over the past decade, the Fed has moved toward a formal commitment to keeping inflation around a 2% target. In October 2014, there was an agreement to make it clear that “its inflation objective is symmetric.” This was expressed in the phrase that the “Committee would be concerned if inflation were running persistently above or below” its 2% objective. Since 2012, the Committee has reaffirmed this inflation objective with “appropriate revisions” at its annual organizational meetings in January. The 2% inflation objective is based on an empirical determination that it represents a reasonable anchor for inflation expectations to provide the best long-run performance for the U.S. economy. |
Goldilocks Likely to Extend into 2019
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Our view of a “Goldilocks” economy this year, characterized by strengthening but not overheating growth and inflation, has been validated. As past correlations indicated, surging consumer and business sentiment to almost 20-year highs were followed by a meaningful acceleration in real gross domestic product (GDP) growth to just above 3%, led by sizzling real consumer-spending growth averaging around 4% in the summer and fall. While housing has suffered stronger-than-expected headwinds from rising interest rates, real business investment growth accelerated to an average of around 7%, helped by surging revenues and earnings as well as favorable lending conditions. |
Global Economy Feels Effect of Higher U.S. Rates and Trade Tensions
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The global economy entered 2018 with a full head of steam in a synchronized global expansion that almost immediately began to succumb to the forces of rising inflation and oil prices along with the impact of persistent U.S. monetary policy tightening. Countries and sectors that had taken advantage of zero interest rates on dollar loans to leverage balance sheets began to feel the impact of higher rates. By the spring, it became apparent that a strong U.S. economy buoyed by tax reform, deregulation and fiscal stimulus was accelerating, while the European economy and some emerging markets started to slow down. |
Risk-Off Sentiment and Related Dollar Strength Trounce Oil Prices
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As we gear up for the holiday season, corporate earnings were once again considered the gift that kept on giving, gauged by Q3 S&P 500 EPS growth tracking 27% YoY. The results are more impressive as we unwrap their contents further, currently illustrating solid revenue gains, cost containment and sustainability. Forward guidance has also been firm with company management commentary generally reinforcing positive momentum moving forward. We expect earnings to continue their ascent through future quarters. |
Bigger Wage Gains for Lower-Pay Occupations
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October employment data show no signs of the slowdown markets continue to fear. Despite trade tensions, Fed rate hikes and the political uncertainty surrounding the mid-term elections, the U.S. economy continues to the upside. Payroll employment, household survey employment and the ADP survey measure of private job creation all rose by over 200,000 in October, surpassing economists’ forecasts by a wide margin. |
The Limits of Globalization
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Rapid industrialization of major Emerging Market economies, a whirlwind of technological advancements in telecommunications, information technology, transportation and logistics—along with the search for low costs of production, have resulted in dizzying economic integration in recent decades. Yet, signs that globalization has occurred too fast and at greater costs than promised have accumulated. |
Active, Passive and Hybrid: In a Nutshell
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"When it comes to active and passive investment approaches, there are no absolute rules of thumb and it need not be a binary decision in favor of one approach over the other. Instead, we believe a thoughtfully constructed mix of both active and passive strategies in varying amounts can potentially help investors achieve their goals." |
Higher Rates Suggest Stronger Growth in the U.S.
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This month equity markets experienced a sharp sell-off, as concern over recently higher rates and decelerating earnings led to a rotation out of high-growth/momentum equities into more defensive, value-oriented segments of the market. We believe fears that the cycle is ending are premature, and that rising interest rates reflect a shift into an environment of stronger growth and higher interest rates along with higher volatility, with meaningful implications for portfolio positioning. |
Waiting for Godot
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Despite extremely high business and consumer confidence, markets and the financial media continue to build a wall of worry citing a litany of reasons why the U.S. economic boom is currently living on borrowed time. These include trade worries, a rising fiscal deficit, peak earnings worries, rising interest rates, a shortage of labor, peak auto and housing cycles and the presumed-temporary “sugar high” from late-cycle fiscal stimulus. |
China and The Fed Driving Volatility
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Early this year, we identified the monetary tightening cycle and the return of inflation to the Fed’s target level as key reasons to expect equity market volatility to return to more normal levels. The yield curve, which is a good indicator of monetary policy tightness or ease, tends to lead the Volatility Index by about two years. Currently, it suggests that volatility should fundamentally trend up and average more historically normal levels by late 2020. |
A Sharp Rotational Pull — But Not The End
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US. stocks are down about 5 percent from their September all-time highs, with NASDAQ and Technology as one of the worst performers. The sell-off is driven by a sharp rotation, from high growth, high momentum, highly valued segments of the equity market to cash, short-selling fixed income and some parts of the defensive sectors. Of course, market sell-offs are not abnormal. Typical years have multiple drawdowns of 5 percent or more. We view this as a healthy correction driven by technical factors not fundmental. |
Fed Upgrades U.S. Growth Outlook
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Our early-year expectations of a likely peak in global manufacturing and trade growth appear to be validated by recent data. The slowdown in growth momentum has been mild, however, as our expectations for upside risks to both U.S. sentiment and "hard" data have also materialized, helping support both global purchasing managers’ surveys and actual activity. |
The Impact of Tax Reform on the Economy and Markets, Nine Months In
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While the U.S. equity market has generally outperformed the rest of the world (ROW) since the 2008 financial crisis, it has surprised investors even more in 2018. Coming into the year, there was a general expectation that the synchronized global expansion that began in 2016 would continue. Under this assumption, most strategists expected markets outside the U.S. to continue their catch-up after a decade of underperformance. |
Global Strategic Trends and Geopolitical Risks for Investors to Consider
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Stock Market Says the U.S. is Winning the Trade War
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While the U.S. equity market has generally outperformed the rest of the world (ROW) since the 2008 financial crisis, it has surprised investors even more in 2018. Coming into the year, there was a general expectation that the synchronized global expansion that began in 2016 would continue. Under this assumption, most strategists expected markets outside the U.S. to continue their catch-up after a decade of underperformance. |
Powell Gives Strong Growth The Green Light
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Beauty is in the eye of the beholder. Similarly, judgments about monetary policy tend to vary with the views of the observer. Fed Chairman Powell’s comments at the Jackson Hole Symposium on August 24 are a good example. |
Fed Closer to Neutral Than it Knows
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From strong consumer spending, a robust labor market, and accelerating business investment to surging corporate revenues and profits, elevated business and consumer confidence, normalizing inflation, and still accommodative Fed monetary policy, our view of "goldilocks" U.S. economic conditions and expectations for a prolonged economic expansion have continued to be validated. We expect sustained strength in business investment and consumer spending as well as employment growth as the year progresses, with real gross domestic product (GDP) growth likely continuing to surprise to the upside as its trend strengthens. At the same time, we maintain the view that growth is unlikely to overheat, causing the Fed to pause sooner than is generally expected. |
Economists' Forecasts Still Chasing Growth Higher Despite Trade Friction
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While the pundits obsess over the supposed negative consequences of a trade war, business and consumer confidence show few signs of any impact. Quite the contrary. In its August report on small business confidence, the National Federation of Independent Business (NFIB) noted that “small business owners have never been so optimistic for so long. And despite challenges in finding qualified workers to fill a record number of job openings, they’re taking advantage of this economy and pursuing growth.” |
Update on Preferred Stock: Supply Gridlock Underpins Valuations
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Given the normalization of Treasury yields, YTD performance of the preferred market has waned following a very strong 2017. That said, preferred valuations have held up well relative to investment grade corporates (IG). Despite the higher interest rate environment, YTD total return through July 10 on the ICE BofAML Fixed Rate Preferred Securities Index was roughly 0.8% compared to -2.6% for the Bloomberg Barclays Investment Grade Corporate index. The yield-to-worst (YTW) for the broader $25 par market has moved off near multi-year lows, reached during the first quarter, and is now generally at a multiyear high of approximately 5%, depending on the individual issuer and security structural characteristics. |
Sticking with Financials
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While lower-for-longer interest rates and a flatter yield curve garner most of the attention, the macro factors that matter the most for U.S. financials, particularly banks, continue their solid track: Consumer spending growth is steady, home prices are growing at a mid-single-digit pace, and valuations are attractive both on a relative and absolute basis. Balance sheets for both banks and consumers are in good shape. Additionally, the headwinds from financial regulation are fading. |
U.S. Outlook Still Improving
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One thing is clear halfway through calendar-year 2018. The pundits seriously underestimated the positive effects of fiscal reform on the U.S. economy. The latest consensus forecasts in the Blue Chip Economic Indicators tell the story. Once again, surveyed economists raised their forecast for 2018 investment spending growth from 6.2% in May to 6.5% in June. A year ago, the consensus only saw 3.7% growth in investment for 2018. |
Earnings Outlook Remains Healthy
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Signs that peak earnings momentum was hit early in the year have turned investors more cautious and left the U.S. equity market range-bound in the first half of 2018. In many respects, the U.S. economy entered 2018 with a second wind as many indicators surged in a way usually only seen in the immediate aftermath of a recession, when expansions are just beginning. |
Hawkish or Dovish
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The June 13 Federal Open Market Committee (FOMC) meeting was generally judged to result in a slightly hawkish outcome. For example, the Financial Times declared “Hawkish Fed lifts rates as Trump tax cuts fuel economic expansion.” There were slight upticks in the Fed’s outlook for gross domestic product (GDP) growth, inflation and the Fed funds rate for the next two years as well as a downward revision to the expected unemployment rate. |
Dollar Risks Remain to the Upside
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In spite of perceived undervaluation and early cycle growth potential versus the U.S., and contrary to consensus expectations, emerging market (EM) and Eurozone equities have underperformed relative to the U.S. this year. Broadbased dollar exchange-rate strength has also defied consensus expectations for continued dollar depreciation in 2018, predicated on growing trade deficits and an increased U.S. government debt burden. |
It's a Wash: U.S. Growth Accelerates While Europe Fades
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U.S. economic data over the past month have confirmed our expectations for strong growth with contained inflation. From employment to wage growth, and from manufacturing surveys to business investment and consumer confidence, U.S. economic data are consistent with a sharp reacceleration from the 2.2% annualized growth pace in the first quarter to over 4% in the second quarter according to recent estimates from the Atlanta Fed and others. |
Capex Outlook
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The major leading indicators of global capital spending prospects that we track have been in an upswing since the end of 2016 (Exhibit 1). In the U.S., the capital expenditure (CAPEX) cycle is experiencing a relatively stronger resurgence than the rest of the world as a result of the fiscal stimulus boost, which added to tailwinds from stronger global growth, lower economic policy uncertainty, rising commodity prices and declining slack in capacity utilization. |
Fixed Income Update: Staying Ahead of the Curve
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After several years during which the Fed and the markets have been at odds—the Fed predicting inflation’s return and higher rates, the market is more circumspect and ultimately being proven right—both are now finally on the same page. The market started to capitulate in September 2017; strong employment and a growing belief that fiscal and tax reforms would pass forced the market to acknowledge the likelihood of higher inflation and a more resolute Fed. |
Premature Inflation Worries
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The tug of war between fears of accelerating inflation and rising interest rates versus worries of an upcoming economicgrowth slowdown in light of mixed global-economic data surprises in recent months has raised doubt about the endurance of the U.S. bull market in stocks. While a pause in the decade-old bull market is not surprising after the eyepopping 25% S&P 500 price rally between January 2017 and January 2018, we believe that worries about growth, inflation and interest rates are exaggerated. CLICK HERE TO READ MORE |
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