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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
Rates Market Signals Another Deflationary Shock
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The lagged effects of the Federal Reserve’s aggressive rate hiking in 2016-2018 continue to put downward pressure on economic growth and future inflation. The slow reversal of this restrictive monetary policy, as reflected in the muted July 31 Fed response to waning growth and inflation trends, has disappointed investors, causing a tightening of financial conditions and deeper inversion of the yield curve. |
Current Market Volatility
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Recent fears that the record longevity of the U.S. economic expansion makes a recession more likely have caused many investors to move into cash and other defensive assets. A look at the factors that generally warn of impending recession suggests that these fears may be overblown. The main exception is Federal Reserve policy, which remains restrictive by our time-tested gauges despite the first rate cut in over a decade. |
Abundant Oil Supply Exerts its Pull
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Following strong global oil-demand growth and an OPEC-engineered inventory decline in 2017, fears of persistently tight oil-market conditions caused oil prices to increasingly exceed our expectations as 2018 progressed, reaching $86 per barrel by early October 2018. However, the price surge proved temporary. Higher-than-expected U.S. supply and a six-month waiver program for eight Iranian oil importing countries caused prices to collapse to $50 per barrel by December and gravitate around $65 per barrel since. In our view, prices are likely to remain moderate despite the expiration of the Iran-oil waivers in May and escalating geopolitical tensions related to the Iran sanctions. |
Catalysts in Focus for the Rest of 2019
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From U.S.-China trade negotiations to central bank meetings and Brexit, there are a number of events coming down the pike that could shake up financial markets. With a weakening growth backdrop and stubbornly low inflation, global monetary easing has shifted into high gear, with many central banks now signaling more accommodative policy. Here we outline some of the major catalysts for investors to watch as we enter the back half of 2019. |
Flirting with Disaster
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While markets continue to be distracted by trade tensions, the deflationary shock the Federal Reserve inflicted on the global economy in 2018 continues to work its way through global cash flows. Inflation and inflation expectations are falling around the world, while businesses report declining pricing power and revenue growth. Signs of weakening consumer-income growth are the last step on the road to recession. These are all signs of overly-tight monetary policy. |
Why 2%?
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Since the Great Depression and WWII, the federal government’s role in promoting certain economic goals has become increasingly formalized through legislative mandates. While Federal Reserve policy has always been focused on the goal of price stability, the specific meaning of price stability has been refined over the years from a general and non-specified, vague concept to the current very specific quantitative definition of a 2% long-run average. We describe the evolution and rationale for the Fed’s more specific target. |
Mixed data reflect shifting global-growth pattern
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U.S. growth remains strong, yet inflation and inflation expectations are falling rapidly. Global growth is shifting away from the rest of the world and back to the U.S. This relative outperformance of domestic versus international growth is apparent in the latest U.S. business survey data. As interest rates have come down, small-business confidence has risen to a new high for the year, with rising plans for capital spending and more optimism that “now is a good time to expand.” |
Nothing to Fear But Fear Itself
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Market commentary has been focused on Federal Reserve and trade policy. Evidence has continued to accumulate supporting the view that tighter monetary policy is the dominant force behind the global slowdown rather than the fears of a trade war. Falling inflation around the world is one of the main signs that policy is too tight. This contradicts the view that tariffs are causing higher inflation. |
Productivity Liftoff: The Story of the Decade
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More economists are starting to acknowledge the rising trend in U.S. productivity growth. We agree with Cornerstone Macro research, who has been among the first to sniff out the end of secular stagnation and call the new stronger productivity trend “the story of the decade." Accelerating productivity growth raises the potential growth rate of the economy. The big rise in productivity growth has caught Federal Reserve policymakers by surprise, causing them to overtighten in 2018. To get inflation up to target, the Fed will need to ease. |
Yield Curve Signals Policy Too Tight
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Trade tensions have combined with excessive Fed tightening to further invert the yield curve in recent weeks. While inversions are often a signal of impending recession, they can also be a sign of disinflationary pressure. Either way, in current circumstances, the inverted yield curve implies the Fed has passed neutral and begun to slow down the economy and reduce inflation. This is causing inflation to fall further below the target. The inverted yield curve reflects the reduced outlook for nominal growth in a tighter monetary policy environment. |
The Latest from the Chief Investment Officer
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It’s shaping up to be a year of historic milestones with the equity bull market having passed ten years, and the economy poised to join it in July, marking the longest economic expansion in U.S. history. Investors might wonder just how long each run-up can continue, and to what degree. We believe there are 4 scenarios to analyze and ones that could develop in the next 12 months. |
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.” |
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