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Friday, April 5, 2019

Today we saw a healthy jobs report with 196,000 added (177,000 expected) and a 13,000 upward revision to February. Manufacturing was still sluggish, reflecting perhaps the drop in ISM manufacturing seen this quarter. Average hours worked was up 0.1% (good for growth), while average hourly earnings were down 0.2% to 3.2%. Assuming a personal consumption expenditures (PCE) deflator inflation rate of 2% and the current productivity run rate of about 1.8%, there should be little pressure on margins.

While the GDP growth rate seems to be slowing towards trend, it’s not there yet and the market may be getting ahead of itself. The 2.25‒2.50% fed funds rate is still a bit below neutral, assuming the Federal Reserve’s preferred Laubach-Williams measure of a 0.8% real rate premium is correct, which with the PCE target of 2%, would imply a 2.8% funds rate would be nearer equilibrium. Therefore, the Fed still appears to be a bit accommodative at present, and even more so if a cut materializes over the next 12 months or so.

I think that a pause with a cut stance is premature, though I wouldn’t expect to see the Fed change its tone until more data come through the pipeline.

Please follow employment on page 63 of the Global Perspectives book.

Tuesday, April 2, 2019

Special Guest Blogger: Tim Kearney

U.S. economic growth slowed more than initially reported in the fourth quarter. GDP advanced by 2.2% rather than 2.6%, as business fixed investment was trimmed down from 3.9% to 3.1% and consumer spending revised to an increase of 2.5% from 2.8%. A moderation of growth is not a recession and investors may be more pessimistic than warranted. Uncertainty surrounding China trade relations, Brexit negotiations and a slightly inverted yield curve will continue to weigh heavily on investors’ minds.

On the flip side, the Federal Reserve has made clear it is on hold. Recent initial jobless claims have come in close to historic lows, suggesting a robust employment outlook for consumers, the mainstay of the economy. These conflicting signals have resulted in a somewhat sideways market over the last month, after two months of strong advances. Despite the ups and downs, the S&P 500 index has gained about 20% from its lows in late December. The volatility makes market timing especially difficult.

Consider this latest study from Dalbar reported in Financial Advisor magazine on March 26, 2019:

• Investors lost 9.42% over the course of 2018, compared with a 4.38% retreat by the S&P
• In October 2018, a bad month, the S&P return was -6.84%, while the average equity investor return was -7.97%
• In August, a good month, the S&P return was 3.26%, while the average equity investor return was 1.8%
• According to its research, the average investor consistently earns “much less” than market indices suggest

Global Perspectives advocates broad global diversification to help smooth market bumps and resist temptation to time volatile markets.

Please see an example of a globally diversified portfolio on page 5 of the Global Perspectives book.

Friday, March 29, 2019

We have seen a vicious cycle of bad news, from slowing growth to nascent inverted yields curves topped with another failed Brexit plan. This has held back the equity market after its initial burst out of the gates in 2019. But is it over for the year? Is it time to sell and lock in gains? Absolutely not. There are too many good things happening that tend to get missed by the sensationalist media. For instance, U.S. GDP is at all-time record highs; as are S&P 500 corporate earnings, U.S. retail sales and U.S. industrial production.

The global economy is also powering along; it has actually more than doubled the annual $38 trillion of GDP since 2003, and stood at $84 trillion in 2018. If a few items tilted in favor of the market — such as a solid China-U.S. trade deal or even a federal funds rate cut by the end of 2019 — they could create a virtuous cycle. We believe this bull market still has legs and possible upside surprises.

Please read the Global Perspectives 2019 outlook, “The Storm before the Calm.”

Tuesday, March 26, 2019

Special Guest Blogger: Tim Kearney

As noted recently, there has been a run of disappointing manufacturing data thus far in 1Q19. This includes two consecutive monthly drops in manufacturing production, softer payrolls, PMI hitting a 25-month low and Markit PMI falling to 52.5. First-quarter GDP is likely to carry a one-handle and concerns over recession have risen. Both the Atlanta Federal Reserve and New York Fed Live Action GDP NowCasts are clocking in at a 1.3% growth rate for 1Q19. With the yield curve flat and the Fed on hold, there is concern over the direction of the economy for the balance of 2019.

This uncertainty is showing up in the NY Fed probability of recession hitting 25% (end-Feb), up from 9% a year earlier. The Voya Multi-Asset Strategy and Solutions team’s probability hit 67%, driven by the weak nonfarm payrolls data (could be revised) and yield-curve inversion (may not mean what we think). Smoothing the payrolls over three months reduces our recession probability from 67% to 51.5%, still elevated.

Nonetheless, I’d caution that it’s too early to call a recession. The NY Fed notes that the yield-curve recession signal is more like an 80‒100 bp inversion, more extreme than what we are seeing now. What’s more, the effects of extraordinary Fed policy over the past 10 years have distorted signals from the yield curve — after all, we have no precedents for gauging the effects of quantitative easing/tightening.

At times like these it’s good to look back at what has worked in the past. The Lucas critique (named for Nobel Prize winning free-market economist Robert Lucas) notes that changing the rules of the road effectively changes the outcome of the analysis — and potentially the expected impact of an inverted yield curve. For success in the markets now it’s better to follow the data, watch what the Fed is doing and monitor the continued emphasis on market economics from the Trump administration.

Please follow U.S. leading indicators on page 68 of the Global Perspectives book.

Thursday, March 21, 2019

What happened to the four rate increases and the federal funds interest rate rising to 3.5%? Well, it seems that the Federal Reserve was looking at the wrong indicator for signs of “overheating.” The Fed was scope-locked on watching real GDP growth surge to a 4% range instead of watching for signs of benign inflation, which by Fed Chair Powell’s own admission is now below expectations for both its core and headline gauges. The Fed was determined to get GDP growth to “trend,” but its 2.1% growth estimate for 2019 may be in error, especially after U.S. growth surged to 2.9% in full-year 2018.

What would Fed policies have been if the growth trend truly were 3%? GDP growth does not presently seem to be causing inflation pressure, so why not let it run? Here we are now with the 10-year U.S Treasury yield plummeting to 2.51%, the Atlanta Fed’s GDPNow 1Q19 forecast at an abysmal 0.4% and the International Monetary Fund having twice downgraded its 2019 global growth forecast — currently at 3.5% — driven by Europe and China, two of our “Big 3.” The good news is that the United States, the third of the Big 3, continues to get a boost from low tax rates and a pro-business regulatory backdrop; my expectation is for an improved second half of 2019. But for now, low bond yields are sending a dire message.

For an explanation of the Big 3, please see Global Perspectives 2019 forecast, “The Storm before the Calm.”

Tuesday, March 19, 2019

Special Guest Blogger: Tim Kearney

February saw disconcerting data from the manufacturing sector, which fell for the second consecutive month in the United States. Industrial production undershot, clocking in at 0.1% MoM (0.4% was expected), although January was revised upward to -0.4% from -0.6%. Manufacturing, which accounts for about three-fourths of industrial production, fell by 0.4% (0.1% was expected) although the big -0.9% MoM in January slimmed to -0.4%; the annual percent change dropped to 1%. Capacity utilization was basically flat at 78.2%. The nonfarm payroll (NFP) print of 20,000 jobs in March also pressured concerns over growth.

At this point, with many estimates at the lower end of their recent ranges, it seems a foregone conclusion that 1Q19 will be soft. The Atlanta Federal Reserve’s GDPNow forecast is currently a weak 0.4%, down from 2.8% earlier in the quarter. The New York Fed Nowcast is holding at 1.4%, down a point since early December 2018. There remain unresolved questions about the issue of 1Q19 seasonality, which may have been exacerbated by the severe winter weather. This is not to argue that we can explain away softer 1Q19 data, but simply that it may be difficult to separate signal from noise this quarter.

The fading inflation rate implies that the Federal Reserve is correct to be “patient”; I believe a useful notion for this pause is “data dependency.” I doubt that we are looking at a rise of inflation in the short run. It will be interesting to see how the Fed handles the next six months.

Please watch GDP on page 70 of the Global Perspectives book.

Thursday, March 14, 2019

According to the NAHB (National Association of Home Builders), housing contributes 12‒15% to U.S. GDP. The actual construction and remodeling of single and multifamily homes account for 3‒5% and the remainder is comprised of the associated consumption of housing services including rent and utilities. In addition, housing is usually a consumer’s biggest asset. Thus, any cracks in the housing market’s foundation are valid reasons for concern.

Limited inventory, high prices and rising interest rates contributed to an overall slowdown in housing sales in 2018. According to the S&P Case Shiller index, housing prices rose at a 4.7% annual pace in December, much higher than the pace of inflation. January new home sales dropped 7% from December and 4.1% from a year ago; not a very encouraging start to 2019. Still, housing starts which are considered a leading indicator, rebounded sharply – up 18.6% in January to an annual pace of 1.23 million. (To give this number some context, housing starts hovered around 2.3 million in 2006).

New construction leads to economic activity: jobs, loans and consumer spending. Mortgage rates recently fell to their lowest levels in a year, which may encourage sidelined buyers to jump in and boost sales. Housing is not as big a driver of the economy as it was pre-recession, but it certainly factors significantly into economic growth. Given limited inventory, increases in population and household formation, and a continued robust economic backdrop, housing prices should keep moving higher in 2019, but at a measured rate.

Please watch housing starts on page 67 of the Global Perspectives Book.

Tuesday, March 12, 2019

Special Guest Blogger: Tim Kearney

The nonfarm payroll (NFP) print of 20,000 jobs raised some concerns about the economy, but the balance of key recent data points to a continued low inflation/good growth situation in the United States. February CPI was up 1.5% YoY while Core CPI rose 2.1%. Each was 0.1% lower than expected. Headline inflation had hit 2.9% YoY as recently as July 2018. As a result, real average weekly earnings continue to grind higher, reaching 1.6% YoY in February, up from -0.7% in January 2017. Importantly, the four-quarter moving average of nonfarm productivity rose by 1.8% in 4Q18 from zero in mid-2016.

As for NFPs, Stanford economist Edward Lazear’s research shows that the initial print is the single most revised data point published in any given month. In fact, the data are so volatile that the most useful cut is the 12-month moving average (where seasonal factors are smoothed). The fading inflation rate implies that the Federal Reserve is correct to be “patient”; I believe a useful notion for this pause is “data dependency.” I doubt that we are looking at a rise of inflation in the short run, but the economy can surprise the Fed to the upside. It will be interesting to see how the Fed handles the next six months.

Please watch inflation on page 60 of the Global Perspectives book.

Thursday, March 7, 2019

Increased productivity allows firms to produce more output with the same level of input. This, in turn, allows for higher profits and the ability to pay higher wages without eroding profit margins or stoking inflation. U.S. productivity advanced 1.9% in 4Q18, a move up from 3Q18 and affirmation of an encouraging trend higher. Annually, the 1.4% increase was the best reading since 2010. Below trend productivity began to turn around in 2017, and it wasn’t caused by a surge in sales of energy drinks.

The means of improving productivity are straightforward — new technologies, investment in human capital with education and training and physical investment in machines and infrastructure. The 2017 tax reform offered incentives to businesses to invest in new technologies and equipment to increase output. The deregulation overhaul made it easier for competition to jump into the market with greater efficiency. Hence, better productivity and improved economic growth allowed the Federal Reserve to raise rates eight times in the last two years.

Europe has failed to receive the memo. European economic growth for 2019 has been slashed from 1.7% to 1.1%. Although 4Q18 GDP growth picked up slightly, the European Central Bank isn’t taking any chances. ECB President Mario Draghi unveiled a new round of “sugary” central bank stimulus in the form of cheap bank loans (TLTRO – Targeted Longer Term Refinancing Operations), its third round since 2016. In addition, the ECB’s guidance revealed that rates will remain on hold for the remainder of 2019.

Please watch U.S. productivity on page 65 of the Global Perspectives book.

Tuesday, March 5, 2019

Special Guest Blogger: Tim Kearney

There are important developments in the running of the Federal Reserve’s monetary policy, centered on the meaning of the inflation target and the disposition of the Fed’s balance sheet expansion. Regarding the target, discussions are beginning to hone in on something akin to nominal GDP targeting or price level targeting. This is a longer-term project, as positions must be worked out and communicated.

By contrast, the discussion over the balance sheet is well underway and in fact, “normalization” seems to be happening. Although the balance sheet has increased by five times since the global financial crisis, there has been no significant inflation — the PCE deflator has averaged 1.8% during this period, the same as the 25-year average ending December 2018.

The flattened yield curve, low level of long-term interest rates, anchored inflation expectations and the fall of commodity prices imply that there is no need for the Fed to reduce the balance sheet further. Nevertheless, recent comments indicate that the reduction process will continue. Be aware that the risks for markets seem to skew more heavily to the downside.


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