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Tuesday, May 14, 2019

Special Guest Blogger: Tim Kearney

Right now, markets are digesting the realization that there may not be a quick resolution to the trade dispute with China — such expectations probably were over optimistic to begin with. That there won’t be a quick resolution appears to have become the mainstream view. As a result, the Dow Jones Industrial Average is off more than 1,000 points from its October highs. The question now is how to analyze the economic impact of a protracted dispute. There is some confusion over the impact on U.S. inflation: to get a bit technical, the price impact comes from the interplay of the China supply curve and the U.S. demand curve.

From the Chinese point of view, supply is pretty much set: whom else can they sell to? China’s first response has been to weaken its currency by about 3%; a modest drop that will help a bit. A second line of defense is for Chinese companies to let tariffs eat into their margins somewhat. From the U.S. point of view, consumer demand — especially in the short term — has plenty of alternatives to buying from China, such as other sellers or delaying purchases until there is some clarity about what is happening. Importantly, consumers still have income to put to work, and likely will look beyond Chinese products. Further, rather than fully pass higher costs along to consumers, the U.S. supply chain may absorb some of the tariffs.

That doesn’t mean there won’t be inflation from the tariffs we’ve seen thus far; it means that the inflation impact is likely to be somewhat muted on the first cut. I do not believe the Federal Reserve will move quickly to rescue the Trump administration from what appears to be a self-inflicted (though promised) problem. Nevertheless, the longer the disagreement continues, the more likely a rate cut becomes. Cutting rates, however, will require economic adjustments — in the form of higher prices through the trade channel or a markedly slower economy.

Please follow global trade on pages 46–48 of the Voya Global Perspectives book.

Friday, May 10, 2019

The key proposals of the China-U.S. trade deal are intended to protect U.S. intellectual property rights and trade secrets. There are certainly many more aspects of the deal but these are the ones the United States considers non-negotiable. This hasn’t been about trade in soybeans for sure. Free trade is essential to world prosperity but theft of a business’s property is not free trade. The lack of agreement looks like another round of tariffs to the tune of $325 billion: this is international poker, creating unsettling uncertainty for investors. However, China has the weaker hand and the saber rattling may be an opportunity to “buy low.” The market is susceptible to a correction going into the weekend, but keep in mind that this looks as if it may turn out to be another “storm before the calm” led by the astounding fundamentals in the economy we have witnessed to date.

Please review Voya Global Perspective’s 2019 forecast “The Storm before the Calm.”

Tuesday, May 7, 2019

Special Guest Blogger: Tim Kearney

The ups and downs of the Trump administration’s policies were in clear view over the past week — the up clearly being the unemployment and productivity data, and the down being the market’s worries about trade talks with China.

The recent run of domestic data show that we are still in an economic run-up: the lowest unemployment rate in 50 years, rising average hourly earnings, falling underemployment and contained wage costs. Productivity continues to ratchet higher (see Friday’s blog). Federal Reserve data for 1Q19 show an easing of lending conditions for small through large firms, per our models consistent with early stages of the cycle. This cycle is a bit like Benjamin Button, seemingly getting younger as time passes.

But then there’s the China–U.S. trade talks, where both sides seem to be digging in. We can’t know what’s happening in the talks, but we can watch to see if China agrees to further talks in Washington. Taking tariffs up to 25% requires a public comment period before any increase can be implemented. Note that the process the administration is using so far — Section 301 of the Trade Act of 1974 — entails a drawn-out time frame, which might argue for finding a quicker outcome.

Please follow global trade on pages 46–47 of the Global Perspectives book.

Thursday, May 2, 2019

The U.S. productivity growth data continue to rise. First quarter 2019 productivity growth of 3.6% well outperformed expectations for 2.2%. As we noted a year ago, “…assuming 0.5% labor force growth and a productivity growth rate of 1.3% we are looking at a potential GDP growth rate approaching 2% —before the impact from the 2018 corporate tax rate reductions…there is a real chance to take trend GDP above 2% and possibly 3%.”

With GDP growth of 3.2% during the most recent trailing four quarters, and the unemployment rate down just 0.2% during the same period, it appears that potential GDP could be higher than previously believed. Despite the tight labor market, productivity is matching employment costs. Hence, unit labor cost declined by 0.9% in 1Q19. On a year-over-year basis, nonfarm business sector output per worker is up to 2.4%. Developments in investment (hence productivity) will be important to markets in the coming quarters.

Please follow productivity on page 65 of the Global Perspectives book.

Tuesday, April 30, 2019

The S&P 500 reached historic all-time highs last week, but not everyone is convinced of the bull market’s ability to keep charging ahead. The worry is that we are in the ninth inning, but we think this game is instead a double-header. There has been some FOMO – fear of missing out – but overall fund flows do not indicate an imminent melt up. Equity flows have picked up in the last few weeks but bond flows are still far outpacing equities for the year.

Investors may be worried that stocks are overvalued; however, the 2019 forward P/E based on today’s S&P 500 price is less than 17x. While this is marginally above the historical average P/E of 15.8x between 1990 and 2018, the current level of earnings has hit a record high. There are additional signs of a double-header:

  • Q1 GDP blasted past expectations with a three-handle at 3.2%
  • Initial jobless claims (unemployment claims) are at a half-century low
  • Industrial production is still expanding with March durable goods orders surging 2.7%, the fastest in seven months
  • The Federal Reserve has affirmed that interest rate hikes are on hold, while other central banks remain accommodative
  • Inflation is still below target, with a recent core PCE reading (the Fed’s preferred measure) well below 2%
  • First quarter earnings growth — the biggest indicator — is just shy of being positive according to Lipper

The market hit all-time highs due to the plethora of good news. Remember it is fundamentals that drive markets. Please follow fund flows on page 80 of the Global Perspectives book and read the latest commentary.

Tuesday, April 23, 2019

Special Guest Blogger: Tim Kearney

As late quarter data roll through, it appears that growth momentum is to the upside. First quarter GDP growth is released on April 26th, and the consensus shifted up to 2.2% growth, within a range of 1%-2.9%. Last week the consensus was for 1.8% growth. The Atlanta Fed GDP Now forecast, which was near zero in mid-March, is now above 2%. March retail outperformed expectations. Sales ex-autos, building materials and gas stations were strong. The Leading Economic Index LEI in March increased from the near zero readings at the turn of the year. The YoY growth rate is now 3.1%, well above the annualized 0.7% six-month change, another indication of momentum. The Bloomberg U.S. National Consumer Economic Expectations index 3-month moving average seems to have stabilized at 50. Consumer Comfort index also appears to be stabilizing above the 3-month average. If momentum picks up from the 2% growth expected in the first quarter, then it should be positive for risk assets. Our expectation is that growth can run at 2.5%. It will take some time to work out, but it’s important to note momentum is shifting and supportive of markets.

Tuesday, April 16, 2019

Special Guest Blogger: Tim Kearney

Manufacturing had a difficult first quarter, perhaps the result of trade concerns. A few areas of the economy recorded weakness was. The slowdown had been presaged by Manufacturing PMI data, which have been ebbing for nearly a year. Manufacturing output in March was flat with the YoY growth rate down to 1.5%. Six months ago, the YoY growth rate reached 3.5%, its fastest pace in six years. The key to the outlook is not so much the growth rate, but rather the business investment data, as well as the following productivity data.

There has been a modest lift of the productivity growth rate over the past two years, but not enough yet to challenge the narrative that growth will sink back to the New Normal trend rate of about 1.8%. New York Federal Reserve President John Williams has warned that the economy is unlikely to return to the 4% growth rates of the 1990s, pegging potential growth at 2%. This is the state of play for the next two to three quarters. Right now, I expect that growth will continue above 2.5%, which would be a major surprise to the Fed but very positive for markets.

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

Friday, April 12, 2019

Fundamentals drive markets, and by fundamentals we mean corporate earnings. So it is no surprise that investors are a little jittery about earnings season, which kicks off in earnest today. Expectations are for -2.5% growth in 1Q19 compared to 1Q18. Yes, negative growth. Recall that 1Q18 earnings were given a boost by the 2017 tax cuts, and that boost has set a high bar to beat. But also consider that on January 1, 4Q18 earnings growth was initially expected to be 11.7%, and ended up at 16.9% when all was said and done a few weeks ago.

Companies slashed expectations in December on the heels of wild swings in the market and widespread fears of a global slowdown. It was a storm before the calm — those estimates may have been too pessimistic. Earnings usually surprise on the upside; because of the magnitude of the downgrade in expectations, the surprises may be higher than usual. Evercore ISI just released a note estimating 1Q19 S&P 500 earnings to be up 4.3%. We too expect growth, just not double-digit growth. The bull market might not be a spring chicken but it may still have a little spring in its step.

Stay tuned and please see the latest Global Perspectives quarterly commentary – Markets Springing Ahead, not Springing a Leak.

Tuesday, April 9, 2019

Special Guest Blogger: Tim Kearney

Was the recent growth pause a refresher? Nonfarm payroll growth averaged a healthy 180,000 per month in 1Q19; just about 100,000 are needed to keep the unemployment rate steady. March PMIs were solid with new orders up; auto sales spiked to a solid 17.5 million. The consensus for 1Q19 is edging back towards above-trend GDP growth of 2%. Which brings us to the Federal Reserve: while the GDP growth rate seems to be slowing towards trend, it is not there yet and there is a risk that both the Fed and market participants may be getting ahead of themselves with expectations for a rate cut.

The current fed funds rate is still a bit accommodative — even more so if a cut materializes within the next nine months. That would imply continuing growth at or above trend, as well as inflation moving back toward target. Hence, the Fed is going to be wrestling with the nexus of growth/inflation, which currently shows low inflation with above-trend growth. In our view, the Fed is now analyzing its target goals and has a high bar to change its current stance, but “patience” means data watching is an important element of its analysis.

Our conclusion is that the developing consensus of a pause with a cut within a year is premature. The Fed has signaled it won’t change its tone until more data come through the pipeline. If those data show continued above-trend growth, it may force the Fed’s hand, but for a good reason.

Please follow fed funds target rate and U.S. Treasury yields on page 34 of the Global Perspectives book.

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.


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