George Hosfield, CFA, discusses Ferguson Wellman's quarterly strategy titled, "Inflation's Flame Flickers," which addresses the narrow market leadership, the impact of higher interest rates on inflation and how assets are priced at this stage of the economic cycle.
George Hosfield, CFA, discusses the firm's quarterly strategy titled "Stalemate," which highlights the Fed's ongoing battle to tame inflation along with our views on the health of the banking industry and capital market expectations for the balance of the year.
Director and Chief Investment Officer George Hosfield, CFA, discusses the Fed raising interest rates, peaking inflation and our view on equities and volatility across all asset classes in our Investment Strategy titled, “Balancing Act.”
That’s the message we heard loud and clear from the markets this week. As economies and markets around the world wobble to start the new year, they were looking to central banks to bail them out. Mario Draghi gave markets around the world some solace with his dovish news conference yesterday.
by Shawn Narancich, CFAExecutive Vice President of Research
While Chinese stocks endured more losses in a week that now puts the A-Shares Index into correction territory, U.S. investors continue to preside over a range-bound market domestically. With U.S. equity indices near record levels and late quarter news flow reduced to a trickle, all eyes were focused on the U.S. Supreme Court decision this week regarding the legality of federal tax subsidies for states not running their own insurance exchanges. A high court ruling upholding a key tenet of the Affordable Care Act (ACA) was greeted with a sigh of relief by investors who own hospital stocks, while sending speculators short names such as HCA Holdings running for cover. While minor tweaks to the ACA are still possible, such as the repeal of the medical device tax, this week’s key ruling all but assures that the key structure of the national healthcare law will remain intact at least until the Obama administration leaves office.
Gathering Pace
As healthcare stocks reacted to the Supreme Court drama, investors with more cyclical leanings received the latest confirmation that moribund first quarter consumption and weak retail sales were transitory. U.S. consumption spending in May rose at the fastest month-to-month rate in nearly six years, and the 0.9 percent surge easily outpaced a smaller increase in consumer income. Indeed, the U.S. consumer has not forgotten how to spend! Coupled with a strong job market confirmed by a surge in May hiring and an upbeat retail sales reported for the same month, we are left to conclude that the U.S. economy has picked up considerable pace from the slight contraction it experienced during the first quarter. Our best guess is that the Federal Reserve will exit zero interest rate policy sometime later this year, and it will most likely be in September.
Greece Ad Nauseum
The melodrama of Greece failed to find a resolution this week, but European stocks seem to have found their footing nonetheless. Regardless of whether ongoing talks with Greece are successful in retaining the country as a solvent member of the Eurozone economy, the European Central Bank (ECB) has demonstrated its commitment to do, as chief Mario Draghi famously observed several year ago, “whatever it takes,” to keep the Eurozone and its currency viable. Exhibit A of this commitment is the ECB’s ongoing program to enhance the European monetary base by purchasing $60 billion of European bonds every month until at least the fall of next year. Exhibit B, key in the latest Greek crisis, is the central bank’s commitment to fund Greek banks with loans to accommodate ongoing deposit flight from these institutions. Our main observation here is that if no acceptable resolution is reached and Greece ends up leaving the common currency, then Europe and its central bank will do what is necessary to keep the region’s banking system and economies liquid, thus preventing any lasting type of contagion from Greece’s exit.
Our Takeaways from the Week
by Ralph Cole, CFA
Executive Vice President of Research
The global economic expansion continues to run at very different speeds around the world. However, the common thread among most all developed economies has been easy money. Today, China joined the party by lowering interest rates for the first time since 2012. The reasons for lower rates has been stubbornly slow growth, and as long as inflation remains low, central banks can feel confident in their choice to stimulate their economies.
Markets were also buoyed this week by dovish comments out of the European Central Bank. With most European economies mired in little to no growth, and the ECB has embarked on its own version of quantitative easing (QE). Mario Draghi hinted in a speech yesterday that their asset-buying program could expand if necessary. The lack of economic growth in Europe can at least be partially explained by Draghi’s habit of speaking about, rather than actually enacting, central bank policy. In Texas, they would call this “all hat and no cattle”.
Thrift Shop
This week just about wrapped up earnings season for retail companies. Earnings were basically strong across the board for retailers from Dollar Tree and Target to Foot Locker and Best Buy. We believe retailers and consumers are starting to feel the benefits of lower prices at the gas pump. Lower gas prices often coincide with higher consumer confidence numbers, which in turn leads to increased consumer spending.
What makes the retail industry so interesting is the plethora of stores from which shoppers have to choose. I don’t think any of us would argue that we aren’t over-retailed in the U.S. This abundance is one reason we don’t see much inflation. Despite a zero percent interest rate policy and a massive expansion of the Fed’s balance sheet, inflation is not yet finding its way onto store shelves. Competition for the consumer’s discretionary dollar remains fierce. Case in point: the phenomenon of Black Friday sales moving earlier into our Thanksgiving holiday week.
Our Takeaways from the Week
by Brad Houle, CFA
Executive Vice President
More than anything, the financial markets dislike uncertainty and the most recent source of angst was the election. With the mid-term elections behind us, the market participants are free to focus on economic data and not political minutia. One of our research partners, Cornerstone Macro, published a great summary of likely legislative change and probable market impact from the change in control of the U.S. Senate.
The European Central Bank (ECB) met this week and the takeaway from their meeting is the ECB is still poised to take extraordinary measures to keep the Eurozone economy from lapsing into a recession and possible deflation. Mario Draghi, the ECB president, reiterated the ECB's commitment to do whatever it takes to keep Europe's economy staggering forward. He did not go so far as to announce quantitative easing which just ended in the United States. The ECB has been doing some bond buying on a smaller scale and keeping the possibility of a large scale quantitative easing program on the back burner in the event the European economy goes from bad to worse.
The employment data for the month of October was released today. The unemployment rate declined to 5.8 percent and nonfarm payrolls increased 214,000 jobs. In addition, there was a 31,000 revision to the September employment report. While the absolute number of jobs was a bit behind the consensus number, this is a very solid report and continues to demonstrate that the labor market is healing.
Takeaway for the Week
by Jason Norris, CFA
Executive Vice President of Research
The first couple weeks of trading in October have been volatile, primarily on the downside. While the U.S. economy continues to print positive data points, most other regions around the globe seem to be experiencing some headwinds. We continue to see deteriorating economic data coming out of the Eurozone. Germany had been stronger; however, recent data is pointing to the country possibly entering into recession. Industrial production and manufacturing orders came in weak, and this concern has pushed the yield on the 10-year German Bund to 0.84 percent.
China is a wildcard as well. Growth has been slowing moderately; however, Thursday evening technology investors were greeted with bad news from a key component supplier. Microchip Semiconductor, a supplier of chips that go into a broad array of consumer, household and industrial products, issued a warning citing weakness in China. The company believes this is a short-term issue, but demand just three months ago was strong. This resulted in a drubbing of the Philadelphia Semiconductor index and caused the industry to be down over 5 percent on Friday. Even though there may be some general hiccups in demand, we continue to play the semiconductor space through specific technologies and applications, primarily in the wireless space.
We don’t anticipate a slowdown here in the states. The U.S. economy should continue to exhibit solid growth and decouple itself from the rest of the globe. The most recent positive development has been the decline in energy prices over the last couple weeks, which will result in a nice increase of discretionary income for U.S. consumers.
When Doves Cry
The Fed released its meeting minutes earlier this week and the capital markets were pleasantly surprised. There had been some concern that the Fed may become more hawkish and looking to tighten. However, contents of the minutes showed the Fed to be focused on the data. They highlighted benign inflation, a strengthening U.S. dollar (which is positive for low inflation) as well as increased risks of a global slowdown due to Europe’s stalling growth. We still believe that the Fed will be looking to raise the funds rate in the second quarter of 2015. Even though inflation remains low, U.S. economic growth will support the beginning of a rate hike cycle.
European Central Bank President Mario Draghi also signaled his dovish intentions for the ECB earlier this week. At a speaking engagement in Washington D.C., he stated that the bank was willing and able to alter its current bond buying program which may eventually move from just asset-backed securities to actual sovereign debt. We believe the ECB will be active in the market and will attempt to push growth higher to fight any possibility of deflation.
Our Takeaways for the Week:
by Ralph Cole, CFA
Executive Vice President of Research
Stronger The U.S. economy was indeed stronger than first reported in the second quarter as estimates were revised higher this week when the commerce department reported that the U.S. economy grew 4.2 percent during the quarter. This pace fits with our narrative that the U.S. economy is truly getting healthier, particularly in the aftermath of a very harsh winter.
In fact, there was a lot to like about most of the economic reports this week. For example, durable goods orders grew 22 percent, led by airplanes; unemployment claims came in again under the 300,000 mark - yet another example of vitality in the labor markets; auto sales for the month of July were robust at over a 16 million annual rate of sales. In summary, current economic statistics suggest a sustainable expansion with moderate inflation.
Witchcraft Black magic may be the only explanation for ultra-low interest rates in the face of sound economic numbers. Our industry heuristic states that strong economic growth ultimately must translate into higher interest rates. Not so fast my friend. While the U.S. economy is growing quite nicely, Europe is suffering from falling growth rates, and plunging inflation which has contributed to record lows in interest rates throughout the Eurozone. For example, Germany’s 10-year bund fell to a .88 percent yield while 10-year debt yields touched 1.24 percent in France and hit a 2.22 percent in Italy. With European Central Bank chief Mario Draghi’s most recent speech in Jackson Hole last week, he essentially took perceived credit risk off the table for the Eurozone. With a compelling endorsement of U.S. style quantitative easing on the horizon, investors clearly are (for the time being) comfortable holding European debt.
Lower rates throughout the Eurozone have effectively put a bid under U.S. bonds. In the global market for debt, savers view U.S. debt as a good deal at these levels and continue to buy. Studies estimate that the downward pressure on U.S. rates from lower European rates is anywhere from 20–30 basis points. As you can see from the chart below, U.S. 10-year yields are at their outer-bounds relative to the yield on the 10-year German bund.
Our Takeaways for the Week
