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.”
A White House in Turmoil, The Fed Shifting Policy: Treasuries Are Actually Calm About It
For all the turmoil roiling Washington, D.C. from the Federal Reserve to the White House, and Treasury bonds, typically a go-to segment of the financial markets when you’re looking for a pessimistic take on the day’s affairs, appear unusually placid.
In a relatively quiet week on the company news front, investors welcomed a series of new highs on the S&P 500 that have pushed the benchmark index to price gains now exceeding 10 percent on the year.
Stocks finished the week off by only 0.80 percent, recovering some of the losses suffered Thursday after the Fed voted to keep interest rates unchanged. Similarly, the Bank of Japan and Bank of England are also maintaining their monetary
by Shawn Narancich, CFAExecutive Vice President of Research
Seeing the Forest through the Trees
The nexus of anxiety surrounding China and its slowing rate of growth eased this week as both the Red Giant and its neighbor Japan signaled tax cuts and infrastructure spending, the kind of expansionary fiscal policy many market watchers have been anticipating. Chinese leaders have been vocal in attempting to reassure markets about their economy but the latest evidence of declining exports and imports reported earlier this week continues to point to an economy struggling to make the transition away from investment-led growth. Though slower growth in China and recessions in Brazil and Russia are dampening the earnings of U.S. multinational companies operating in these countries, we see nothing more systematic in the latest stock market correction. As they say, this too shall pass.
All Over but the Yellen
All of which brings us to next week’s Federal Reserve meetings, at which time FOMC policymakers will convene to decide whether the U.S. central bank will finally lift short-term interest rates, which have been targeted to zero percent for nearly seven years. Arguably, the Fed has achieved its employment objective as measured by an unemployment rate approaching 5 percent and a job base that has joined GDP in record territory. What hasn’t been achieved is the Fed’s price objective of 2 percent inflation, and though Chairwoman Janet Yellen has signaled her belief that low oil prices and the inflation dampening effect of a strong dollar are transitory, some pundits question the sagacity of moving on rates with inflation so far from the target.
Will Tighter Labor Markets Hold Sway?
We agree with Yellen’s view on both points – our belief is that oil prices have bottomed and will rise from here, and that the best gains of the trade-weighted dollar have already been achieved. What’s driving Fed hawks to be pro-active in raising rates ahead of any visible inflation is the labor market which, according to this week’s Job Openings and Labor Turnover Survey (JOLTS), now sports the highest level of unfilled jobs in 15 years. High demand for jobs relative to the supply of labor could draw disaffected workers off the sidelines but tighter labor markets might also begin to force employers to raise wages and salaries to attract and retain talent. So while investors have yet to see the evidence of a tightening labor market in key statistics, like wage growth and rising unit labor costs, we would argue that the Fed is best served to be anticipatory in setting monetary policy.
Our Takeaways from the Week
by Shawn Narancich, CFAExecutive Vice President of Research
Green Shoots
A week chocked full of economic insight concluded with a bang, as a strong jobs report for the month of May provided more assurance to investors that a contraction in first quarter GDP is likely to be transitory. The U.S. economy created a net 280,000 nonfarm jobs last month, nearly a third better than what Wall Street was expecting. Good news on the jobs front was widespread among various industries and accompanied by more evidence that wage gains are firming. After being hamstrung by the West Coast ports strike, an exceedingly strong dollar and another harsh conclusion to winter, the U.S. economy now appears to be gathering speed.
In its attempt to determine the right time to begin raising interest rates, the Fed will triangulate today’s bullish job report with additional evidence of gathering momentum in manufacturing released earlier this week, that coming in the form of an ISM report showing that activity has picked up for the first time since last fall. As well, construction spending perked up in April and previous months’ activity was revised upward. Finally, Yellen & Co. would observe that U.S. light vehicle sales posted another strong number in May, rising to a seasonally adjusted annual rate of 17.8 million vehicles sold, a 10-year high. The plurality of this week’s data reveals an economy no longer in need of unconventional monetary policy and leads us to believe that the Fed will achieve lift-off from zero interest rate policy this fall, most likely in September.
Raise Rates in 2015 … Mais Non?
As investors were digesting the good news domestically, the International Monetary Fund was busy revising down its estimate of how fast the U.S. economy will grow this year. In an unusual move, Managing Director Christine Lagarde urged the Fed to hold off on raising rates this year, arguing that doing so would lead to an even stronger dollar and threaten the rate of expansion globally. The French may be opinionated, but even her admonition is likely to fall on deaf ears. We have said repeatedly that when the Fed raises rates, it will be for the right reasons, and the data we are beginning to see affirm for us that the U.S. economy is rebounding in the second quarter. Like last year, we see a second quarter reversal carrying through with strength into the second half of 2015.
Markets on the Move
Although the IMF might not be convinced, bond investors have responded in dramatic fashion, selling longer dated issues in mass and sending benchmark U.S. rates to their highest levels of the year. Equities in the financial sector are doing the opposite, rallying in anticipating of higher rates boosting banks’ net interest margins. In anticipation of rising rates, we recently increased our weighting to financials, while further trimming our exposure to a consumer discretionary sector that appears closer to full value.
Our Takeaways from the Week
by Ralph Cole, CFA
Executive Vice President of Research
Melt with You
It feels like the market is melting up these days as stocks continued their year-long rise during the shortened holiday week. Investors continue to be heartened by positive economic data signaling stronger growth as we enter 2014. Durable goods orders were up 3.5 percent in November with automobiles, airplanes and refrigerators helping drive end demand. Also, new home sales remain robust with record-setting sale prices. Both of these data points hit on some important topics for our 2014 Investment Outlook. Specifically, we think demand for capital equipment will finally accelerate in 2014 due to underinvestment and substantial cash balances on corporate and consumer balance sheets. Furthermore, consumers are increasing their spending as a result of the “wealth effect” that has been fueled by increased home and stock prices.
Crosstown Traffic
Our investment team has been writing for some time about the shift to online shopping and this trend came to a head this week for Amazon and UPS. For those of us who like to start shopping closer to Christmas, Amazon Prime© seems like the perfect solution. For an annual fee of $79.00, Amazon provides two-day free shipping on most merchandise. We don’t think anyone is surprised to learn that we live in an era of procrastinating techno-geeks who wait until the last minute to ship gifts. This time, the sheer volume of orders overwhelmed both Amazon and UPS. Though UPS has not stated how many packages were affected, the number seems to be in the hundreds of thousands. While both Amazon and UPS are doing what they can to satisfy customers, the real story is the volume shift to cyberspace. Amazon signed up over 1 million additional Prime© customers in the third week of Christmas alone. This is a nice development for Amazon because these shoppers tend to spend twice as much in a given year as those who don’t have Amazon Prime©.
Our Takeaways for the Week
by Shawn Narancich, CFA
Executive Vice President of Research
Early Christmas Gifts
In what turned out to be a surprisingly action-packed week before Christmas, the markets finally shook off the shackles of worry concerning what would happen when the Fed began tapering its program of quantitative easing (QE). Bernanke proved that he’s no lame duck chairman and investors learned that stocks can still go up despite a slightly less accommodative Fed. In reducing monthly purchases of Treasury and mortgage-backed bonds by $10 billion per month, our central bank is acknowledging a slowly improving labor market and an expanding economy that is being boosted by several key drivers: a renaissance in U.S. energy production and manufacturing and, increasingly, the wealth effect of rising house and stock prices that is giving a nice lift to consumer spending. Looking ahead, we expect incoming Fed Chair Janet Yellen to continue what Bernanke started. Our view is that further reductions to QE will be commensurate with continued improvement in labor markets, subject as always to the Fed’s other key mandate—keeping inflation low.
Always a Bear Market Somewhere
In stark contrast to stock prices that are once again setting new highs, gold prices have fallen substantially. After attracting increasing amounts of attention as a hedge against monetary dislocation and unchecked growth in the money supply, gold is increasingly being abandoned by investors now more attracted to robust stock market returns and, for those with a lower risk tolerance, bonds that are now offering real rates of return. From its high in August 2011, gold is now down 36 percent. It may be pretty to look at, but with the Fed now in the early stages of unwinding QE, it has lost its shine.
Blue Burner
Sticking to the commodity theme, one key source of energy whose price is going the opposite direction is natural gas. Much maligned by investors because of its seeming ubiquity, the front-month contract is up 31 percent since August. Cold weather has boosted the demand for natural gas, one of the nation’s most common sources of home heating. Weather vicissitudes aside, we like the longer-term demand case for the cleaner burning fuel to take market share of electricity generation from its dirtier cousin coal. Will gas currently priced for $4.40 per-million-BTUs go to $5.50? In the short-term, probably not, because the prolific shale fields in Pennsylvania, Wyoming and Texas will induce considerably more production if prices continue to rise.
Nevertheless, key suppliers can make a lot of money with natural gas prices in the $4.00 to $5.00 range. More importantly, our economy should increasingly benefit from using low cost natural gas and natural gas liquids to generate cheaper power and manufacture plastics. In the latter case, low cost ethane, propane and butane feedstocks are displacing oil-based naptha, incenting major chemical companies like Dow and the petrochemical arm of Shell to locate plastic manufacturing facilities stateside. The beneficial result for America is new jobs, additional exports, and healthier levels of GDP growth.
In this festive season, we wish all our friends and clients a Merry Christmas and a very happy and healthy new year.
Our Takeaways from the Week
