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.”
This week, Portland residents braved the cold to venture outside and watch snow blanket the city. In contrast, January's inflation data was seemingly the opposite, rising higher month-over-month and year-over-year. While the snowfall might have been a pleasant surprise for some Oregonians, this inflation data was anything but for most investors and consumers.
Since the release of the Consumer Price Index (CPI) on July 11, the stock market has experienced a noticeable shift in leadership as the inflation rate continues to move toward the Fed’s target of 2%. Investors have been moving away from technology stocks, which have been the darlings of the market this year, towards small-cap and value stocks.
At Ferguson Wellman, we are nearing the end of our Mid-Year Update events season, where we present updates to our yearly Investment Outlook and deepen our connections with clients and the community.
One year ago this week, the Federal Reserve raised interest rates for the first time since the pandemic began. After two years of holding rates near zero, this first hike to combat rising inflation only raised the policy rate by a mere 0.25%.
The hotter-than-expected August Consumer Price Index (CPI) data released this week was a shock to financial markets, as other recent measures had suggested a moderation of inflationary pressures. While there is clear evidence that energy and gasoline costs have declined since earlier this summer, broad-based increases observed in major categories like food (14% of CPI) and shelter (32% of CPI) reinforce that significant and upward price momentum remains intact.
On Tuesday this week, inflation data as measured by the consumer price index (CPI) for the month of March was reported at 2.6 percent. This year-over-year inflation reading was significantly higher than it had been trending over the past few months.
Inflation expectations are rising. Next month, we begin to lap the extraordinarily low inflation measured last year when the pandemic triggered a dramatic reduction of demand for both goods and services globally. Upcoming reports may be elevated when compared to last year’s weak results and we may see 3 to 4 percent increases in inflation this spring.
by Brad Houle, CFA
Executive Vice President
In Europe there are now more than $4 trillion in bonds that have a negative yield, a number which is about 15 percent of the global bond market. The countries of Germany, Switzerland, Sweden, Finland and the Netherlands are all unfortunate members of this club for at least part of their respective yield curves. What this means is investors are paying a government such as Germany for the privilege of loaning them money. This is contrary to the concept of compound interest or the time value of money. In the investment profession we do not use the word "guarantee" as it can cause trouble with our chief compliance officer or possibly the SEC. However, with negative yielding bonds you are all but guaranteed to lose money except in the circumstance where the yield on the bond goes more negative. In this instance you can then sell the bond for more than you paid for it earning a small profit. This is a flimsy investment thesis at best.
Bond yields in Europe are negative for fear of falling inflation and the fact that the European Central Bank is purchasing large quantities of sovereign debt in an effort to hopefully stimulate the economy. All of this begs the question: who is buying these bonds with negative interest rates and why? Some bond managers are forced to buy negative yielding bonds due to flows of funds into the mutual funds they manage. For example, if the bond manager is managing an index fund that replicates the debt markets of countries experiencing negative yields and receives cash deposited in the fund, the manager is forced to invest in bonds in markets that are outlined in the prospectus of the fund. In addition, many investors are restricted to investing in very narrow slices of the bond market. Owning sovereign debt is important to banks due to regulatory capital requirements. This means that banks need to own high quality assets as part of their capital in order to makes loans to customers. For instance, it’s likely that a bank in Germany will need to own negative yielding German government bonds as capital.
The long-term implications of negative yields are unknown. This phenomenon has been exceedingly rare in history and has never been this widespread. We have received questions from clients as to the chances of this happening in the United States. Short-term treasury bills did go negative for a time during the financial crisis in 2008; however, we do not believe that we will see negative interest rates in the United States anytime soon. While it is possible, the U.S. has inflation of 1.6 percent, as measured by the Consumer Price Index last month, and the U.S. also has GDP growth of 2.2 percent. These facts would suggest higher interest rates as opposed to negative interest rates.
Our Takeaways for the Week:
by Shawn Narancich, CFA
Executive Vice President of Research
A good indicator of financial markets adjusting to a slower rate of news flow is the frequency with which the same stories are replayed and debated in the financial press and on television. With retailers now wrapping up second quarter earnings season, Wall Street strategists and commentators have resorted to debating ad nauseum what will happen to short-term interest rates once the Fed ends its program of quantitative easing. Minutes of the latest Fed meeting this week revealed that the Fed will remain data dependent, letting incoming economic reports and anecdotal Beige Book reports tell the story of progress for the economy in general and for the labor markets and inflation in particular.
On the latter topic, policy makers received reassurance this week that inflation is not presently a problem, as headline CPI numbers came in spot-on with the Fed’s 2.0 percent target. Tame inflation indicates that labor markets, absent select areas in energy and manufacturing, still contain the sufficient slack necessary to boost output without spurring a wage spiral. As the old saw says, time will tell. In the meantime, investors seem to be tuning out the chatter as they bid equities to new record highs.
Like Sands Through the Hour Glass. . .
Believe it or not, we’re now halfway through the third quarter and, once again, the error of estimates appears to be on the downside with regard to economic growth forecasts. While this week’s housing statistics were encouraging, with July new housing starts up 16 percent sequentially, a key fly in the ointment was last week’s retail sales report, which came in flat with June numbers and continued a disappointing trend of sequentially slowing retail sales since May. At a time when international headwinds are increasing thanks to Europe teetering just above stall speed and China continuing to undergo a growth-slowing transition away from excessive investment, our forecast for 3 percent GDP growth domestically is starting to feel just a bit optimistic.
Ka-Ching!
As tempting as it might have been to write-off last week’s poor retail sales report as a statistical anomaly when juxtaposed against increasingly positive employment numbers, considerable anecdotal evidence from retailers reporting fiscal second quarter numbers affirms the data. Two key bellwethers of American retailing – Wal-Mart and Target – both reported earnings declines on moribund U.S. sales, and investors have consistently overestimated the companies’ earnings power over the past six months. In addition, Macy’s surprised investors by uncharacteristically missing numbers and lowering sales guidance. Alas, this week brought some better news on the retailing front, with Home Depot reporting strong sales and earnings coupled with a boost to their full year earnings forecast. In contrast to the drubbing that Macy’s took, stock of the home improvement leader broke out to new all-time highs. Similarly, off-price merchandisers T.J. Maxx and Ross Stores both outperformed Wall Street expectations and were accordingly rewarded by investors. With retail earnings reports nearly wrapped up for the quarter, we observe that results are hit and miss, and that investors are best served to take a rifle shot approach to owning specific names advantaged by key trends in retail.
Our Takeaways from the Week
