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.”
Jerome Powell has the most difficult job in America. The Fed Chairman and the Federal Reserve Open Market Committee are tasked with lowering inflation and they primarily have only one blunt tool to accomplish this goal, adjusting interest rates.
Earlier this week, the Federal Reserve raised its benchmark interest rate to 1.75%, an increase of 0.75% from the previous rate. This increase, the largest since 1994, was considered a possibility, albeit one the market hadn’t fully discounted.
Earlier this week, my family and I were out to dinner when we saw a sign on the front door of the restaurant that read: “Being short staffed is the new pandemic… Thank you for your patience with us.” While we are familiar with the standard “help wanted” signs, specifically in the service sectors industry, you may have noticed a recent addition to these signs: signing bonuses.
Investors anticipating Fed rate cuts in the months ahead have become inversely sensitized to economic news supporting continued economic expansion. Last week’s surprisingly tepid payroll report and today’s reassuring read on U.S. retail sales resulted in opposing stock price reactions.
by Jason Norris, CFAExecutive Vice President of Research
Good News First
The jobs market continues to chug along adding 215,000 jobs in the month of July with upward revisions to June and May of 14,000. While this is a solid pace of gains, it hasn’t been strong enough to push wages higher.
Equity markets, on the other hand, have struggled the last several sessions, despite favorable earnings reports. We have seen the major declines in profits in the energy sector; however, the rest of the economy seems to doing well. With just under 90 percent of companies in the S&P 500 reporting second quarter earnings, year-over-year profit growth could very well be negative 1 percent. While nothing to write home about, the main culprit has been the energy sector. Energy earnings are going to be down close to 60 percent year-over-year. If you back out the energy sector, earnings for the rest of the market will be up 5 percent year-over-year. Healthcare, consumer discretionary and financials have led the way higher. We recommend that investors don’t get caught up in the headline numbers, especially now that one sector is having such a major impact on the overall number.
The price of oil won’t necessarily be helping out the energy sector in the third quarter. With WTI at $44, it is close to its March lows. We moved to an overweight in the energy sector six months ago with the belief that as prices fell, demand would increase and supply would decline. What surprised us was the supply side. While rig count has declined by 60 percent domestically, U.S. supply has been somewhat slow to respond to reduced drilling activity. Nevertheless, U.S. supply has peaked and should decline into the second half of the year. We contrast the ex-growth situation domestically with OPEC, where key producers Saudi Arabia and Iraq have combined to boost cartel volumes by 6 percent so far this year. Aside from flattened production domestically and OPEC’s production growth this year, the key to our call for higher oil prices is stronger than commonly perceived demand growth and production from non-U.S., non-OPEC regions around the world. Despite oil prices that reached $140/barrel in 2008, this key source of global supply has failed to deliver any additional production over the past eight years. Our bet is that if additional volumes weren’t forthcoming in more propitious times, this key source of approximately 54 million barrels/day of supply is likely declining at currently depressed prices. Therefore, it will increasingly help to balance the market. We still believe oil will be closer to $70 then $40 at year-end and are focusing on companies with strong balance sheets to weather this near-term storm.
Only a Matter of Time
Recent economic data has not been conducive to a September Fed rate hike. While the unemployment rate at 5.3 percent is a positive sign, coupled with weekly jobless claims at historic lows, there is still a lot of slack in the labor market. There are currently over 5 million jobs that are available, which is an all-time high. While this data signals a tight labor market, the unemployment rate figure does not. Also, wages aren’t increasing at a rate that is a threat to inflation. Earlier this week, the Employment Cost Index showed only a 2 percent increase in labor costs, which comprised 2.1 percent in wages and 1.8 percent in benefits. Today’s jobs report confirmed this with hourly wages rising only 2.1 percent.
We believe a Fed rate hike will happen before the end of the year. Given current data trends, whether it is September or December is a toss-up. We have seen and read about indications that the Fed wants to start the process; however, we believe the data is still signaling uncertainty.
Our Takeaways for the Week
by Jason Norris, CFAExecutive Vice President of Research
Volatility in the second quarter reigned in both equity and bond markets. Interest rates rose close to half-of-a–percent, resulting in negative returns for bonds. While U.S. equities were volatile, they ended the quarter relatively flat. International markets were roiled in June with China equities moving into bear market territory following a parabolic run and as for Greece…
In the face of this uncertainty, we are still constructive on equities for the back half of 2015. The U.S. economy is slowly improving. Excluding energy, corporate profits should still exhibit high single-digit growth and equities are still relatively inexpensive. Therefore, with the Fed set to raise interest rates later this year, bonds will continue to face a headwind, thus equities warrant an overweight versus fixed income.
While headlines reported a healthy increase of 223,000 new jobs in the month of June, analyst expectations were a bit higher. Also, previous reports were revised lower and the labor participation rate declined, which resulted in a lower unemployment rate of 5.3 percent, which is a seven year low.
One of the major disconnects in the job market is that there are close to 5.4 million job openings currently in the U.S. This is the highest level we’ve seen since January of 2001. We believe this will provide a tailwind throughout 2015 in the labor market.
There are a lot of mixed data in Thursday’s report that can help us assess if it’s too hot, too cold, or just right. Therefore we do believe that our call that the Fed will raise rates later this year has not changed.
Grexit, Greferendum, Grapituation and Gratigue
Frankie Valli sang it best in 1978, “Grease is the word.” After missing a payment to the IMF on June 30, Greece headlines have rattled markets in the last few weeks and that volatility are here to stay with the possibility of a pending referendum on July 5 and a debt payment due to the ECB July 20. The key issue we are focusing on include whether or not the Greek contagion will affect other nations in southern Europe. Whether we have yet to see if the Germans will let the Greeks leave the Eurozone or if they will be “hopelessly devoted.” What has changed since 2010 is that Greek debt is now held by government agencies, such as the IMF and ECB, not banks. In 2010, 140 billion euros of Greek debt was held by global banks, with over 100 billion of that amount being held by European banks. The amount held by banks has dropped by over 100 billion with the European banks, on the hook for less than 20 billion.*
We don’t want to handicap the pending referendum (on whether vote for or against austerity) by the Greek people and current polls show a dead heat. What we do believe is that volatility will continue in July, fueled by Greece and earnings season; however, by year-end this Greek drama will be in the rear-view mirror.
Our Takeaways for the Week
*Euro to US Dollar exchange rate was +0.13367 percent at time of publication.
