A Relatively Dovish Fed Statement
March 23, 2015
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A more dovish-than-expected Fed statement
pushed back expectations for rate increases
and provided a boost to equity prices.
We continue to believe the Fed will begin
increasing rates in 2015.
Global policy remains supportive for equities
and we continue to have a pro-growth
Last week featured some disappointing economic data and further downward
revisions of corporate earnings estimates, but investors focused heavily on last
week’s Federal Reserve policy meeting. The Fed’s statement was more dovish
than expected, and investors interpreted the comments as an indication that
rate increases would not happen as soon as some anticipated. As a result,
the U.S. dollar lost some ground and equities rallied, with the S&P 500 Index
snapping a three-week losing streak to gain 2.7%.1 Health care was the best-performing
sector, while materials was the only area of the market to end the
week in the red.1
We Still Expect Rate Increases Will Begin in 2015
The main headline from the Fed’s statement was the removal of the word “patient”
when discussing the path toward rate increases, but almost every other aspect
signaled no immediate hurry to act. The Fed indicated that it still saw some slack in
the labor market and noted that inflationary pressures remain absent.
Our view is the Fed is reacting to the strong upward trend of the dollar, muted wage
increases and signs that economic growth has become sluggish. Federal Reserve
officials understandably want to retain some flexibility, but we believe rate increases
at some point over the coming months are almost inevitable. Our best guess would
be that the Fed will enact its first rate increase at its September policy meeting,
rather than in June as many had previously anticipated.
Weekly Top Themes
- The manufacturing sector has been struggling. Industrial production increased
at a disappointing 0.1% rate in February, while manufacturing output fell 0.2%.2
Some of the weakness can be attributed to temporary factors such as the harsh
winter weather and the West Coast port strike, but we also believe that the
strength in the dollar has been hurting manufacturing.
- Lower oil prices and the stronger dollar bring both positives and negatives.
Specifically, we believe that while these trends are hurting U.S. corporate
earnings results and expectations, they are also net positives for the U.S. economy.
- We expect several market trends to continue. The months-long themes of
falling commodity prices and a rising U.S. dollar may be taking a break, but
those trends are probably not over. At the same time, we expect equities will outperform bonds in the coming months and European equity strength will
persist in the near-term.
The Global Economy Should Gradually Accelerate, Providing a Tailwind for Stock Prices
It appears the world economy may be at the beginning of a gradual leadership
transition from the U.S. to non-U.S. markets. With the Fed likely to begin
increasing rates later this year, the reflation banner is being passed from the U.S. to
the euro area and Japan. Many emerging market economies should also benefit from
interest rate cuts, but it will take some time before economic growth accelerates.
Reflationary trends have been a critical driver of equity market performance in
recent years and we do not believe that the era of reflation is over. Many central
banks are still in the early stages of easing. In the U.S., Fed policy remains highly
accommodative and even when the Fed finally does begin raising rates, it will be
starting from such a low level that monetary policy should remain supportive for
equities for some time.
Given this backdrop, we continue to believe that equities look attractive and expect
they should benefit from a gradual acceleration in global growth. With commodity
prices likely to remain soft, we tend to prefer commodity users rather than
producers, and have a bias toward the non-commodity cyclical sectors. Over the
coming months, we expect upward pressure on the value of the dollar to continue,
but do not anticipate the dollar’s rise will continue at the same breakneck pace we
have seen in recent months. At the same time, we expect to see a gradual rise in
global bond yields as the Fed approaches the start of interest rate increases.
1 Source: Morningstar Direct, as of 3/20/15
2 Source: Federal Reserve
Last Week's Commentary
Monetary Policy Concerns
Continue to Weigh on Markets
March 16, 2015
Fed policy questions have been driving
volatility in both equity and bond markets.
The rising value of the U.S. dollar has put
pressure on earnings and has contributed
to the market downturn, but ultimately is a
positive for the global economy.
Equity markets should be able to withstand
Fed rate increases, and our pro-growth
investment view remains unchanged.
Investors continued to focus on global monetary policy last week. The
divergence between the start of the European Central Bank’s quantitative
easing program and the pending shift in the Federal Reserve’s policy stance
caused the euro to fall, the U.S. dollar to rally and acted as a drag on U.S.
equities.1 Concerns over a weakening corporate earnings environment acted
as an additional headwind for stock prices. The S&P 500 Index declined 0.8%
for the week.1
Weekly Top Themes
- Retail sales figures declined, but the outlook remains solid. U.S. retail sales fell
for a third consecutive month, dropping 0.6% in February.2 This marks the first
time since 2012 that we have seen a three-month downturn.2 Looking ahead,
we believe a combination of solid employment gains, rising income levels and
improving consumer confidence should provide a boost to spending.
- Last week’s stress test results are a positive sign for the banking sector. All 31
of the largest U.S. banks passed the Federal Reserve's annual regulatory test for
the first time since they were introduced in 2008.3 It has taken nearly eight years,
but in some ways this could be seen as marking an end of the financial crisis that
began in 2007.
- Wage increases appear to be on the horizon. The latest survey from the
National Federation of Independent Business shows that more small businesses
than not are planning to hire workers.4 This trend, combined with the fact that
the unemployment rate has fallen to 5.5%,5 suggests that we should soon see an
uptick in wage inflation.
- Corporate earnings are being buffeted by a number of crosscurrents. Citigroup
Global Capital Markets data shows how the current environment is affecting
earnings. On the negative side, every 10% appreciation of the U.S. dollar
translates into between a 2% and 3% decline in earnings-per-share (ESP) growth
and every 10% drop in oil prices drags down growth by 1%.6 On the positive side,
each 1% increase in gross domestic product growth boosts EPS growth by 4%.6
- A multitude of factors can be blamed for the recent downturn in equity
prices. We would cite a growing belief that the Fed is on the verge of increasing
rates, the beginning of the ECB’s easing program, concerns over Greece’s debt
restructuring, the rising dollar and a weaker earnings environment.
Equities Should Absorb a Shift in Fed Policy
At this point, it seems almost a foregone conclusion that the Fed will begin
increasing rates at some point in 2015. When it does act, we think the Fed will raise
rates slowly and carefully. Even with modest rate increases, monetary policy will
remain at accommodative levels. It is normal to see heightened volatility in advance
of Fed action, and market action is unlikely to deter the Fed absent a more severe
downturn in equities and/or a sharp spike in bond yields.
This pending shift, along with easing elsewhere in the world, has caused the
U.S. dollar to appreciate rapidly. A stronger dollar has some negative effects, but
ultimately is a net positive for the global economy. The sharp increase has hurt
corporate earnings, but should eventually help the U.S. economy since it provides
a boost to consumer spending. At the same time, an appreciating dollar is a plus
for the eurozone, Japan and export-oriented emerging markets and should help
promote a self-reinforcing global recovery.
Uncertainty over exactly when the Fed will act and how fast it will move when it
does so has caused a rise in bond market volatility, and we believe a shift in the fed
funds rate is likely to act as a drag on many areas of the fixed income market. Equity
markets have also been under pressure, but we believe equities should be able to
weather Fed rate increases. Corporate earnings are providing less of a tailwind than
they once were, but improving global economic growth and policy easing elsewhere
in the world should continue to support risk assets. As such, we continue to advocate
a pro-growth investment stance and believe investors should continue to hold
overweight positions in equities.
1 Source: Morningstar Direct and Bloomberg, as of 3/13/15
2 Source: U.S. Commerce Department
3 Source: Federal Reserve
4 Source: NFIB
5 Source: Bureau of Labor Statistics
6 Source: Citigroup Global Capital Markets