It’s that time of year again when families across the nation pack their bags and continue the time-honored American tradition of the summer family road trip. No matter where the final destination may be, all families will be confronted with the same inevitable query, “are we there yet?” These days I feel like I’m still in the back seat, except now the Fed is driving my dad’s Chevy Caprice. “Fed Chair Yellen, are we there yet?”
But before we talk about where the Fed is taking us let’s see what happened to risky assets this month. Most were showing a positive return until the final day of the month when global stocks declined the most in almost six months following a strong U.S. GDP number, which increased the likelihood of sooner-rather-than later rate hikes.
- The MSCI World Index, a broad measure of developed world’s stock markets fell 1.67 percent for the month.
- The S&P 500, a measure of large U.S. companies, fell 1.51 percent for the month.
- The MSCI Emerging Market Index, a broad measure of the emerging world’s stock markets, rose 1.43 percent for the month.
- The MSCI REIT Index fell 0.07 percent for the month.
- Gold fell 3.37 percent during the month.
Last week we received evidence that the U.S. economy is likely back on track, as GDP rose at a 4% annualized rate in the second quarter. Economists had expected 3%. To sweeten the pot even further, the first quarter’s winter-inflicted -2.9% reading was revised to -2.1%. It’s still an ugly contraction but we’ll take it. Markets responded to the report with a sharp sell-off in prices, a reaction usually reserved for negative headlines. So what gives? The decline in prices reflected the markets belief that the Fed is behind the curve with respect to policy rate lift-off. In its statement, the Fed finally acknowledged that the U.S. economy is “approaching” its target for both of the Fed’s mandates, to promote maximum employment and keep prices stable. But this left market participants wondering where the Fed draws the finish line on near zero interest rate policy. Unemployment is currently at 6.2%, down from 10% during the financial crisis. That’s right on top of our economy’s average unemployment rate over the last fifty years. The Fed’s main argument for continued accommodation is based upon their belief that inflation is still well below their long-term target of 2%, but recent indicators have shown that we’re probably already there. Last week, second quarter core PCE inflation came in at 2.0%, quarter over quarter. Aren’t we there yet?
Most economists predict a June 2015 lift-off from the Fed. The strong GDP number marginally increased the likelihood of a quicker time frame for policy normalization, but then the July job’s report provided the Fed with some breathing room. The report continued to show improvement in the labor market, but the increase in the unemployment rate to 6.2%, from 6.1%, is a little more consistent with the Fed’s concern that the job market still has some healing to do. I think it’s fair to say that the Fed is behind the curve but will err on the side of too much easy policy until they see upward pressure on wages, not just overall market prices, and continued reduction in the level of long-term unemployment. Their dovish-at-all-cost posture will continue to support equity prices for the foreseeable future, and their willingness to accept higher inflation in the long-run could have dangerous implications for the bond market.
Overall, we believe the positives largely outweigh the negatives. Corporate earnings are at all-time highs (and continue to surprise to the upside), despite lagging top-line growth. Some will point to corporate reliance on financial engineering (i.e. share buybacks and, more recently, tax avoidance activity) to boost earnings results, but we also note that M&A and capital expenditures are on the rise, indicating that corporate managers have an eye towards future growth. The housing market has been disappointing recently but we look forward to a pick-up as payrolls increase and affordability remains high. Furthermore, we are pleased to see that global geopolitical unrest is having minimal effects on financial markets, as the price of crude has dropped approximately 7% in the month of July, amid ongoing concerns in Ukraine, Gaza Strip and Iraq.
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S&P 500 Index
is a composite of 500 companies, amongst the largest based in the United
States, and it often used as a measure of the overall U.S. stock market.
MSCI EMF (Emerging
Markets Free) Index is a free float-adjusted market
capitalization index that is designed to measure equity market performance in
the global emerging markets. As of June 2006 the MSCI Emerging Markets Index
consisted of the following 25 emerging market country indices: Argentina,
Brazil, Chile, China, Colombia, Czech Republic, Egypt, Hungary, India,
Indonesia, Israel, Jordan, Korea, Malaysia, Mexico, Morocco, Pakistan, Peru,
Philippines, Poland, Russia, South Africa, Taiwan, Thailand, and Turkey.
MSCI US REIT Index
is a free float- adjusted market capitalization weighted index that is
comprised of equity REITs that are included in the MSCI US Investable Market
2500 Index, with the exception of specialty equity REITs that do not generate a
majority of their revenue and income from real estate rental and leasing
operations. The index represents approximately 85% of the US REIT universe.
The MSCI World Index
is a free float-adjusted market capitalization weighted index that is designed
to measure the equity market performance of developed markets. The MSCI World
Index consists of the following 24 developed market country indices: Australia,
Austria, Belgium, Canada, Denmark, Finland, France, Germany, Greece, Hong Kong,
Ireland, Israel, Italy, Japan, Netherlands, New Zealand, Norway, Portugal,
Singapore, Spain, Sweden, Switzerland, the United Kingdom, and the United
is the U.S. dollar per Troy ounce.
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