Monday Morning Minute 050817
WASHINGTON CROSSING ADVISORS
THE WEEK AHEAD
Friday’s inflation data should underscore slow-but-positive growth with slower pace for rate hikes.
The market will get the latest inflation numbers on Friday which should show only a modest increase in consumer prices. Continuation of low underlying inflation bolsters the Federal Reserve’s case to maintain low interest rates. In turn, lower interest rates provide some near-term tonic to the economy through easier terms of financing and support for asset prices. Under a regime of very low inflation and interest rates, the value of future cash flow streams on real estate, equities, and other assets is improved. Unless a recession threatens the level of those cash flow streams, investors should continue to benefit from owning equities all else being equal.
Economists expect headline consumer prices to advance 2.3% over the prior year, but the bond market is pricing in less prospective inflation. The chart below shows the inflation rate priced into 10-year U.S. Inflation Indexed Treasury bonds. As the “reflation trade” of late 2016 fades, the market is backing away from expectations of significantly higher inflation (chart, below). Signs of moderation in China and greater uncertainty over a sizable late-cycle fiscal push in the U.S. take some of the steam out of expectations for higher inflation and interest rates. Fading uncertainty over inflation can also be seen in the slope of the yield curve as the yield spread between 3-month Treasury Bills and 10-year Treasury bonds now stands at 1.45% (145 basis points) versus 2.10% (210 basis points) in December.
To the extent slow-but-positive growth persists without inflation, this may deliver the least amount of uncertainty to markets. Last week, as expected, the Federal Reserve chose to pass on raising rates. They largely dismissed weak first quarter growth as an anomaly (rightly, we think), and implied they continue with their intention to raise rates slowly (perhaps June). They also buy some time in communicating with markets their plans for reducing their $4.5 trillion balance sheet.
Lastly, the passage of the French elections removes another uncertainty for markets. Mainstream politician Emmanuel Macron’s election over populist contender Marine Le Pen signals greatly diminished odds France would follow the UK’s lead in leaving the European Union. Fading risk of “Frexit” is a positive for multinationals that have a large presence in Europe.
We continue to see data that suggests low near-term recession probabilities and continued growth. This supports the case for equities in a slow-growth / low-rate environment.
ECONOMIC DATA THIS WEEK
|Monday, May 8:||No Economic Data|
|Tuesday, May 9:||JOLTS||Mar||—||5.743 M|
|Wednesday, May 10:||Import Price Index M/M||Apr||0.2%||-0.2%|
|Import Price Index Y/Y||Apr||—||4.2%|
|Export Price Index M/M||Apr||—||0.2%|
|Export Price Index Y/Y||Apr||—||3.6%|
|Treasury Budget Statement||Apr||—||-$176.2 B|
|Thursday, May 11:||Weekly Jobless Claims||May 6||—||238 K|
|PPI Final Demand M/M||Apr||0.2%||-0.1%|
|PPI Ex Food & Energy M/M||Apr||0.2%||0.0%|
|PPI Ex Food, Energy & Trade M/M||Apr||—||0.1%|
|PPI Final Demand Y/Y||Apr||—||2.3%|
|PPI Ex Food & Energy Y/Y||Apr||—||1.6%|
|PPI Ex Food, Energy & Trade Y/Y||Apr||—||1.7%|
|Friday, May 12:||CPI M/M||Apr||0.3%||-0.3%|
|CPI Ex Food & Energy M/M||Apr||0.2%||-0.1%|
|CPI Ex Food & Energy Y/Y||Apr||—||2.0%|
|Retail Sales M/M||Apr||0.6%||-0.2%|
|Retail Sales Ex Auto M/M||Apr||0.6%||0.0%|
|Retail Sales Ex Auto & Gas M/M||Apr||—||0.1%|
ASSET ALLOCATION PORTFOLIO POSTURE
Based on our long-run capital market expectations, the “core” equity allocation in portfolios are underweight foreign equities / overweight large cap domestic growth, and underweight REITs / overweight Gold. The “core” bond allocation is underweight long-term Treasuries / overweight corporate high-yield bonds.
Based on shorter-term expectations, the “tactical” allocation within portfolios is underweight bonds / overweight stocks.
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Kevin Caron, CFA, Senior Portfolio Manager
Chad Morganlander, Senior Portfolio Manager
Matthew Battipaglia, Portfolio Manager
WCA Fundamental Conditions Barometer Description: We regularly assess changes in fundamental conditions to help guide near-term asset allocation decisions. The analysis incorporates approximately 30 forward-looking indicators in categories ranging from Credit and Capital Markets to U.S. Economic Conditions and Foreign Conditions. From each category of data, we create three diffusion-style sub-indices that measure the trends in the underlying data. Sustained improvement that is spread across a wide variety of observations will produce index readings above 50 (potentially favoring stocks), while readings below 50 would indicate potential deterioration (potentially favoring bonds). The WCA Fundamental Conditions Index combines the three underlying categories into a single summary measure. This measure can be thought of as a “barometer” for changes in fundamental conditions.
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