Dovish Monetary Policy Signs Push Risk Assets Higher

Key Points

A surprisingly dovish Fed statement helped stock prices rise for a fifth consecutive week.

U.S. economic data continue to improve, although manufacturing levels still need to show a sustained advance.

Over the near-term, we would not be surprised to see some sort of consolidation in equity prices.

The macro backdrop remained positive for risk assets last week. The Federal Reserve issued a surprisingly dovish statement, oil prices continued to climb and the crowded long-dollar trade unwound further. As a result, the S&P 500 Index climbed 1.4% and moved into positive territory for the year.1

Despite Continuing Worries, Equities Continue to Climb
The list of positive factors supporting the U.S. economy and equities has grown over the past several weeks. Oil prices stabilized and the value of the dollar climbed, both of which reversed trends that have put downward pressure on corporate earnings. The Fed’s comments added to the list of positives. The bearish case is that there is a long list of factors that could derail markets, including issues in China, credit concerns, a U.K. exit from the EU or a resumption of the oil down/dollar up trade. That hasn’t happened so far. We do not expect this sort of market advance to continue, but we do believe the U.S. economy is improving and trends are starting to look more positive for corporate earnings.

Weekly Top Themes

1. The Fed dampened expectations for rising rates and suggested only two rate increases were likely in 2016. The Fed made it clear that it is erring on the side of caution. The central bank does not want to make a policy mistake that could derail the recent stabilization in the global financial system by tightening too quickly. We think the next increase will most likely come in June.

2. Manufacturing data are starting to improve. The latest indication of a turnaround comes from the March Philadelphia Fed manufacturing index, which rose to its highest level in more than a year.2 The improvement supports our view that we are starting to move past the weakness in manufacturing.

3. Consumer spending is a source of strength for the economy. The latest retail sales figures from February were disappointing, showing a 0.1% decline.3 Over the past three months, however, sales are up a solid 4.8%.3 In our view, the consumer sector is the healthiest it has been in years. Sentiment is high, savings have increased and Americans are spending at a moderate and sustainable pace.

4. Inflation appears to be slowly rising. Year-over-year core CPI rose to 2.3% in February and is up 3.0% on a three-month basis.4 Some of the increase may be transitory, but it shows that labor market tightening, the oil recovery and dollar stabilization are finally pushing prices higher.

5. We think the odds of a U.S. recession are extremely low. Interest rates and inflation are low and the labor market and consumer sector appear quite healthy. We expect a continued moderate advance in U.S. gross domestic product unless some sort of global crisis materializes.

Have Stock Prices Risen Too Far Too Fast?
Equities and other risk assets began the year in a near free-fall, but conditions have since turned around sharply. One of the main changes since mid-February is additional support from central banks.The European Central Bank and Bank of Japan both promised more easing measures, Chinese policymakers are focused on increasing clarity and the Fed lowered its expected path of rate increases. At the same time, the rising price of oil and falling value of the U.S. dollar have removed some risk from the global financial markets.

Despite these improvements, we remain cautious about the near-term. We think
it is more likely than not that stock prices will advance over the coming year, but we also believe markets may be overdue for a pause and some sort of consolidation. The recent rebound appears to be largely driven by short covering rather than new long positions, and investor confidence remains fragile. In other words, it won’t take much for markets to experience another downturn.

Looking ahead, we think we still need to see some stronger economic data before investor unease diminishes enough to allow for a widespread reentry into equities. Our key data point for us is the U.S. ISM Manufacturing Index, which remains below the key 50 level.5 A move above 50 would go a long way toward providing evidence that the U.S. economy is moving into a higher gear.

1 Source: Morningstar Direct, as of 3/18/16
2 Source: Federal Reserve Bank of Philadelphia
3 Source: Commerce Department
4 Source: Labor Department
5 Source: Institute of Supply Management

The S&P 500 Index is a capitalization-weighted index of 500 stocks designed to measure the performance of the broad domestic economy. The Dow Jones Industrial Average is a price-weighted average of 30 significant stocks traded on the New York Stock Exchange and the Nasdaq. The Nasdaq Composite is a stock market index of the common stocks and similar securities listed on the NASDAQ stock market. FTSE 100 Index is a capitalization-weighted index of the 100 most highly capitalized companies traded on the London Stock Exchange. Deutsche Borse AG German Stock Index (DAX Index) is a total return index of 30 selected German blue chip stocks traded on the Frankfurt Stock Exchange. Nikkei 225 Index is a price-weighted average of 225 top-rated Japanese companies listed in the First Section of the Tokyo Stock Exchange. Hong Kong Hang Seng Index is a free-float capitalization-weighted index of selection of companies from the Stock Exchange of Hong Kong. Shanghai Stock Exchange Composite is a capitalization-weighted index that tracks the daily price performance of all A-shares and B-shares listed on the Shanghai Stock Exchange. MSCI EAFE Index is a free float-adjusted market capitalization weighted index designed to measure developed market equity performance, excluding the U.S. and Canada. The MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance of emerging markets. Barclays U.S. Aggregate Bond Index covers the U.S. investment grade fixed rate bond market. The BofA Merrill Lynch 3-Month U.S. Treasury Bill Index is an unmanaged market index of U.S. Treasury securities maturing in 90 days that assumes reinvestment of all income.


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