The Dynasty Economic & Market Outlook: Volatility is the New Black
Topics for discussion
- Economic Outlook – “It’s a Mad Mad Mad Mad World”
- Market Outlook – “Volatility is the New Black”
- Building “All Weather” Portfolios
Economic Outlook: “It’s a Mad Mad Mad Mad World”
Divergence is the new kid in town
Yield curve getting flatter…
USD finally behaving as we expected
The fiscal vs. monetary tug-of -war
US economy gaining speed
Wage inflation starting to kick in
Some signs of economic “decoupling”
Global economy remains positive
Labor squeeze = wage inflation
The numbers behind the number
Inflation rising slowly but surely
Sentiment high and improving
Euro area starting to decelerate
Japan and China ok, but slowing
Divergence between oil and other commodities
How we see the world…
The word for the current state of affairs is desynchronization:
- The consensus estimate for Q2 GDP growth in the US is a sizzling 3.6%. GDP growth is expected to remain strong but decelerate through Q3 (3.0%) and Q4 (2.9%); (source: The Wall Street Journal);
- There remains some uncertainty regarding this forecast, however, as the outcome of ongoing trade negotiations could change the economic outlook for the US over the remainder of the year;
- Specifically, current trade negotiations seem to be taking a protectionist-leaning turn for the worst, which has already resulted in retaliation policies that will affect both inflation and global growth. Of specific concern are agricultural products, including soy beans, which are a major source of exports to China;
- Politically, these policies affect many of the voters who helped propel Donald Trump into office. We can expect that Congress people and Senators from states most affected by increased tariffs will increasingly speak out against current policy;
- Both the US manufacturing and services sectors remain well in expansionary mode (58.7 and 58.6 in May, respectively; any reading above 50 is considered expansionary), and after several month-overmonth declines seem to be accelerating again;
- The manufacturing index has been in expansionary territory for 109 consecutive months, while the non-manufacturing index notched its 100th consecutive expansionary month (source: Institute for Supply Management);
- Inflation (as measured by CPI) rose 2.8% year-over-year in May, slightly above market expectations, driven largely by increases in gasoline and housing costs;
- The Personal Consumption Expenditure (PCE) index – which is the Fed’s preferred measure of overall inflation, increased 2% year-overyear in May, in line with the Fed target rate (source: TradingEconomics);
- We continue to believe that inflation will tick up over the rest of this year, but that it does not yet constitute a primary risk to economic growth. Further, we continue to believe the Fed will allow inflation to run slightly “hot” before stepping in more aggressively;
- After raising rates (as expected) in mid-June, the consensus estimates are that the Fed will raise rates at least two more times in 2018. This may change depending on what unfolds with the outcome of current trade negotiations – a negative turn of events may slow down the planned steady tightening initiatives;
- After a sharp decline in yields in late May due to the Italian political crisis, interest rates continued their “grind higher” path through most of June, before dropping yet again toward month-end as trade war fears swept the market. The 10-year Treasury yield is once again below the mental barrier level of 3%, currently trading at approximately 2.9%;
- We maintain our outlook that rates in the US generally will inch steadily higher, with periodic reversals during market disruptions;
Market Outlook: “Volatility is the New Black”
Tax reform driving share buybacks
But CAPEX and dividends also improving
But companies just doing what shareholders prefer
But is the bloom coming off the rose for financial engineering?
Mixed signals on valuations
Non-US valuations look more attractive, but risks are higher
Earnings are solid, but expected to decelerate in Q3 or Q4
And banks are lending again
Non-US earnings positive, but below US
Momentum still in your favor
Spreads are tight, but so are defaults
Spreads widening, rare risk regime
Remains a rough year for yield hunters
Ex-oil, mixed bag for “real assets”
But “valuations” look ok
Modest year for most HF strategies
Liquids alts not delivering, so far
Building “All Weather” Portfolios
Reminder: no free lunch anymore
Are you being adequately rewarded?
Who you gonna call?
Not very many anti -volatility tools
How we see things…
- The global economy continues to expand, though there is a “desynchronization” of growth. The US economy appears to be accelerating as the full effects of regulatory and tax reform work their way through the system. At the same time, the rest of the world appears to be decelerating – still expansionary, but slowing down;
- We believe going forward that an expanding US economy, rising inflation rates, continued tightening of Fed policy, and strong investment flows will further strengthen the dollar;
- Inflation is trending higher, but we maintain our belief that it (as of yet) does not represent a problem for continued economic expansion. Wages finally are starting to increase, though slowly, as there currently are more job openings in the US than qualified workers to fill them;
- Outside the US, inflation simply is not a problem, despite rising oil prices. We also maintain our belief that the Fed is inclined to let inflation “run hot” before stepping in;
- In the US, tax and regulatory reform currently are trumping (pun fully intended) monetary tightening. Adding stimulatory fat to an already raging economic fire remains an unknown with respect to the longer term impact on deficits and inflation.
- We continue to believe this is at least a contributing factor to ongoing market uncertainty and volatility;
- Solid US GDP growth, and solid earnings and revenue growth, make for a generally positive market environment, and we still think stocks will end the year higher than where they began. However, decelerating earnings growth and rising interest rates will most likely combine to push valuations down and volatility up;
- Market volatility will also be affected by what seems to be a continuing series of geopolitical events. The most current (and probably the most feared) is the ongoing trade tensions.
Boring but true: diversification and compounding work
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