Overview
Valuation, schmaluation. In spite of rather expensive pricing in U.S. markets (in both stocks and bonds) and very tepid growth in economic profits, the mood has remained reasonably positive for stocks. However, some caution has emerged in fixed-income instruments, as treasury yields have risen on concerns that higher wages and commodity prices, as well as a narrowing of the output gap, may finally translate into inflation. As we write this, we are also seeing a bit of nervousness in junk bonds and even some stocks, though hardly an earth-shattering amount so far.
Abroad, developed and emerging-market (EM) central banks remain quite stimulative, and earnings are growing strongly. This has translated into robust stock price gains in places like EMs, Japan and Europe.
North America
Tony M. Caxide, CFA®
Chairman - Senior Investment Council
U.S. growth continues to hover near 2%, even as recent data has been buffeted (first down, then up) by hurricanes and inventory accumulation. Meanwhile, inflation remains well-behaved, even as several of our compass needles point to a higher pace of wage growth.
If one looks at just the facts, our central bank and its departing chair, Janet Yellen, have delivered an enviable combination of sustainable growth – one of the longest recoveries since the Civil War – while holding inflation near 1 to 2% and driving unemployment from 10% at the depths of the Great Recession to a current adjusted level of 4% to 5%. Quite an achievement, really.
We will soon have a new Fed chair (Jerome Powell), who’s a lot like the old chair. He may prove to be another successful consensus-builder, though less of a leader, given his training as an attorney rather than a macroeconomic economist. His main job, in our financial-markets-obsessed view, is to maintain both the discipline and independence of this hallowed institution and ensure no hollowing is permitted by the political body.
Japan
Jeffrey G. Wilkins,
Deputy Chief Investment Officer
Many economic and leading indicators in Japan continue to suggest that the recent surge in corporate earnings may continue. PMI services, consumer confidence, and the eco watchers indices all showed good numbers for October and recent trends. These positive indicators in the context of a relatively weak and stable yen and a clear voter mandate for the current administration may point to continued gains for Japanese corporations. Similar to other developed markets, these gains have yet to translate into higher wages for Japanese workers, which is keeping a lid on inflation despite tight labor markets.
Europe
Srinath Sampath, CFA®, PhD
Managing Director, Portfolio Management
In October, the ECB extended the European Quantitative Easing program to run through next September, with monthly bond purchases of €30 billion in 2018 – half the current level. ECB President Mario Draghi also indicated that lending rates are expected to stay at current levels throughout this period, and he left the door open for enhancements and extensions to the program. In addition to – and partly due to – these favorable monetary conditions, continental Europe is experiencing a period of robust industrial production, retail sales and car registrations. For the first time since the global financial crisis, unemployment has ticked down below 9%, and confidence indicators continue to rise. Core inflation, while underwhelming at 0.8% against the ECB target of “below but close to 2%,” supports the ECB plan to continue applying monetary stimulus to the economy.
UK
Jeff (Shengde) Liu, CFA®
Managing Director, Portfolio Management
The Bank of England (BoE) raised its benchmark interest rate by 25 bps. The move is primarily out of concern for UK inflation, which is running near 3% – above the BoE’s target of 2.5%. If inflation does not rise farther, it is unlikely that the central bank will raise the rate again in the near term. With Brexit still hanging over the economy, several leading indicators are turning “weak-ish.” Although home prices are rising at a healthy clip, construction PMI and construction output weakened. Further, the service sector is well off its 2015 peak and car sales growth turned negative. On the bright side, the industrial sector remains healthy and trade balance has improved thanks to the collapse of the pound.
Emerging Markets
Jeff (Shengde) Liu, CFA®
Managing Director, Portfolio Management
EM earnings continue to improve, mainly driven by rising commodities prices. Major exporters also gained from the increasing demand from the global recovery. The big uncertainty is now China. Its corporate debt surged to 159% of GDP in 2016, compared with 104% 10 years ago, while overall borrowing climbed to 260% of GDP. More and more signs suggest that China is intensifying deleveraging and environmental/pollution control after the Party’s Congress, just held in October. The new policy is to focus on “quality growth” rather than “fast growth.” The question rests on how the government cracks this issue and whether there will be a so-called “beautiful deleveraging,” to quote Ray Dalio. This has important implications for commodities prices and the trade of resource-oriented EM countries. China represents half of EM total GDP and is a major EM trade partner.