PMC Weekly Review – February 19, 2019
A Macro View – Robbing Peter to Pay Paul?
Following one of the most difficult Decembers in recent years for equity markets, investors surely are pleased to see 2019 begin with a rally in risk assets. One of the key factors fueling this risk appetite is the recent shift in the Federal Reserve’s (the Fed) tone on monetary policy. Following its January meeting, the Fed announced it will be patient as it determines future adjustments to the federal funds rate, and flexible with the pace of its balance sheet runoff. Investors keyed in on the word “patient” as an indication additional rate hikes may be off the table for now, and this dovish pivot in tone bolstered risk assets even as expectations for US and global growth have moderated.
However, with policy tools still limited following the Great Recession, it is worth pondering whether the Fed may be sacrificing ammunition to combat the next recession in order to help prolong the current economic cycle. If, in fact, the current federal funds rate (2.25%-2.50%) is the terminal level of this cycle, the Fed will have far less slack to cut rates when stimulus is needed than it has in past recessions. Furthermore, with the balance sheet runoff following quantitative easing (QE) only 15 months underway, and speculation that the passive runoff could end later this year with nearly $4 trillion still on the balance sheet, it could limit the effectiveness of another QE stimulus package in the future. The price of this decision could ultimately be a longer and deeper recession in the next economic downturn.
One may look to Europe as an example of the predicament in which a central bank can find itself: a slowing economy with limited stimulus tools at its disposal. Although the European Central Bank (ECB) terminated its QE program at the end of last year, it originally had planned to begin raising interest rates shortly thereafter, by as early as midyear. However, slowing economic growth across the continent almost certainly will prevent this from happening. Last month, the ECB said risks to the Eurozone's economic outlook had shifted to the downside, while the European Commission slashed its outlook for growth across the region last week. Brexit also remains an uncertainty, with the likelihood of a no-deal Brexit increasing as March grows closer on the calendar. Just last Thursday, the Bank of England forecast 2019 UK gross domestic product would grow at the slowest pace since 2009. With policy rates still in negative territory, and having all but run out of bonds to buy as part of its QE program, the ECB will be extremely challenged to stimulate growth and inflation if the trajectory of the continent continues to head toward a recession.
Fortunately, on this side of the pond, the economic outlook is measurably stronger despite a moderating pace of GDP growth. Perhaps most importantly, consumers, who account for nearly 70% of US GDP, continue to be supported by low unemployment and the strongest wage growth since 2005. The old adage that business cycles do not die of old age remains true, and stimulative factors, such as a trade deal between the US and China and corporate capital expenditures, certainly could serve to extend the current cycle. Of course, no one can predict precisely when the next recession will hit, so perhaps as this cycle continues to mature, it’s prudent for investors to focus a bit more on quality and liquidity, while maintaining a diversified portfolio designed to meet long-term goals.
David Hawal, CFA
VP, Senior Investment Analyst
The information, analysis, and opinions expressed herein are for general and educational purposes only. Nothing contained in this weekly review is intended to constitute legal, tax, accounting, securities, or investment advice, nor an opinion regarding the appropriateness of any investment, nor a solicitation of any type. All investments carry a certain risk, and there is no assurance that an investment will provide positive performance over any period of time. An investor may experience loss of principal. Investment decisions should always be made based on the investor’s specific financial needs and objectives, goals, time horizon, and risk tolerance. The asset classes and/or investment strategies described may not be suitable for all investors and investors should consult with an investment advisor to determine the appropriate investment strategy. Past performance is not indicative of future results.
Information obtained from third party sources are believed to be reliable but not guaranteed. Envestnet|PMC™ makes no representation regarding the accuracy or completeness of information provided herein. All opinions and views constitute our judgments as of the date of writing and are subject to change at any time without notice.
Investments in smaller companies carry greater risk than is customarily associated with larger companies for various reasons such as volatility of earnings and prospects, higher failure rates, and limited markets, product lines or financial resources. Investing overseas involves special risks, including the volatility of currency exchange rates and, in some cases, limited geographic focus, political and economic instability, and relatively illiquid markets. Income (bond) securities are subject to interest rate risk, which is the risk that debt securities in a portfolio will decline in value because of increases in market interest rates. Exchange Traded Funds (ETFs) are subject to risks similar to those of stocks, such as market risk. Investing in ETFs may bear indirect fees and expenses charged by ETFs in addition to its direct fees and expenses, as well as indirectly bearing the principal risks of those ETFs. ETFs may trade at a discount to their net asset value and are subject to the market fluctuations of their underlying investments. Investing in commodities can be volatile and can suffer from periods of prolonged decline in value and may not be suitable for all investors. Index Performance is presented for illustrative purposes only and does not represent the performance of any specific investment product or portfolio. An investment cannot be made directly into an index.
Alternative Investments may have complex terms and features that are not easily understood and are not suitable for all investors. You should conduct your own due diligence to ensure you understand the features of the product before investing. Alternative investment strategies may employ a variety of hedging techniques and non-traditional instruments such as inverse and leveraged products. Certain hedging techniques include matched combinations that neutralize or offset individual risks such as merger arbitrage, long/short equity, convertible bond arbitrage and fixed-income arbitrage. Leveraged products are those that employ financial derivatives and debt to try to achieve a multiple (for example two or three times) of the return or inverse return of a stated index or benchmark over the course of a single day. Inverse products utilize short selling, derivatives trading, and other leveraged investment techniques, such as futures trading to achieve their objectives, mainly to track the inverse of their benchmarks. As with all investments, there is no assurance that any investment strategies will achieve their objectives or protect against losses.
Neither Envestnet, Envestnet|PMC™ nor its representatives render tax, accounting or legal advice. Any tax statements contained herein are not intended or written to be used, and cannot be used, for the purpose of avoiding U.S. federal, state, or local tax penalties. Taxpayers should always seek advice based on their own particular circumstances from an independent tax advisor.
© 2019 Envestnet. All rights reserved.