PMC Weekly Review - October 21, 2016

A Macro View – Goldilocks and the three bears: the Election, European Stimulus, and US Interest Rates

As we approach October’s end on the heels of an unseasonably warm fall, many of us are thinking about what lies ahead and the impact it will have on the markets. At the forefront, of course, are the US presidential election, the possibility of a Federal Reserve (Fed) rate hike as early as December, and what (if any) additional stimulus will come from the European Central Bank (ECB). And, just because I like euphemisms, and am in the Halloween spirit, as we prepare for what is sure to be an onslaught of very colorfully and elaborately dressed children on our front lawn in the next two weeks, I present my theme: Goldilocks and the three bears.

Envision the Fed as a sort of Goldilocks, navigating seemingly familiar, but in some ways unchartered and precarious, territory in the wake of a range-bound market, looming inflation, anemic domestic and international growth, and a very visible and public US presidential election cycle that has taken global center stage. No other presidential race in modern times has ever had the type of noise and divide we have experienced thus far in 2016. Debate viewership alone will convince anyone of this, with a record 84 million viewers tuning into the first presidential debate, and 66 million watching the final one on Wednesday night. Even the vice presidential debate drew 37 million viewers—37 million—staggering when one considers that up to a third of Americans cannot name the vice president in office at any given point in time.

Without getting into the nitty gritty of each of the presidential candidates’ proposed policies, suffice it to say that the implications for the stock market will look very different if Trump prevails versus a Clinton regime. A vote for Hillary in many ways will be a vote for the status quo, largely continuing her predecessor’s policies, albeit with some new initiatives, higher taxes, and increased regulation. In this scenario, investors are unlikely to perceive either a threat of, or potential for, significant change, and the market is likely to keep ho-humming along as it has been. In contrast, a vote for Trump will be for a new and much-less-predictable path, and at the very least, it is reasonable to conclude that the uncertainty may carry an increased risk of market volatility.

Across the pond, the ECB contends with the prospect of rising inflation and questions regarding the scope and duration of its quantitative easing. Many wonder how long it can possibly continue, and when the bank will begin to taper. Europe is fraught with many ongoing growth hurdles of its own. In the background, of course, are the struggles of large financial lenders, such as Deutsche Bank. Although Germany seems to have turned its back on the possibility of a bailout, many wonder whether the bank will pull through, as other similarly large and struggling financial institutions (particularly in Italy) watch closely. On Thursday, European equities finished higher after ECB President Draghi hinted of announcing plans in December for additional easing.

So, what is the Fed to do? Although the FOMC will meet in November, no policy changes are expected until at least the December meeting. Given a mixed bag of domestic economic data, a bevy of geopolitical concerns ranging from Brexit, to Russian tensions, and the Italian referendum, the committee must carefully consider the health of the US economy in its rate hike trajectory. Of note this week, initial jobless claims rose to a five-week high of 260,000, from 247,000 the week prior. The Philadelphia Fed Manufacturing Index decreased to 9.7 in October, from 12.8 in September, but remained well above market expectations of 5.3. And, existing home sales beat market expectations, rising 3.2% to 5,470,000 in September, from 5,300,000 the month prior. Corporate earnings season has begun, and despite some misses, several companies are beating expectations, and the dollar’s October rally continues to strengthen on the prospect of a rate increase. With an abundance of factors at play, one thing is certain – the committee has its work cut out for it! For our sake, let’s hope it gets it ‘just right.’

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