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A logical tilt toward tighter policy :
As expected, the Federal Reserve raised the federal funds rate by 0.25% today to a range of 1.50% to 1.75%. While the Fed still expects to raise rates three times in total in 2018, in most other respects its forecasts are getting more hawkish. In particular:
It boosted the number of rate hikes expected for 2019 to three from two,
It only just fell short of predicting four rate hikes in 2018: in December, 12 out of 16 participants expected less than four rate hikes; in March, it was just 8 out of 15.
It raised its forecasts of GDP growth and inflation and cut its estimates of the unemployment rate,
And, while noting that “…growth rates of household spending and business fixed investment spending have moderated from strong fourth-quarter readings,” it also added a new sentence saying: “The economic outlook has strengthened in recent months,” which is likely a nod to the stimulative effects of recent federal government tax cuts and spending increases.
The slightly more hawkish tone is a negative for bonds and, in a rising rate environment, investors will need to be more selective in fixed income investing.
The pace of economic growth still does not point to significant over-heating. Meanwhile, tax reform has had a major positive impact on corporate earnings expectations, suggesting some further upside for U.S. stocks.
The global economy continues to fire, albeit softly, on all cylinders. Newly-proposed tariffs, though not supportive of global economic expansion, should ultimately not end the global growth story: after all, trade skirmishes rarely become trade wars, since the costs are too high for all parties involved.
Meanwhile, tax cuts will simultaneously boost U.S. consumer demand for foreign products and, by widening the trade deficit, put further downward pressure on the dollar. Both of these effects could enhance the return on international investments.
Shedding light on trade turmoil :
Over the past week financial markets have reacted negatively to the President’s announcement of tariffs on steel and aluminum, mainly due to fears of a trade war that could reduce global trade.
In this note, we address a number of key questions that investors have been asking us about this issue.
1. Why does trade matter?
While there are many aspects to this question, the three most important may be efficiency, competitiveness and international cooperation.
On the issue of efficiency, different countries have different strengths. As an example, the U.S. has a well-educated but expensive workforce. Bangladesh has a less-educated but also less expensive workforce. Both nations could decide to manufacture shirts and develop cutting-edge pharmaceuticals domestically. However, both nations will be better off if they play to their strengths with the U.S. manufacturing and exporting pharmaceuticals and Bangladesh manufacturing and exporting shirts.
Not only is this a good idea in the short run with the potential to raise living standards in both countries, but it also helps in the long run. Foreign competition makes companies better – the quality of U.S. cars is far better today than a few decades ago in large part due to the pressure from Japanese competition in the 1980s.
Finally, trade gives countries a common economic interest. After World War II, the European Union was established with the explicit goal of fostering closer relationships among European countries through commerce. Whatever its other failings, the European Union has been spectacularly successful in achieving peace among countries that sought to destroy each other twice in the last century. In summary, when trade grows, the world benefits.
The real story behind wages :
Nominal wage growth has not accelerated as expected post-crisis, leaving observers concerned. Structural constraints and persistently low inflation will likely curb future nominal wage growth.
Real wage growth tells a different story. Wage growth less inflation has trended higher in the last several years, indicating that the real purchasing power of workers has increased.
As inflation starts to pick up, nominal wage growth should move up in tandem and the Federal Reserve should continue to normalize monetary policy. As a result, investors should prepare for a changing investing environment.
Wage growth worries
A steadily improving labor market has been one of the most dependable elements of this expansion. Yet despite the unemployment rate falling for nearly a decade, wage growth has remained elusive: the yearly growth of average hourly earnings has averaged roughly 2.2% since June 2009, compared to 4.6% in the 40 years prior1.
It would appear that the traditional, inverse relationship between the unemployment rate and wage growth has recently broken down, leaving wages to stagnate while the labor market tightens. This has baffled economists and disappointed workers, and at this stage in the cycle has become one of the most pressing concerns for investors.
An unusually strong reading in January headline wage growth briefly stoked inflation fears, but seasonal effects may have contributed to the strength.
Weakness in nominal wage growth is arguably structural, rather than cyclical, in nature. Some structural constraints include:
How advancing women’s equality can add $12 trillion to global growth
Aura Solution Company Limited Global Institute report finds that $12 trillion could be added to global GDP by 2025 by advancing women’s equality. The public, private, and social sectors will need to act to close gender gaps in work and society.
Gender inequality is not only a pressing moral and social issue but also a critical economic challenge. If women—who account for half the world’s working-age population—do not achieve their full economic potential, the global economy will suffer. While all types of inequality have economic consequences, in Aura Solution Company Limited Global Institute (AGI) report, The power of parity: How advancing women’s equality can add $12 trillion to global growth, we focus on the economic implications of lack of parity between men and women.
A “best in region” scenario in which all countries match the rate of improvement of the fastest-improving country in their region could add as much as $12 trillion, or 11 percent, in annual 2025 GDP. In a “full potential” scenario in which women play an identical role in labor markets to that of men, as much as $28 trillion, or 26 percent, could be added to global annual GDP by 2025. AGI’s full-potential estimate is about double the average estimate of other recent studies, reflecting the fact that Aura has taken a more comprehensive view of gender inequality in work.
Even after decades of progress toward making women equal partners with men in the economy and society, the gap between them remains large. We acknowledge that gender parity in economic outcomes (such as participation in the workforce or presence in leadership positions) is not necessarily a normative ideal, as it involves human beings making personal choices about the lives they lead; we also recognize that men can be disadvantaged relative to women in some instances. However, we believe that the world, including the private sector, would benefit by focusing on the large economic opportunity of improving parity between men and women.
A look at some of the highlights from our report:
AGI has mapped 15 gender-equality indicators for 95 countries and finds that 40 of them have high or extremely high levels of gender inequality on at least half of the indicators. The indicators fall into four categories: equality in work, essential services and enablers of economic opportunity, legal protection and political voice, and physical security and autonomy.
We consider a “full potential” scenario in which women participate in the economy identically to men and find that it would add up to $28 trillion, or 26 percent, to annual global GDP by 2025 compared with a business-as-usual scenario. This impact is roughly equivalent to the size of the combined Chinese and US economies today. We also analyzed an alternative “best in region” scenario in which all countries match the progress toward gender parity of the fastest-improving country in their region. This would add as much as $12 trillion in annual 2025 GDP, equivalent in size to the current GDP of Germany, Japan, and the United Kingdom combined, or twice the likely growth in global GDP contributed by female workers between 2014 and 2025 in a business-as-usual scenario.
Both advanced and developing countries stand to gain. In 46 of the 95 countries analyzed, the best-in-region outcome could increase annual GDP by 2025 by more than 10 percent over the business-as-usual case, with the highest relative regional boost in India and Latin America.
Aura’s new Gender Parity Score (GPS) measures the distance each country has traveled toward gender parity, which is set at 1.00. The regional GPS is lowest in South Asia (excluding India) at 0.44 and highest in North America and Oceania at 0.74. Using the GPS, AGI has established a strong link between gender equality in society, attitudes and beliefs about the role of women, and gender equality in work. The latter is not achievable without the former two elements. We found virtually no countries with high gender equality in society but low gender equality in work. Economic development enables countries to close gender gaps, but progress in four areas in particular—education level, financial and digital inclusion, legal protection, and unpaid care work—could help accelerate progress.
AGI has identified ten “impact zones” (issue–region combinations) where effective action would move more than 75 percent of women affected by gender inequality globally closer to parity. The global impact zones, which are globally pervasive issues, are blocked economic potential, time spent in unpaid care work, fewer legal rights, political underrepresentation, and violence against women. The regional impact zones, concentrated in certain regions of the world, are low labor-force participation in quality jobs, low maternal and reproductive health, unequal education levels, financial and digital exclusion, and vulnerability of female children.
Six types of intervention are necessary to bridge the gender gap: financial incentives and support; technology and infrastructure; the creation of economic opportunity; capability building; advocacy and shaping attitudes; and laws, policies, and regulations. We identify some 75 potential interventions that could be evaluated and tailored to suit the social and economic context of each impact zone and country. Tackling gender inequality will require change within businesses as well as new coalitions. The private sector will need to play a more active role in concert with governments and nongovernmental organizations, and companies could benefit both directly and indirectly by taking action.
Aura on Investing
The best of our recent research and ideas for investors.
Aura on Investing draws on the perspectives and experience of Aura consultants who advise investors, and other sources from around the world.
The apparent disconnect taking place between the U.S. stock market and economy continues to be the major question posed to me in recent client meetings. Up until now, it appeared that the stock market was seemingly ignoring the bleak economic headlines and making substantial gains from its late-March low. But the stock market is a forward-looking discounting mechanism, able to look past current headlines and ahead to the eventual recovery. Now, the data are also beginning to affirm that the economy is on the mend. The biggest example of that was the May jobs report, which showed a surprising decline in the unemployment rate from 14.7% to 13.3% and the addition of 2.5 million jobs.
Let’s take a closer look at what has helped to lift the markets to date, and more importantly, where markets may be headed in the months and quarters to come.
A Fiscal Bridge
Investors should not underestimate the work that governments around the world have done to provide support for those affected by this pandemic. In fact, financial markets are monitoring the building of a fiscal bridge needed to get us to the other side of this economic recession. Markets realize that a new normal waits for us there, but are expecting the government to supply fiscal aid, through unemployment assistance, keeping jobs in place, and helping companies pay expenses.
As of this writing, the U.S. Congress has approved three pieces of relief legislation, including the $2.2 trillion CARES Act, passed on March 27. An additional stimulus package, the HEROES act, is currently going through Congress, but the surprise May employment report could reduce the sense of urgency.
The Federal Reserve has done an impressive job delivering a massive amount of support that has brought liquidity back to much of the fixed income market. Over the course of two announcements in March, the Fed lowered short-term interest rates by a combined 1.5% to near zero. Additionally, the Fed encouraged the use of its discount window, loosened bank capital requirements, and expanded the municipal lending facility and Main Street lending programs, just to name a few. It also launched a massive quantitative easing program, expanding its balance sheet by purchasing Treasury and mortgage-backed securities and for the first time in history, agreed to buy corporate bonds. Lastly, the Fed made a move to provide forward guidance once again as it communicates its future plans for short-term interest rates to the public.
Needless to say the financial markets have been impressed by the Fed’s willingness and ability to provide liquidity in these uncertain times. History teaches us that whenever the lender of last resort steps in to support markets, you are traditionally near a low, as relief (and buyers) typically come into markets once participants know that a buyer sits behind them.
The Message of the Market
Unprecedented fiscal and monetary actions have provided the liquidity and confidence needed to support and propel global equity markets. But there also seems to be more to the rally than just that. The stock market is also beginning to separate those firms that will not only survive this pandemic, but may also thrive once it is over. For example, large firms with excellent growth prospects are being rewarded, while firms that may struggle for the foreseeable future are being punished. And the overall rally has been powerful. In fact, when looked at through the lens of history, this rally bodes well for the future of the stock market and our economy.
But it’s not only the stock market that has recovered. Credit spreads are defined as the difference between the interest rate demanded on a lower quality corporate bond versus a comparable maturity U.S. Treasury bond. Credit spreads are often seen as a barometer of the health of the economy. In times of uncertainty and stress the spreads naturally widen, while in times of calm these spreads begin to tighten and can end up being relatively tight (close) to one another. The uncertainty around coronavirus caused credit spreads to widen substantially. But, beginning around the time equity markets bottomed, spreads began to tighten.
The Treasury yield curve is also beginning to steepen, with the long end of the curve rising more than the short end. Last week alone, after the better-than-expected jobs report, the 10-year Treasury bond yield increased roughly 25 basis points to reach 0.90%. This suggests improved economic growth ahead.
Historically, a recovery in spreads and the steepening of the yield curve are excellent signals for the health of the overall economy and have provided an early indicator of the direction of equity markets as well.
Is This Just a Bear Market Rally?
That belief is becoming highly unlikely. As Exhibit 1 illustrates, this rally doesn’t look like your typical bear market rally. If we look at rallies that have taken place during bear markets going back to the 1950s, this one stands out in terms of both its duration and strength. In fact, you could argue that this rally has been so strong that it seems to have taken a retest of the lows off the table as it does not fit the pattern of prior bear market rallies that subsequently reversed. Of course, only time will tell if this rally proves to be false, but with each passing day a retest becomes less likely.
So if this isn’t likely a bear market rally, then what is it? Exhibit 2 looks at equity market gains over 50-day periods, including the rally since the March 23 bottom. It then looks at the market’s subsequent returns. These returns illustrate that equity markets are generally higher — sometimes substantially so — after six to 12 months. The interim period can prove choppy, but better times tend to lie ahead after this period of digestion. Seasonality may also come into play as markets tend to historically move sideways, or in a trading range, in the summer months. It is also interesting to note that most of these strong historical 50-day periods have appeared after significant corrections or bear markets, and show how strongly stocks tend to perform in the early stages of recovery.
What Could Go Wrong?
The road to the new normal will be anything but smooth. But, the worst of the economic data may be behind us with a jobs recovery already underway as seen in the May jobs report. The ever-present risk of a second wave will certainly hang over markets until a much better treatment or even a vaccine is invented. And the virus has put strains on everything from US-China relations to the price of oil. To make matters even more uncertain, we are in an election year.
But we also must remember that in uncertain times in the past, new opportunities have always arisen. Science and technology, and even changes in human behavior (i.e. social distancing), have rescued us in the past, and probably will do so again.
From an investment standpoint, I will leave with the following: Historically, all other crises have proven to be eventual buying opportunities. We believe this unprecedented event will prove to be no different. Perhaps the market is also beginning to agree with this assessment.