The Federal Reserve left interest rates unchanged yesterday, which Janet Yellen insisted wasn’t because the central bank is downgrading its outlook on the economy. Quite the contrary, Fed Chair Janet Yellen advised. “Our decision does not reflect a lack of confidence in the economy,” she said in a press conference on Wednesday. Economic growth is holding steady at a “moderate pace,” by her reckoning. But the Treasury market isn’t wholly convinced. Maybe that’s because the Fed’s economic forecasts were flat to slightly lower vs. the June projections.
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The US economy’s forward momentum remained sluggish in August. Although recession risk was low last month, a series of disappointing indicator updates in recent weeks suggest that the macro trend continues to struggle.
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Is the US economy trapped in what might be described as a macro version of Dante’s Nine Circles of Hell? No one knows the answer at this point, but the possibility may be rising that the US economy is destined to hobble along with tepid growth while avoiding a formal NBER-defined recession. In that scenario, the Federal Reserve can’t raise interest rates or “normalize” policy, leaving the economy in a perpetual state of dysfunction.
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US stocks and bonds managed to eke out gains last week as the remainder of the major asset classes slumped, based on a set of representative ETFs.
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● The Upside of Inequality: How Good Intentions Undermine the Middle Class
By Edward Conrad
Summary via publisher (Portfolio)
Four years ago, Edward Conard wrote a controversial bestseller, Unintended Consequences, which set the record straight on the financial crisis of 2008 and explained why U.S. growth was accelerating relative to other high-wage economies. He warned that loose monetary policy would produce neither growth nor inflation, that expansionary fiscal policy would have no lasting benefit on growth in the aftermath of the crisis, and that ill-advised attempts to rein in banking based on misplaced blame would slow an already weak recovery. Unfortunately, he was right. Now he’s back with another provocative argument: that our current obsession with income inequality is misguided and will only slow growth further. Using fact-based logic, Conard tracks the implications of an economy now constrained by both its capacity for risk-taking and by a shortage of properly trained talent—rather than by labor or capital, as was the case historically. He uses this fresh perspective to challenge the conclusions of liberal economists like Larry Summers and Joseph Stiglitz and the myths of “crony capitalism” more broadly.
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Softer-than-expected data continues to weigh on the August economic profile for the US. Retail sales slumped last month as did industrial output; translating the numbers into year-over-year changes reveals a downside bias. Initial jobless claims remain a bright spot, although the August payrolls report that was published earlier in the month posted a sharp deceleration in growth. Although the macro trend for the US is still on track to remain positive, recent numbers raise the possibility that growth will remain sluggish. As a result, the Federal Reserve is unlikely to raise interest rates at next week’s monetary policy meeting.
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Mid-cap stocks are often called the “sweet spot” in the market-capitalization spectrum for equity investing. History agrees. Mid-cap performance has delivered a solid premium over large-caps and small-caps over the last two decades. This is a bit of conundrum for financial economics. The academy’s models, after all, insist that small caps are destined for stellar performance over the rest of the field. But the track record over the last 20 years has thrown out the script and awarded the gold to mid-caps.
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US equities had another rough day yesterday, but the market’s momentum profile via sectors has firmed up lately by way of one-year changes. In contrast with recent history, annual returns for sector funds have turned uniformly positive via a set of proxy ETFs. Even the battered energy group is now sitting on a respectable year-over-year increase.
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Knowing why an investment strategy has stumbled is just as important as recognizing why it succeeded. This obvious-but-often-unheeded bit of wisdom comes to mind after reading yesterday’s Bloomberg story that seven large, public US university endowments posted disappointing results for the year through the end of June 2016. “It was a bit of a bloodbath,” said Jagdeep Bachher, chief investment officer at the University of California system. The weakness is surprising because the year through the end of this year’s first half generated a modest upside bias for the Global Market Index (GMI), an unmanaged benchmark that holds all the major asset classes in market-value weights.
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Friday’s sharp selloff left most markets in the red last week, although commodities and foreign bonds (in unhedged US dollar terms) bucked the downside bias and posted gains, based on a set of proxy ETFs for the major asset classes. A factor in the firmer pricing for offshore fixed income via ETFs: a slightly weaker dollar in last week’s trading.
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