26 Sept 2016
Fed Policy Uncertainty Shook the US Market out of Slumber
Some complacency had set in along with the low-volatility summer rally, but Fed policy uncertainty yet again shook the market out of its slumber. The S&P 500 didn’t decline more than 1% for 52 consecutive trading sessions, before 9 September’s 2.5% decline. Volatility spiked in the ensuing week, largely fueled by a renewed uncertainty regarding global central bank policy, rising U.S. and global bond yields, and exacerbated by valuation concerns.
We remain relatively optimistic that the long bull market in stocks can continue, but have been consistent in our view that risks for a pick-up in volatility and more frequent pullbacks remain elevated. As a result, we maintain our neutral view on U.S. equities and urge investors to remain vigilant and stick to their long-term asset allocations—using volatility to tactically rebalance around strategic allocations.
Patience can be difficult in this environment where we seem to be on an economic version of the classic movie “Groundhog Day.” Economic data appeared to be perking up in June and July, with better readings on durable goods orders, housing data, industrial production, and railcar loadings according to ISI Evercore Research. And while the economy still appears to be growing, the recent round of data has thrown some cold water on the hopes for a sustainable uptick in growth. The recent soft patch has become a pattern—with dips in growth having been experienced in every year since the recession ended over seven years ago. Manufacturing continues to struggle with the Institute for Supply Management’s (ISM) Manufacturing Index moving back into territory depicting contraction (below 50) at 49.4. Even more disappointing was the sharp drop in the new orders component (a key leading indicator) from 56.9 to 49.1. We believe that this weakness was exaggerated by the “August” effect when worldwide activity seemed to come to a standstill, but the trend bears close scrutiny. Also discouraging was the ISM Non-Manufacturing (services) Index falling by a larger-than-expected 4.1 points, although still on the expansion side of 50, while the new order component also fell precipitously.
The labor market still looks healthy, but the rate of improvement appears to be slowing. This should be expected as a tighter labor market means there are fewer qualified workers to fill open positions—which according to the July JOLTS report (Job Openings and Labor Turnover Survey) hit a record high. The tighter labor market has yet to generate a sustainable improvement in wage growth, with average hourly earnings (AHE) declining in August to 2.4% from 2.6% year-over-year. However, the mix shift of workers entering and exiting the workforce may be biasing this growth rate down. That is why an alternate measure of wage growth put out by the Atlanta Fed (via its “Wage Tracker”)—accounting for mix shift calculation problems—shows wage growth of a full percentage point higher than AHE.
There was also recently some very good news on the personal income front. Two weeks ago the U.S. Census reported that median incomes rose from $53,718 to $56,516—the largest arithmetic and percentage increase in the history of the data back to 1967. While real median incomes are still below their 2007 peak of $57,423, the spiking income growth is being driven most by the bottom two deciles of the income distribution, which is good news in terms of income inequality.
The epicenter of déjà vu
This uptick in economic activity followed by some disappointing results has appeared to continually stymie the Fed and leave investors awash in uncertainty. Fed members have been talking up the likelihood of at least one rate hike this year. We still believe one rate hike is on the table by year-end.
The uncertainty is global as the recent G-20 meeting produced agreement that more fiscal action was needed from all major countries, with leaders noting that monetary policy has probably reached its efficacy limits. In fact, some of the market’s recent volatility and the move higher in global bond yields are due to the possibility that quantitative easing (QE) is running its course globally and will not continue indefinitely.
Volatility has picked up along with global central bank policy uncertainty and a back-up in U.S. and global bond yields. We believe the Fed is likely to hike rates one time this year, probably in December, but that central bank consternation will continue to elevate volatility. The long-running equity bull market should stay intact with modest economic growth continuing; and investors should remain globally diversified.
This material is issued by Charles Schwab, Hong Kong, Ltd. The information provided here is for general informational purposes only and has not been reviewed by the Securities and Futures Commission in Hong Kong.