As Fall begins, and the air gets heavy with anticipation about presidential politics and the direction of U.S. and global monetary policy, here are my four key views on the markets:
1. The Federal Reserve (Fed) does not tighten in December.
Despite statements from Federal Reserve (Fed) Chair Janet Yellen and Vice Chair Stanley Fischer throughout the summer, the Fed did not raise interest rates in September. The data simply did not support a hike, and yet there is still talk of a move before the end of 2016 at the Fed’s meeting in December. While the markets are assigning a real probability to that possibility, I still firmly believe the Fed is unlikely to move in December.
Yes, I know all the arguments that point to a Fed rate hike coming sooner rather than later:
- The U.S. economy has rebounded from a dismal first half of 2016 and growth is likely to be better in the second half.
- Labor markets, despite a modest August non-farm payrolls report, are in decent shape.
- The trade picture has improved somewhat as Emerging Markets (EM) come back to life.
Nevertheless, the overall U.S. growth rate is quite modest. Bureau of Economic Analysis Final Sales data are actually decelerating, with the most pronounced evidence to be found in auto sales. Most importantly, other large global central banks are still easing and inflation overall remains below the Fed’s target.
Bottom line: There’s not enough strength in the U.S. economy for the Fed to tighten just yet. With my expectation that Final Sales will continue to decelerate, I don’t expect the Fed to tighten in December, either. That said, Fed policymakers certainly could decide to tighten despite what I see as the arguments against it, but if they do, the U.S. economy will pay a heavy price in terms of a strengthening dollar and a meaningful slowdown in the consumer economy.
2. Global equity markets will continue to do well in the low rate environment.
The absence of monetary policy mistakes coupled with continuing support from all large central banks, a less-than-expected slowdown in economic activity post-Brexit, and continued recovery in EM bode well for global equity markets. Volatility has been unusually low but may pick up some as investors fret about the Fed. I believe the best performing markets are likely to be the U.S. and EM.
The U.S. has the best growth outlook for any large economy, valuations are not extended, and it has the potential for the highest positive policy change versus expectations. EM economies continue to bottom out as China’s growth rate stabilizes and political, commodity and currency volatility subsides. Further, despite the recent rally in all things EM, valuations in EM equities, rates, credit and even foreign exchange are quite attractive.
3. Negative interest rates as a policy tool are being cast aside.
While some central banks have negative rates that will probably remain in place at current levels to avoid shocks to the system, the likelihood that policy rates will go even more negative is quite small, in my view. There is a consensus building within policy circles that the cost to a financial system from negative rates is just too high. Even Bank of Japan Governor Haruhiko Kuroda alluded to that over the weekend.
This consensus has two significant and related implications:
- We have seen the near-term bottom in financial sector equity and credit assets, and
- Since quantitative easing, as opposed to negative rates, is going to be the policy weapon of choice, that bodes well for credit assets.
Sooner or later, every large central bank in the world will end up buying credit assets. Both financial equities and credit spreads have been on a tear and I expect that to continue.
4. The allure of value investing will soon fade.
Due to a cyclical jump in economic activity in both EM and developed markets in the second half of 2016, value investing has lately become the investment style of choice. However, as that growth momentum is likely to fade, so will the allure of value investing. This is likely to be true in developed markets, but even more so in EM. While we can debate the attractiveness of value in developed markets, I am convinced that value in EM is the ultimate trap for the singular reason that the Chinese industrial economy will continue to slow and that, in turn, will continue to pressure the old EM economy.
For long-term investors in a growth-short world, growth is what we should focus on. In my view, that is surely true in developed markets and absolutely true for EM in spades.
An original copy of this blog first appeared on September 6, and predicted that the Federal Reserve would not tighten in either September or December. The blog has been updated following the September FOMC meeting when the decision was made to keep interest rates unchanged, as noted above, confirming our initial thesis.
Risks associated with rising interest rates are heightened given that rates in the U.S. are at or near historic lows. When interest rates rise, bond prices generally fall. Eurozone investments may be subject to volatility and liquidity issues.
Equities are subject to market risk and volatility; they may gain or lose value. Emerging and developing market investments may be especially volatile. Value investing involves the risk that undervalued securities may not appreciate as anticipated
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These views represent the opinions of OppenheimerFunds, Inc. and are not intended as investment advice or to predict or depict the performance of any investment. These views are as of the publication date, and are subject to change based on subsequent developments.