November 2015 Market Commentary

With a month to go until year end, now is no time to be counting our eggs. However, there has been a very marked decrease in volatility, in stocks, bonds, domestically, internationally, etc. This doesn’t’ mean all is good, but it does provide a nice indication. What we’re seeing is investors appear to finally be waiting to see how some near term risks shake out before moving the needle too much in any one direction.


Within the global landscape, we are noticing something wherein most foreign Central Banks are looking to continue to keep rates low, while at home everyone is expecting rates to rise, and rise soon. Notice I said “everyone,” and not “a lot of folks,” when everyone expects something, it happens! However, to go along with a rise in rates here and low rates abroad, the US dollar will very likely continue to strengthen, putting a damper on our exports, increasing our imports, potentially choking our seaports, while commodity prices could very well continue their treacherous fall.


The biggest news internationally has been Chinese investors growing nervous about policymakers’ latest attempts to regulate the Chinese brokerage industry. The global economy remains uneven and somewhat weak as one or more major economies have suffered periodic setbacks at various points. As a result, investors have relied on easy monetary policy rather than on improving growth to power risk assets higher.


As such, the markets now sit at a crossroads. Monetary policy should remain an important consideration, but for risk assets (including equities) to achieve a sustained uptrend, we believe better global economic growth will be needed. And we expect global conditions to gradually improve. China is stabilizing and policymakers are keenly attuned to promoting continued growth. The U.S. remains in decent shape, as the improving job market should drive consumer spending levels higher; and notably the unemployment rate just reached a 4 decade low. Additionally, after years of acting as a drag, government spending should serve as a positive force. Global manufacturing has been weak, but we think this area is starting to turn.


The biggest news at home was admittedly much quieter, but also better. Third quarter GDP was revised higher. The best piece of news that was associated with this was the inventory levels being revised higher. This means businesses are once again spending to grow their inventory, taking a burden off the consumer, and the government to keep GDP growth positive! On a related point, domestic nonfinancial (not banks) profits remain strong. Notably, they are 3x larger than financial profits and twice as large as non-US profits. Restrained unit labor costs, the strength in the US dollar, solid consumer spending levels and housing and HC spending are all tailwinds for domestic success.


Despite some worries, consumer spending is strong. Several prominent retailers posted disappointing third quarter earnings results, which have caused some observers to opine that consumer spending levels are weakening. We disagree. Spending levels remain strong in areas such as housing, autos, "experiences" and e-commerce, which may be diverting spending from traditional brick-and-mortar companies. The tailwinds for spending outweigh the headwinds, and include an improving labor market, wage gains, low core inflation, low energy prices, rising consumer net worth and rising real income expectations.


From a risk perspective, risks should diminish over time though near-term risks still remain. Investors and financial markets seem stuck in a holding pattern, waiting to see how a number of near-term risks shake out. The renewed strength of the U.S. dollar is causing some angst, especially since pending Fed rate hikes may put additional upward pressure on the currency. China’s precarious economy is also much in focus. Despite some signs of stability over the past couple of months, weakening growth has led to lower commodity prices, which have hurt emerging market economies. And broad fears of deflation and renewed recession still linger in pockets around the world, although core inflation in developed markets appears to be creeping higher.


None of these issues can be easily dismissed, but we believe these risks should remain contained. Overall, we expect the world economy to avoid widespread recession and experience improved growth levels. Policymakers in China are highly attuned to promoting growth and supporting domestic demand. Europe remains another risk, especially since we may see some negative effects from the Paris terrorist attacks. However, overall economic momentum remains positive. The strength in the dollar is a negative for overall U.S. corporate profits, and this headwind may well persist into next year. Yet we doubt we will see a repeat of the degrees of upward movement in for the dollar we witnessed over the last 18 months.


So what about Fed policy? It is possible investors will view the first rate increase as a negative, believing the Fed acted prematurely and is putting a fragile recovery at risk. Or, investors could view the move as an acknowledgement that the economy is strong enough to warrant higher rates and breathe a sigh of relief that the will-they-or- won’t-they drama is finally over. We think the latter outcome is more likely.


While there are a number of risks, most should remain relatively contained. Terrorism and geopolitical instability are again driving a number of financial conversations. But while the human costs of the tragic events we have seen in France, Mali and elsewhere are staggering, geopolitical issues are unlikely to significantly affect financial markets unless they undermine broader economic growth. Many are also concerned about a shift in Fed policy, but we believe the Fed will move cautiously. And while a stronger dollar has some downside, we don’t expect the sort of sharp surge we witnessed in late 2014 into 2015.


As a result of these views, we maintain a positive growth investment bias. Government bonds appear unattractive, and are likely to come under pressure if and when economic growth accelerates. We are banking on improved corporate profits in 2016 and expect interest rates to rise modestly and gradually over the coming year. Equities should do relatively well in such an environment.


Finally, when it comes to the more recent drop in energy prices, there is additional good news for us as consumers, typically lower energy prices have historically led to periods of improved economic growth. As happened in such times as 1981 - 1982, 1986, 2008 and 2011, declining energy prices may help real gross domestic product growth, payrolls, capital expenditures, manufacturing and industrial production in 2016.


Ultimately, we think evidence of better global economic growth will cause investors to move out of safe-haven assets such as Treasuries and cash and into equities. The path ahead will likely be bumpy, but we do expect equity prices to grind higher over the long term.



The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Any opinions are those of David Abuaf and not necessarily those of RJFS or Raymond James.

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