Macro Wrap-Up

Who is the MVP of the Market (Most Valued Performer)?

Topics - Macroeconomics

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Who is the MVP of the Market (Most Valued Performer)?

It’s June. If you’re a sports fan, it’s the month of the NBA Finals, the Stanley Cup Finals, the French Open and, depending on the year, a World Cup in cricket or soccer. If you’re a market commentary fan, it’s the month to review the big events of the first half of the year. Fortunately, this year has gotten off to an interesting start. As is often the case, many of the predictions made in January seem as far from the current situation as if they had been made a century ago. 1 1 Close Or the last time the Knicks were good. When we began the year, stocks were reeling, the market was concerned about rate hikes, most observers thought trade negotiations were moving in a good direction, and strategists were looking for ways to take advantage of an imminent surge in the European economy. But forecasting is always difficult. We can’t criticize: some of us here made far worse predictions — we had the Philadelphia 76ers winning the East. 2 2 Close For non-basketball fans, they didn’t. What we can do, though, is give you a mid-year review that compares each of the major markets to an NBA team in this year’s playoffs.

Of the major markets, U.S. bonds were probably the least loved at the beginning of the year. They were considered boring and defensive. Relative to other cycles, yields were still historically low, scaring some investors into thinking that there was no room for further capital appreciation. 3 3 Close “Yields can’t go below zero.” “Winning a land war in Asia is easy.” “The Lakers can’t miss the playoffs with Lebron.” The economic environment was unfavorable to bonds: growth was strong and the Fed had just hiked in December. Even falling stock prices only generated weak interest in fixed income. Other assets seemed more exciting and were favored in recommended portfolios. Since then, U.S. bonds have had a great year on a risk-adjusted basis. 4 4 Close The Barclays U.S. Treasury Total Return Index has returned +4.3% year-to-date, as of the close on June 12, 2019, on an annualized volatility of 3.4%. Source: Bloomberg. Stocks have also done well. We’ll get to that later. They have been helped by some old-fashioned fundamentals. Most importantly, inflation has been stubbornly low, which created favorable conditions for a rally. Then the trade conflict, combined with slowing activity numbers, pushed the Fed toward a more dovish stance. The most hated asset became the most loved. Can you think of an NBA team that had a similar experience this year? One that everyone expected to lose its last three series, but it kept on winning? One that was considered boring and, while strong on defense, offered little scoring excitement? The NBA Champion Toronto Raptors! Perhaps Kawhi Leonard would make a good spokesman for U.S. bonds. 5 5 Close Yes I know Toronto is in Canada not the U.S. But outside of that, the analogy works. Okay?

Stocks have been the star performer among markets for as long as most millennials can remember. At the end of last year, however, they experienced a rare setback. The fear of excessive Fed tightening and an accompanying recession temporarily knocked stocks off of their perch. Still, it’s probably not a huge surprise that they have done well this year. The dovish Fed probably helped stocks as much as bonds. Because the recession fears were rooted in concern about Fed policy, stocks have been able to shrug off softening economic data. The trade war has dented returns, but they remain solidly in double digits. 6 6 Close S&P 500 Index total returns year-to-date, as of the close on June 12, 2019, were +15.9%. Source: Bloomberg. You’ve probably already guessed which NBA team fits this profile. It’s been the favorite for years but has hit some setbacks in the form of injuries, one of which returned recently, but they’ve still managed to make it to the Finals in an impressive fashion. Yes, Steph Curry of the Golden State Warriors might want to consider dropping the miniature golf show and become your stock broker.

Commodities have been more polarizing than stocks. They have some very exciting stories behind them and, unlike many other assets, have maintained reasonable volatility over the past few years. Despite all of the flash, investors are skeptical of their usefulness in portfolios. Oil is by far the most heavily-traded commodity, and it showed some potential this year. It looked like supplies might tighten and that OPEC had finally found some discipline. When the U.S. tightened sanctions on Iran by ending waivers that had allowed select countries to buy Iranian oil, there was some talk, maybe not consensus, but some talk of $100 oil. 7 7 Close Bloomberg: “What Oil at $100 a Barrel Would Mean for the World Economy,” 4/28/19. The trade wars brought up questions about demand and very quickly cut into the optimism. Soon after, the Department of Energy reported higher than expected oil inventories. The energy markets fell back to earth, though they are still sensitive to events in the Middle East. There is an NBA team that has arguably the most exciting player, one with a great life story. The team had high expectations and did well for a while, but ultimately lost to a more defensive team. This franchise may be competitive again, but like commodities it hasn’t won a championship since the 1970s. 8 8 Close Ok, maybe you could argue commodities did have a bright spot in the early to mid- 2000s, but probably did not actually win a championship, so the analogy holds. Giannis Antetokounmpo of the Milwaukee Bucks may be in the oil business.

Finally, we have the foreign exchange market. It has high volumes of transactions, but volatility has been very low. The dollar, yen and euro are right around where they were at the beginning of the year. The political environment has made currency interventions taboo — they are viewed as manipulation to get an unfair advantage in trade. There was hope for a euro rally early on, but that might have required stronger data and some indication of rate hikes from the ECB. There have been very few big or interesting moves in major currencies. It’s kind of like they’re just passing the ball around the perimeter while trying to draw a foul. Is there a team that resembles FX? One that was an expansion team in late 1960s or early 70s that provided some good performance in the 80s and 90s but maybe never quite made it over the top? One that is still relevant, but at times really boring to watch? James Harden might be swapping euros for dollars with the Houston Rockets.

The Raptors’ win in game six does not necessarily mean that bonds will outperform for the rest of the year. Basketball is not a good predictor of market returns. 9 9 Close We haven’t backtested, but we’ll make that assumption. In the offseason there may be some trade wars in both the NBA and in politics. If there is one lesson from the first half of the year it’s that predictions are difficult, and circumstances change quickly in unexpected ways. Maybe basketball analogies are just as useful for investors as well-thought-out economic arguments. We’ll update you next season.

What We Are Watching

FOMC Meeting (Wednesday)
After hiking four times in 2018, the Fed has left rates unchanged at each of its meetings so far in 2019. As U.S. data has pointed to subdued inflation and somewhat slower growth, and as escalating trade tensions have added uncertainty to the outlook, economists and market participants have moved from expectations of continued hikes to increasingly confident forecasts of rate cuts. 10 10 Close As of this writing, Fed Funds futures imply a modest probability of a cut at the Fed’s June meeting and fully price a cut by the next meeting in July. Pricing from Bloomberg. Recent comments from Chair Powell emphasized that the central bank is paying attention to downside risks and will “act as appropriate to sustain the expansion.” 11 11 Close Chair Jerome H. Powell: “Opening Remarks” at the "Conference on Monetary Policy Strategy, Tools, and Communications Practices" sponsored by the Federal Reserve Bank of Chicago, 6/4/19 However, key growth and labor market indicators remain at healthier levels than has typically been the case before rate cuts. Investors will be watching the post-meeting statement, Chair Powell’s press conference, and the updated Summary of Economic Projections (SEP) to determine how close the central bank is to delivering looser policy. If the Fed signals that it still expects rates to remain on hold, it could generate a negative reaction in fixed income and equities.

Bank of Japan Meeting (Thursday)
The Bank of Japan changed its guidance at its last meeting in April, stating it would “maintain the current extremely low levels of short- and long-term interest rates… at least through around spring 2020.” 12 12 Close Bank of Japan: “Statement on Monetary Policy,” 4/25/19. With global growth and trade concerns increasing, the BOJ faces a difficult set of options moving forward. Inflation has remained stubbornly below its inflation target of 2%, the yen has appreciated recently and the Japanese government seems set to proceed with a Consumption Tax increase from 8% to 10% in October, which some worry could weigh on growth. While it may be too early for the BOJ to take further action this month, Governor Kuroda recently laid out a potential toolkit for easing, including “cutting the -0.1% negative rate further, lowering the target for 10-year yields, increasing the monetary base, or boosting asset purchases.” 13 13 Close Bloomberg: “Kuroda Says BOJ Has Enough Ammunition, Wary of Side Effects,” 6/10/19. Any comments around the potential use and/or effectiveness of these policies could impact the yen, Japanese equities, and domestic fixed income.

Eurozone PMIs (Friday)
Preliminary PMIs for June will be released next week in the euro area. The Eurozone Manufacturing PMI began to trend down over a year ago, foreshadowing a broad deterioration in industrial activity that has shown little sign of abating. Manufacturing sentiment has been particularly weak in Germany, where the PMI points to deep contraction. The Eurozone Services PMI has also slowed, but remains at less alarming levels. With the ECB signaling willingness to ease further should downside risks to growth materialize, PMIs will be watched closely to inform expectations of additional easing ahead. Weaker readings might boost sovereign bonds (particular in countries with less perceived credit risk), while weighing on the euro and regional equities.

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