This is part of an ongoing series of articles published by Johnson Financial Group. This issue is written by Brian Andrew, EVP, Chief Investment Officer.
This week our investment team gathered, as they do each quarter, to discuss the economy, markets, portfolio construction and risk management. The meeting was interrupted by a fire drill. Undeterred, the group of more than 20 took over a nearby restaurant and were excited to get there in time to hear the Federal Reserve chairman announce the first interest rate cut since the hiking cycle began, late in 2015. I am sure the restaurateur had never been asked to turn all televisions to a Fed press conference! Our team allows guests to address other issues – this time, our new Director of Wealth Strategy, Joe Maier, addressed the group on financial planning. He started by saying he had never been to a “geek fest” of investment professionals, which seemed apropos given the passion in the room.
This week has been an investment geek’s dream, with news from the Fed, an update on the Purchasing Managers Index (PMI), an announcement from the Trump administration on trade, and the monthly jobs report. That’s a lot to digest for our investment team, and we’re all excited about the challenge.
On Wednesday, the Federal Reserve announced that they were reducing the Fed Funds interest rate by .25% as the market had largely expected and priced in. In their statement, they dropped the word “closely” and added the word “continue” to describe how they are looking at the economic data that drives their decision. In their world, words are everything, and this change may take a further reduction off the table for the next meeting in September and push it out to December or January.
This is the first time they’ve cut rates since 2008. While some would say this is an insurance move, like their policy change in 1995, it bears noting that it opens the door for a more meaningful shift in policy. We don’t believe the current environment warrants deeper cuts because the economy continues to perform in a stable fashion.
Bond yields fell further on Fed action, extending the price rally. Today, the 2-year Treasury yield, a good predictor of the market’s view on the Fed’s future moves, stands at 1.72%, down .2% from a month ago. More importantly, intermediate-term yields have also declined as have mortgage yields, which may add some energy to the housing market.
One of the most significant changes that occurred after the announcement was the rally in the value of the U.S. dollar. It briefly traded above a level that has been hard to penetrate all year, so we’ll watch this closely going forward as it impacts the cost of U.S. goods overseas. Those companies who rely on exports for growth may see a tougher road ahead.
Last week’s report on the economy noted a growth rate of 2.1%, near the 10-year trend. Today’s jobs report indicated that more than 170,000 jobs were created last month – 16,000 of those were manufacturing jobs. Because of the higher wages in this sector, these jobs add to consumer spending.
Yesterday, we received a new report on the PMI for the U.S. The index was at 51.2 (above 50 represents an expanding economy), which is down .5 from the prior month. The New Orders portion of the report also showed some weakness. This report is consistent with a softer economy than we had last year; however, it doesn’t reflect the kind of contraction that leads to recession.
In addition, the unemployment rate remained at 3.7% and wage growth ticked up to a 3.2% year-over-year growth rate. None of this sounds to us like an economy in trouble and in need of help from lower interest rates.
Still, policy makers are concerned about the potential for weakness from ongoing trade differences between the U.S. and China as well as slower global growth, particularly in Europe and Asia.
To keep the week interesting, yesterday the administration indicated that they would add a 10% tariff on $300 billion worth of Chinese exports, effective Sept. 1. This was just two days after Secretary of the Treasury Steve Mnuchin returned from a trip to China to negotiate a trade deal. Apparently, the administration doesn’t believe enough progress has been made and that the Chinese aren’t taking the U.S. position seriously enough.
We’ve noted in the past that these tariffs have a negative effect on economic growth both in China and here at home. However, we don’t believe the impact is enough to push us to recession. This latest round of tariffs, if implemented, could have a more deleterious effect on the consumer and cause some price inflation. It may also be a ploy, as it has been in the past, to bring negotiators back to the table.
From an investor’s point of view, the trade war with China will continue to cause volatility in asset prices. We don’t see a clear path to near-term resolution and so can only determine which industries are most likely affected and make investment decisions accordingly.
A busy week for our group of investment geeks! Through all of this, we agreed to leave our current allocation to stocks neutral and remain comfortable with our neutral stance on bond portfolio average maturity. We continue to believe that the Fed’s stance on interest rates supports high stock valuation and that a stable interest rate environment supports using average maturity to maximize bond portfolio yields. More on that in next week’s commentary.
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