Quarterly Investment Outlook: June 2018

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SUMMARY

  • In the May 16th FOMC policy statement, the Fed implied it will foster monetary policy that allows inflation to rise modestly above 2%, consistent with its symmetric objective.  This policy is equivalent to price-level targeting, which has been advocated in recent years by former Federal Reserve Chairman Dr. Bernanke.
  • The U.S. administration's recent announcement that it would be investigating tariffs on auto imports, as well as the lack of the clear trade policy with China, raises the risk of a "trade war".
  • 1Q18 earnings were strong, supported by an 8% yoy revenue gain.  While earnings growth is forecasted to slow into 2019, profits should continue to support equity prices, which should lead to another increase in the stock market into 2H18.  Normally the best gains in a mid-term election year occur in Q4.
  • Global growth is diverging.  The U.S. is strong while the Eurozone and China have lost momentum.  The recent decline in the euro should benefit European growth/equity markets in the second half of the year.  It should be particularly helpful to the weaker members.  China should be aided by a lower bank reserve requirement (with the release of additional reserves), coupled with the potential for more fiscal stimulus, which we are anticipating. 
  • We believe the dollar has entered a multi-year bear market driven by long-term deterioration in both our fiscal and current accounts.  Gold miners should be an excellent hedge against future dollar weakness and the growing possibility of monetizing the expected increase in Federal debt.             
  • We expect bond yields to resume their upward climb later in the year after a brief consolidation, driven by an increase in inflation.  This is supported by the trend in the Fed's Underlying Inflation Gauge, a leading indicator that is currently at 3.2% yoy.  BCA Research recently noted that for the first time in the 17 year history of the BLS JOLTS Survey, job openings exceeded the number of unemployed workers.  A surge in the proportion of workers willing to leave their jobs, at a time when it is getting more difficult for employers to find skilled labor, should also foster higher wages leading to increased inflation.
  • Our favored domestic sectors include Energy, Financials, Materials, and Healthcare.  Following a 16% gain in oil prices, the Saudi oil minister stated that OPEC was likely to increase production quotas at their June meeting, which has led to profit-taking.  We believe that OPEC production will increase by several hundred thousand barrels in the second half of the year in an effort to offset the expected loss of equivalent Venezuelan production.  With strong demand, oil prices should rise above $80/bbl with risk to the upside.  There has been insufficient investment in ex-shale energy producing assets, causing an increase in the fragility of the oil production system. 

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