Quarterly Investment Outlook: September 2018

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SUMMARY

 

  • The rate of domestic economic growth is likely to peak in either 2Q18 or 3Q18 based on the leading economic indicators that we monitor.  Growth should subsequently trend towards the Fed's projection of long-term growth at approximately 2.0%.  If this is true then a continuation of the Fed's rate hiking program may result in an overly restrictive monetary policy within the next twelve months.  We will not be surprised if President Trump attempts to influence the Fed in order to appease his constituency by promoting a policy that will allow for the continuation of the economic expansion.

  • Quantitative tightening is causing the Fed's balance sheet to shrink at an accelerating rate.  The Fed's balance sheet has been positively correlated with the decade-long equity bull market.  It is disconcerting that the balance sheet is now beginning to shrink since this correlation is backed by a fundamental causation.  We ultimately believe the long-term path of least resistance for the Fed will be to decrease the rate of tightening. 

  • The Federal Reserve's Underlying Inflation Gauge is forecasting that inflation is likely to accelerate to above 3.00% within the next six months.  Rising wages, fiscal stimulus and higher oil prices should cause inflation expectations to trend higher.  Our fixed income allocation towards Treasury Inflation Protection Securities will benefit if the rate of inflation accelerates.

  • · We continue to forecast a recovery in G-10 ex-US economic growth in the closing months of 2018, where G-10 includes European countries plus Canada and Japan.  The current period of dollar strength is serving to reallocate growth away from the U.S. towards the G-10.  Chinese stimulus in the form of lower rates, a pickup in credit growth, and higher infrastructure spending should benefit growth in Asia ex-Japan.  Cyclical stocks have dramatically underperformed defensives over the last quarter.  Green shoots in the global economy relative to the US economy should serve as a catalyst in revaluing our cyclical and international holdings.

  • Oil production in the continental US is beginning to undershoot expectations.We believe this is due to insufficient investment in midstream assets, a lack of qualified laborers, and shortages of key drilling materials such as frack sands and water.These shortages are likely to continue into at least 2H19. A significant supply deficit is likely to materialize in oil as we enter 2019 due to continued OPEC production shortfalls, coupled with the re-implementation of Iranian sanctions.Oil stocks are cheap and remain a core holding.

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