In his last testimony to Congress, Chair Powell agreed with Representative Ocasio-Cortez (D-NY) that the relationship between unemployment and inflation appears to have been broken. This relationship, usually referred to as the Phillips Curve, suggests there is an inverse relationship between the two variables. If one desires low inflation, then the tradeoff is higher unemployment.
The Phillips Curve has a controversial history. There is nothing in economic theory that necessarily supports the tradeoff. In fact, in its original construction by the economist A.W.H. Phillips, the relationship was between wages and unemployment and was developed by observation. On the one hand, the relationship makes intuitive sense. The unemployment rate should offer some insight into the supply/demand balance for labor and it would be reasonable to expect that the relative scarcity of labor should increase wages. Economists then took the next step and assumed that rising wages would lead to higher price levels. There are periods when the relationship between prices and unemployment is stable. But, history shows the relationship is far from consistent.
Both charts are scatterplots of the unemployment rate and the yearly change in CPI. The chart on the left shows the relationship from 1960 through 1969. It exhibits what the theory suggests—declines in unemployment are consistent with higher inflation. It also suggests a non-linear relationship, in that when the unemployment rate declines below a certain point then inflation tends to rise quickly with little improvement in the labor markets. This chart was part of the development of the theory of the “natural unemployment rate,” which suggested there was a long-term unemployment rate and falling below that rate would lead to sharply higher prices, thus limiting the impact of policy.
The chart on the right suggests something quite different. In the data since 2010, the relationship is positive, meaning that higher levels of prices are consistent with high unemployment. Although that relationship is due, in part, to the distortions caused by the Great Financial Crisis, the fact that the curve slopes upward does suggest the relationship between price levels and unemployment may be sensitive to other factors.
It is no great secret that the relationship between unemployment and price levels is inconsistent. So, in light of this problem, why has the Federal Reserve clung to the Phillips Curve in policymaking? As the linked article above notes, Chair Powell appears to have given up on the relationship but others on the FOMC have not. We suspect the Phillips Curve served an important narrative for the Federal Reserve tied to its dual mandate. The Fed is expected to execute monetary policy that yields stable prices and full employment. The Phillips Curve made it clear that this mandate had a tradeoff; if the Fed delivered low unemployment, there was an inherent risk of rising price levels. The belief in the Phillips Curve allowed the Fed to avoid policies that brought very low unemployment that might risk higher price levels.
For the Federal Reserve, the Phillips Curve was a useful theory even if it wasn’t always consistent. But, if there is a belief that the Phillips Curve doesn’t work anymore, then one could see Congress demanding ever lower levels of unemployment. If the theory really doesn’t hold, there is no risk of inflation coming from falling unemployment. However, there may be other issues. For example, very low interest rates could distort financial markets. It could lead to malinvestment in the economy. Perhaps the most potent problem is that terms such as “stable prices” and “full employment” are not fully defined. Former Fed Chair Allen Greenspan defined stable prices as inflation that is low enough to where consumers and firms do not take inflation into account when making investment and purchase decisions. Although workable, Greenspan’s definition is clearly ad hoc. It is arguable that any level of inflation is inappropriate. Defining full employment has been difficult as well. Part of the Phillips Curve theory is the concept of Non-Accelerating Inflation Rate of Unemployment (NAIRU), which suggests there is a minimum rate of unemployment consistent with steady prices. Policymakers have used NAIRU as a proxy for full employment, even though it changes over time. Most elected members of Congress would describe full employment as every likely voter in their district or state has a job if they want one.
The problem for the Fed is that if the Phillips Curve is jettisoned, there could be a focus on the unemployment rate of the mandate and the inflation mandate could become secondary. After all, if inflation isn’t affected by the unemployment rate, the political class would generally want a rate as close to zero as possible. Since inflation is affected by the degree of deregulation and globalization, it may be possible that inflation will remain low even at historically low levels of unemployment. Unfortunately, it is also possible that the Phillips Curve relationship has become dormant for a myriad of reasons, including the aforementioned globalization and deregulation policies, demographics, and custom. One observation we have noted is that the level of service seems to decline when the unemployment rate falls significantly. Businesses note that they don’t have much pricing power and, in the face of rising wages, firms may opt to simply deliver less in terms of normal service. In other words, hotel rooms may not be available at check-in time due to the lack of housekeeping staff or tables in restaurants may not be bussed as quickly due to the lack of entry level staff. Such deterioration is not technically “inflation” but can occur in response to factors that otherwise would trigger rising price levels.
In the end, the Fed may find itself without an adequate response to Congress when it demands ever lower levels of unemployment. The Phillips Curve was useful for the FOMC to avoid being forced into extreme policy positions. Without the Phillips Curve, there is the potential that the Fed will be forced to engage in persistently accommodative monetary policy, with outcomes that could either lead to inflation or significantly distorted financial markets.
by Bill O’Grady, Thomas Wash, and Patrick Fearon-Hernandez, CFA
[Posted: 9:30 AM EDT]
Happy Friday! Fifty years ago today, Apollo 11 orbited the dark side of the moon as a precursor to the landing. In market news, it is still all about monetary policy. Tensions with Iran are rising. Here is what we are watching today:
It’s all about monetary policy: We had three central banks cut rates in the wee hours of the U.S. morning yesterday. Then, around midday, NY FRB President Williams delivered what appeared to be a blockbuster, hinting that when policy rates are low, measured cuts are less effective and faster measures are needed. This news caught financial markets by surprise and rapidly lifted the sentiment toward a 50 bps cut at the end of July. Equities reversed course and rallied strongly on the speech. In a rare occurrence, the NY FRB tried to “clarify” the boss’s comment (suggesting à la Greenspan of “if I seem unduly clear to you, you must have misunderstood what I said…”), and indicated that Williams didn’t really signal a larger than expected rate cut. Other known doves didn’t support the bigger cut but Williams’s comments are important. First, he is the president of the NY FRB, the only regional bank that is a permanent voting member of the FOMC. All the other regional banks vote in a rotation, every three years. Second, he is considered a policy wonk and can back up the statements he makes with monetary theory, unlike others without similar training. Simply put, he may be able to sway others on the committee to his position on the strength of his argument. It is possible that we could see dissents on both sides; some preferring no cuts (KC FRB President George) and others, such as Williams, calling for bigger reductions. What we found interesting, though, was the market reaction. Clearly, the behavior yesterday shows that equity markets are almost solely focused on rate reductions.
Tensions with Iran: President Trump indicated that the U.S. downed a suspected Iranian drone. Wall Street Journal reporters aboard the U.S.S. Boxer in the Persian Gulf say the drone was actually downed electronically by a new system that detects the aircraft and then jams its communications link with its remote pilots. The revelation of this new weapon is newsworthy in itself, but it’s especially notable that the system is nonlethal, meaning it could provide defensive capability without necessarily spurring a response from the adversary. The engagement with the U.S.S. Boxer, one of six other U.S. warships in the area, included an Iranian military helicopter buzzing the U.S. vessel. Iran disputes the American claim of downing the drone. Although this news lifted oil prices on fears of geopolitical risks to supply, Iran did offer an “olive branch” of sorts, saying it would agree to intrusive inspections if the U.S. lifted sanctions. The U.S. didn’t move to take Iran up on the offer as it isn’t clear whether Iran is proposing anything beyond what has already been agreed upon. But, it does make clear that the sanctions are biting. Treasury Secretary Mnuchin told our European allies that they must either abide by U.S. sanctions on Iran or leave the dollar system. We note the Trump administration announced new sanctions yesterday against several more Iranian companies and individuals for helping the country procure materials for its nuclear program.
In other news concerning the Middle East, the U.S. has sent additional troops to Saudi Arabia. Meanwhile, allies in the region and elsewhere are trying to cope with U.S. policy against Iran. Persian Gulf states are struggling to build a solid front to confront Iran based on U.S. direction. In some respects, they like the tougher attitude that the Trump administration is taking toward Iran compared to the Obama government, but they are becoming concerned about the potential for war. Meanwhile, allies have shown reluctance to participate in protecting Persian Gulf shipping from Iranian threats. This position may be a mistake; although previous U.S. administrations would simply shoulder the burden to protect oil flows, the Trump administration, supported by shale oil production, may be less generous and simply allow oil flows to decline. That isn’t necessarily how it will go (the president does clearly pay attention to oil prices and abandoning oil tankers to the tender mercies of Iran will likely lift oil prices into an election year), but the threat is probably higher than the Europeans realize. In the Yemen conflict, Gulf State allies are quietly exiting the fight, leaving the Saudis increasingly responsible for continuing the conflict. This war is turning into something of an albatross for the crown prince; Saudi Arabia is asking for greater U.S. involvement, which we doubt will be forthcoming.
Finally, the IEA has revised its 2019 oil demand growth forecast to 1.1 mbpd, down from 1.2 mbpd in June and much lower than the 1.5 mbpd earlier this year. Fears of weakening demand have pressured oil prices lower this week.
Brexit: Boris Johnson, poised to become the next British PM next week, was dealt a blow before even taking office as Parliament voted to prevent him from pursuing a no-deal Brexit by closing the legislature. The vote highlights the problem Johnson (or, for that matter, Theresa May) faces, which is a divided party; nearly 40 Tories voted for the measure. There are hints from the new EU Commission president that she might be open to an extension, which would drive the Brexit supporters crazy; however, if Johnson can’t deliver a program (and it is hard to see how he can, given the current structure of Parliament) then an extension may occur. On the other hand, he might be better off taking his chances on snap elections. On a related note, with Mark Carney set to exit the leadership of the BOE, the bank is struggling to find anyone to take the job due to the uncertainties surrounding Brexit.
Ukraine: In recent weeks, we’ve noted several reports suggesting the new president of Ukraine, Volodymyr Zelenskiy, may be making progress in his effort to resolve the war between his government and Russian-backed separatists in the country’s eastern region. As we’ve noted, Zelenskiy and Russian President Putin have talked by phone about enhanced multilateral talks on a peace accord, and the two governments are discussing the possible release of Ukrainian soldiers seized by Russia last year. Now, the Ukrainian military and the separatists have also implemented a deal in which each side pulled back one kilometer from their previous fighting positions in certain segments of the front line, although distrust remains and the fighting hasn’t stopped completely. Perhaps just as important, Zelenskiy has taken a sympathetic approach toward Ukrainian citizens in the separatist-held territories, whom the previous president had treated as collaborationists. Zelenskiy’s well-received moves have made his Servant of the People Party the frontrunner in this weekend’s snap parliamentary elections. Given President Putin’s commitment to Russia’s traditional defense strategy, which emphasizes holding or controlling buffer territories to protect the Russian homeland, we see no chance that he would reverse Russia’s 2014 annexation of the Crimean peninsula or grant Ukraine full autonomy. However, if Servant of the People wins big, as expected, Zelenskiy may have the political capital needed to make additional peace concessions to Russia, which could eventually convince Putin to rein in the separatists and allow for a Russia-dominated modus vivendi between the countries.
Tech observations: First, finance ministers from the G-7 countries reached a preliminary, high-level agreement on how to tax multinational firms. The first principle they agreed on was that all multinational companies should be subject to a minimum level of global tax, similar to a measure in the U.S. tax reform of 2017. To ensure that big, digital services firms can’t escape taxation, the second principle was that countries should be able to tax firms based on both their digital and physical presence in the country. More specific rules are due to be hammered out by January.
The Europeans are beginning to realize that fining the large tech firms doesn’t really change their behavior. Regulators are starting to explore actions that change the business model of these firms.
Second, cyberattacks appear to be increasing. In a report on its “AccountGuard” service, which helps political campaigns and other policy-oriented organizations detect cyberattacks, Microsoft (MSFT, 135.42) said it has detected almost 800 attacks by nation-state hackers against enrollees in the program just over the last year. Most of the attacks originated from Russia, Iran, and North Korea, although China was also active. The attacks are being seen as potentially laying the groundwork for further attacks to influence the U.S. elections in 2020.
NSO Group, a privately held Israeli company, has developed software that can unknowingly gather user information across servers and the digital cloud. This software would allow a body (government, terrorist group, etc.) to gather a significant amount of information on a person. Another threat? Audio deepfakes are coming, which is software that records a person’s voice and can create inflammatory statements from that audio. One can easily imagine how this could affect a political campaign but it could also be used for someone trying to drive a stock price lower.
by Bill O’Grady, Thomas Wash, and Patrick Fearon-Hernandez, CFA
[Posted: 9:30 AM EDT] Global equity markets are trading lower this morning as worries over earnings are pressuring prices. Japan fell on weak export data and the Bank of Korea surprised with a rate cut. Here is what we are watching today:
Fed talk: Perhaps the most important variable in the path of equities this year is monetary policy. The financial markets have built in at least 100 bps of easing over the coming months. The current economy, as noted by yesterday’s Beige Book, doesn’t look weak enough to warrant such strong action. Of course, if policymakers wait until they get unambiguous evidence of economic weakness, they will miss their opportunity to avoid recession. If policymakers key off the financial markets, they do run the risk of the “false positive” and may cut rates when such action isn’t needed. Our position is that the costs for cutting rates too much and too early are low; inflation probably doesn’t become a problem and the real risk is overheating asset markets. And, even the risk there isn’t all that obvious. The risk from financial asset bubbles is usually over-investment as firms use the rising stock market or tighter credit spreads to build capacity, which turns out to be excessive and weighs on future growth. We don’t see that happening, either. The investment reaction to either strong equities or tighter credit spreads has been modest this entire expansion and that factor probably won’t change. The Fed’s leadership may be underestimating the risk of recession to bank independence. When the GOP is pushing to undermine the central bank’s independence, imagine what a left-wing populist would do. To some extent, MMT relies on a central bank that is compliant to the needs of the fiscal authority. So, from where we sit, the risk of easing too much pales in comparison to the risks of reducing rates too slowly or not enough.
However, we carry no illusions that our views matter. Instead, we watch what policymakers do. There remains a fairly large contingent on the FOMC that still relies on some form of the Phillips Curve. These members will have a hard time moving to ease without a rise in unemployment. What this means in practice is if Chair Powell pushes to lower rates, he will need to manage a rising number of hawkish dissenters. If the Fed eases, as expected, at the end of this month, we expect KC FRB President George to dissent. There are others who won’t support the action among the presidents but they don’t vote in this cycle. As a general rule, three dissents are considered a vote of no confidence in a Fed chair, although governors count more in this rule than presidents. The dissents are probably not enough to thwart a move toward easing but the markets will prefer unanimous outcomes.
Stalled trade talks: China wants to know what the U.S. wants. Although there are conversations occurring, there appears to be little progress. According to sources familiar with the U.S.-China trade talks, one reason for their recent lack of progress is that administration officials can’t agree on how to ease restrictions on Chinese telecom equipment firm Huawei (002502.SZ, 3.44). In a major concession to Chinese President Xi at last month’s G-20 meeting, President Trump promised to allow U.S. firms to supply components to Huawei so long as they don’t endanger national security, but officials in the Trump administration are having trouble agreeing on which products meet that standard and wouldn’t give the firm a strategic edge. At the same time, Chinese officials want Huawei off the U.S. “entity list” altogether. The resulting logjam provides more evidence that a final trade agreement is unlikely to be achieved for some time, keeping the issue as a cloud over the markets.
Meanwhile, Larry Kudlow made critical statements about China and the WSJ reports that China’s growth model is fading even excluding the trade tensions. The article suggests that socialism may have undermined China’s growth and prevented it from lifting per capita GDP at a level seen in other Asian nations. Although socialism may have played a role, other factors did as well. The one-child policy, a direct outgrowth of CPC control, gave China an initial lift by reducing its dependency ratio. However, the cost of that policy is being witnessed now as China is aging rapidly and its working age population is beginning to slow. China’s size alone likely played a role too. The U.S. was willing to allow the smaller Asian nations to expand exports for longer because the impact was small in the bigger scheme of things. China doesn’t have that benefit due to its size. Nevertheless, it should be noted that all the Asian growth miracles were based on investment-led development. In all cases, there is a transition that occurs when investment can no longer lead the economy; we would note that Japan was never able to fully make the transition and has been mired in three decades of sub-par growth. In sum, China’s communist system doesn’t make this transition any easier, but no nation makes the transition without trouble. The U.S. transition was seen in the Great Depression.
So, what do we see going forward? We have growing doubts that a deal can be negotiated because we can’t separate out the trade issue from the technology issue. In addition, both sides appear to be overestimating their positions and underestimating their opponents. China may conclude it has a vested interest in stringing out talks and hoping for a new administration in 2020. If we are correct, this issue will remain in limbo and thus be less of a market factor going forward.
In another side note, the WSJ reports that there has been a decline in foreign buyers for U.S. real estate. The National Association of Realtors reports that buying fell by 36% in Q1 compared to the same period last year. It is unclear what is driving the decline. Dollar strength has probably played a role. It is possible that fears of anti-foreign sentiment in the U.S. may be sending this capital flight elsewhere. Or, it is also possible that the amount of capital flight is declining. But, the outcome is a drop in coastal real estate activity.
China: New data shows that Chinese stock buybacks have surged so far this year, with the total through July 17 reaching some $13.6 billion. That’s almost double the total for all of 2018, reflecting an easing of regulations by authorities last year. Stock dilution from new issuance can be a detriment to per-share returns in the emerging markets; in contrast, further increases in buybacks would likely be a positive for Chinese stocks.
Hong Kong: Officials in Beijing are working on a comprehensive strategy to resolve the Hong Kong political crisis, which was sparked by Chief Executive Carrie Lam’s effort to push through a bill allowing extradition to China. The plan, which reportedly would not include the use of military force, will soon be presented to China’s top leadership.
Instex: This is an alternative payments system created by the EU to circumvent U.S. financial sanctions and maintain JCPOA. Russia announced its support for the system, with the clear goal of using it to avoid U.S. sanctions as well. This news may be more than the Europeans were bargaining for as we doubt the EU was planning on the platform becoming a way for rogue nations to avoid sanctions. So far, activity in the platform has been modest at best, but Russia’s actions show the risk of creating mechanisms that might be used for other, more nefarious, purposes.
Libra: Testimony between Congress and Facebook (FB, 201.80) grew contentious yesterday. Rep. Maxine Waters (D-CA) called for a moratorium on the Libra project and was rebuffed. Tech firms are moving into difficult waters; they have generally been given a pass by governments, dazzled by the products and services they offered. However, sentiment has turned to some extent and managing domestic and foreign legislatures and regulators is going to become increasingly difficult. For example, the EU competition commission has hit U.S. semiconductor firm Qualcomm (QCOM, 75.76) with a fine of €242 million for dumping baseband chipsets in the EU market at below-cost prices. That’s the second major EU fine against Qualcomm in the last year, and it continues a long series of EU competition actions against U.S. technology firms. The twist this time? The EU says Qualcomm’s dumping aimed to secure more business with Chinese technology firms Huawei (002502.SZ, 3.44) and ZTE (ZTCOY, 5.77). Separately, at a meeting of G-7 finance ministers in France, U.S. Treasury Secretary Mnuchin continued to complain about France’s new 3% tax on digital services. Mnuchin complained the tax unfairly hits big, dominant U.S. technology firms, while Le Maire stressed that the tax would only be temporary until a broader, international approach to digital taxation is agreed upon by the Organization for Economic Cooperation and Development (OECD).
Debt ceiling: Speaker Pelosi (D-CA) has indicated that the deadline for a deal is Friday. Although the White House and the Speaker have been in close contact, it is still unclear if a deal can be struck. If not, we will likely face a debt ceiling issue. Perhaps a bigger concern is that even if a deal is made, the president may not, in the end, accept it. If a deal can’t be made, we will see automatic spending cuts that will tend to dampen the economy.
International Monetary Fund: The G-7 finance ministers have also been discussing who should replace Christine Lagarde as the head of the IMF. The frontrunners appear to be Jeroen Dijsselbloem, the former finance minister of the Netherlands, and Olli Rehn, the current head of the Finnish central bank. Portuguese Finance Minister Mário Centeno and Spanish Economy Minister Calviño are also in the running. Reflecting Britain’s loss of status amidst its Brexit convulsions, Bank of England Governor Mark Carney didn’t make the short list.
Mexico: President López Obrador has released his plan to bolster the finances of state-owned oil company Petróleos Mexicanos (Pemex) and reverse its flagging production. The plan would include significant tax relief in 2020 and 2021, as well as capital injections from the government. However, private-sector firms would only be allowed to participate in the country’s oil sector through incentivized service contracts rather than the production-sharing joint ventures that had begun to be implemented under a 2014 constitutional reform. Pemex would also push ahead with an expensive new refinery project that many observers think doesn’t make economic sense. The plan is being taken as more evidence that López Obrador really does intend to fully implement the populist, nationalist policies that many investors fear.
Odds and ends: The EU’s alternative to GPS, Galileo, has “gone dark” now for almost a week. Operators have not offered any reason why. The new EU Commission president is likely to face a throng of MEPs essentially trying to leverage her narrow win into their own pet projects. As PM May leaves, she warns against political division.
Energy update: Crude oil inventories fell 3.1 mb last week compared to the forecast drop of 2.8 mb.
In the details, refining activity fell 0.3%, modestly less than the 0.35% decline forecast. Estimated U.S. oil production rose by 0.3 mbpd to 12.0 mbpd; Hurricane Barry probably was the reason for the decline. Crude oil imports fell 0.5 mbpd, while exports fell by the same amount. Stocks fell due to the decline in production.
(Sources: DOE, CIM)
This is the seasonal pattern chart for commercial crude oil inventories. We are now well within the spring/summer withdrawal season. This week’s decline is consistent with the seasonal pattern in terms of direction but was larger than normal.
Based on oil inventories alone, fair value for crude oil is $56.02. Based on the EUR, fair value is $52.70. Using both independent variables, a more complete way of looking at the data, fair value is $52.62. We have seen a sharp decline in oil prices in the recent week. There are two factors behind this drop. First, there has been some movement on the diplomatic front with Iran. Rand Paul (R-KY), who leans libertarian and tends to support avoiding global conflicts, may lead a U.S. negotiating team to Iran. It would be unlikely that he would support a war so this news is taking some of the geopolitical risk premium out of the market. However, we do note reports that say Iran’s Revolutionary Guards have seized a foreign oil tanker in the Persian Gulf on grounds that it was smuggling fuel. The tanker appears to be a United Arab Emirates ship that disappeared from radar screens last Sunday. The news has heightened concerns about Iran’s response to new U.S. sanctions over its nuclear program, so global oil prices have jumped.
Second, although oil inventories are declining, product inventories are building which may undercut refining activity.
(Sources: DOE, CIM)
This chart shows the level of inventory divided by the four-week average of consumption, showing how many days of inventory there are available relative to demand. This time of year, the days to cover tend to decline. The ratio rose this week, suggesting product inventories are rising. If they continue to build, especially for gasoline, we would not be surprised to see falling refining activity and lower oil demand.
We maintain our sanguine view of the economy and markets, though it is more guarded than last quarter.
We expect the Federal Reserve to implement easier policy in the third quarter, marking its first rate reduction since 2008.
In the absence of a recession, which is not in our forecast, the rate reduction should lead to a healthy environment for U.S. equities.
Although economic weakness abroad is forecast to persist in the near-term, such weakness will only modestly impact the U.S. economy.
The Fed’s accommodation and our expectations for continued, albeit muted, U.S. growth encourages our decision to maintain historically high allocations to U.S. equities in the strategies.
Although several indicators show increased potential for a recession and several metrics have softened, our consensus forecast is that recession in the U.S. is not imminent, and the economic expansion, already in record territory,[1] may continue beyond our three-year forecast period. While some factors, such as the inverted yield curve, the two-year forward LIBOR rate lower than fed funds, and softening in the composite index of 10 leading indicators, have led to an increase in the probability of a recession, this rise is from a level that was close to zero several months ago. Our expectation is that the Fed will be successful in engineering a soft landing, or at least forestalling a recession. One of the principal arguments for our anticipation of continued, albeit muted, growth is the lack of excesses that exist in the economy. Credit creation, housing values, and equity valuations are certainly elevated relative to the depth of the Great Financial Crisis a little over 10 years ago, yet are far from being stretched. Moreover, the Fed retains some room for maneuvering that can assist in its efforts to maintain the expansion, inclusive of further rate cuts and curtailment of its balance sheet reduction.
Beyond the U.S., significant leadership and economic uncertainties remain unresolved for the balance of the year. These include the probability of a hard Brexit, Christine Lagarde’s ability to steer the European Central Bank, Italy’s flirtation with broaching the EU’s fiscal rules, the new German chancellor, the replacement of Mark Carney as governor of the Bank of England, the potential for a large reduction in the Bank of Japan’s quantitative easing, and the ability of the People’s Bank of China to continue stimulus measures. Though difficulties beyond our shores can impact the U.S. economy, as the global hegemon it is unlikely that a global slowdown, or even a recession in certain jurisdictions, would cause a recession in the U.S.
The U.S. economy continues to grow, albeit at a muted pace relative to its long-term average. Given the absence of overt inflationary pressures, the Fed is likely to lower the fed funds rate at its meeting in the third quarter, marking its first reduction since 2008. The elevated level of fed funds relative to the implied LIBOR rate, two years deferred, is supportive of a rate reduction as the Fed attempts to engineer a soft-landing in a fashion similar to 1997.
[1] Assuming this is confirmed by the National Bureau of Economic Research, Inc.
STOCK MARKET OUTLOOK
In every instance following an initial reduction in the fed funds rate that was not accompanied by a recession, equity investors were rewarded. However, as the accompanying chart indicates, each business cycle has its own unique characteristics. Those cycles where the initial reduction in fed funds were concurrent with a recession are indicated by dots on the associated lines.
Our position is that the accommodative posture of the Fed will continue to propel the economy and risk-based assets through the end of this year and into next year’s election cycle. In addition, our estimates for S&P 500 earnings are $157.30 in 2019, increasing to $161.32 for 2020.[2] Obviously, a 2.5% increase is far from a cause for celebration, but it does represent an improvement from year-over-year declines recorded over the first half of 2019. Additionally, such growth corresponds with our consensus forecast for positive, though muted, GDP growth. Nevertheless, the potential for a policy mistake, intensifying trade impediments, or building inflationary pressures necessitate vigilance and the willingness to trim equity exposure should conditions warrant.
All risk assets within the strategies remain in the U.S. As noted in the Economic Viewpoints section on the previous page, we remain cautious on non-U.S. exposure over the near-term. Although relative valuations are promising, the range of uncertainties encourage our purely domestic exposure. Within investing styles, we maintain our neutral posture between value and growth. Among sectors, Industrials, Technology, and Materials continue to be overweight. While the allocations to equities remain at historically high levels in the strategies, with an overweight to lower capitalization stocks, we trimmed a portion of the small cap position in three of the strategies in favor of increasing the exposure to mid-caps in all strategies. The rationale for this change is due to our view that the latter stages of an economic cycle coupled with pronounced M&A activity is normally favorable for mid-cap stocks.
[2] Using Standard and Poor’s method of calculating operating earnings
BOND MARKET OUTLOOK
The prospect for an increasingly accommodative Fed going into the election season guides our view that the yield curve will return to its traditional slope over the course of the year, principally through a reduction in short-term rates. Through our full three-year forecast period, we are positive on longer term rates as long Treasuries have significantly attractive yields relative to those from other developed countries. Though we have some concerns regarding the nearly $5 trillion in corporate debt maturing before 2023, this concern is offset by the $12 trillion of bonds outstanding globally with negative yields, representing 24% of the global bond market. This fact supports the notion of an adequate appetite for the maturing investment grade corporate credits. In the speculative bond space, however, we expect spread widening over the full forecast period owing to a slower economy being less supportive of lesser rated bonds.
The duration of bond holdings in the strategies with income objectives has been extended slightly accruing from our forecast for an accommodative Fed, a slowing economy, lack of inflationary pressure, and global demand for bonds. We retain the laddered structure as a nucleus beyond the short-term segment in these strategies.
OTHER MARKETS
Although REITs have enjoyed outsized returns thus far this year, our forecast for rates combined with a lack of excesses in the commercial real estate segment leads to our sanguine view on REITs. Thus, the small exposure remains in the Income with Growth strategy due to the diversified income stream that REITs provide.
Gold is retained at a modest allocation given its ability to offer a hedge against geopolitical risks combined with the safe haven it can afford during an uncertain climate for the U.S. dollar.
by Bill O’Grady, Thomas Wash, and Patrick Fearon-Hernandez, CFA
[Posted: 9:30 AM EDT]
Global markets are trading quietly this morning, consistent with mid-summer. Here is what we are watching today:
The EU vote: Well, she won, but it was close. Ursula von der Leyen received 383 votes, marginally more than the 374 she needed to win. She will be the first German to hold this post since 1958. Although the vote is anonymous, it does appear she had some backing of British MEPs, which means she may not have a working majority once Brexit occurs. This outcome will likely create a weak EU Commission President which will likely be quietly preferred across the EU’s capitals. In Germany, because Leyen resigned from her post as defense minister, the CDU leaker AKK will take over the position. The pattern of the vote shows the dwindling power of the center-left and center-right and the rising power of single issue parties (e.g., Greens) and the extremes of the left-wing and right-wing.
In related news, The European Union’s competition commission has launched a formal investigation into whether Amazon (AMZN, 2,009.90) is competing unfairly against the third-party sellers using its website. The investigation arises from Amazon’s dual role providing a marketplace for those sellers and also selling its own products in competition with them. At issue is whether Amazon is unfairly using data collected from those third-party sellers in order to out-sell them. The inquiry illustrates how data rights and data ownership have become so important to consumers and businesses alike. It also broadens the EU’s scrutiny of big, dominant technology firms based largely in the United States, which is sure to draw the ire of President Trump and worsen U.S.-EU tensions.
Iran: Yesterday, oil prices plunged on reports that the U.S. and Iran might be open to negotiations. However, this news comes in the midst of increasing tensions. Contact with a UAE oil tanker has been lost in the Strait of Hormuz and it is possible that Iran has seized the vessel. Iran claims it “aided” the ship but that has not been confirmed by outside sources. Meanwhile, the tone coming out of Iranian leadership remains hostile. What we may be seeing is a recalibration by the U.S. It is possible the Trump administration thought Iran would capitulate quickly to a return of sanctions and make a new agreement, one that would preclude ever making a nuclear weapon. Now that Iran has shown it won’t back down, a case could be made that the U.S. and its allies are not taking the Iranian bait to escalate hostilities. There is another possibility. Governments around the world are “gaming” the U.S. 2020 elections. For example, the EU is clearly stalling on trade talks, hoping for a new government to end the current trade regime. Iran may want a new U.S. president as well but wants to achieve that by drawing the U.S. into a war that will spike oil prices and probably push the U.S. into recession. Instead, the U.S. response is to avoid strong reactions to provocations and allow sanctions to continue to weaken the Iranian economy. In either case, Iran will likely continue to take bolder actions to eventually trigger a response. Thus, yesterday’s decline probably overstates the degree of “thaw”.
The EU is also downplaying Iran’s behavior, going along with U.S. efforts to prevent an escalation. And, Iran is also trying to draw Europe into a conflict. Judicial officials confirmed that Iran has arrested a French-Iranian scholar on unspecified charges, drawing demands for information and diplomatic access by France. Such arrests of dual citizens have sometimes led to espionage charges. If it comes to that this time, it would be a sign that France is having little success in its efforts to keep Iran in the 2015 nuclear deal in the face of renewed U.S. sanctions.
Turkey: President Trump has confirmed that the United States will stop any further sales of the F-35 fighter jet to Turkey, in response to Ankara’s purchase of Russia’s S-400 air defense system. Not only does Turkey stand to lose the hefty down payment it has made for its F-35 order, but the Pentagon has also taken steps to exclude Turkish firms from supplying parts for the plane. Since Turkey reportedly produces approximately 6% of the value of every F-35, that could be a noticeable blow to Turkish industry.
U.S.-China Trade: In a decision that could play into the current U.S.-China trade dispute, the World Trade Organization (WTO) has issued a final ruling in a 2012 case in which China complained about U.S. import tariffs imposed in retaliation for China’s subsidizing of certain export firms. On its face, the ruling went against the U.S. tariffs, in the sense that it said the tariffs were calculated incorrectly. However, the ruling also confirmed that the subsidies really were giving the Chinese firms an unfair advantage, which could help harden the U.S. position in the current dispute.
Taiwan: Han Kuo-yu, the popular mayor of Taiwan’s second-biggest city, has won the opposition Kuomintang Party’s presidential primary, beating Terry Gou, the founder of Apple (AAPL, 204.50) supplier Foxconn (2354.TW, 66.80). The China-friendly Han, with overt and covert support from Beijing, will compete against the independence-minded incumbent, Tsai Ing-wen, next January.
A lift in GDP: The Atlanta FRB GDPNow forecast increased to 1.6%, up 0.3%, after yesterday’s retail sales data. The 30 bps of growth came exclusively from increased consumption.
Here is the contribution table.
The general strength of the economy does appear to be dividing the FOMC. Dallas FRB President Kaplan seems to be leaning to only one cut, whereas Chicago FRB President Evans seems open to more. Although economists remain divided on the path of the economy, some prominent money managers are looking for further weakness. In an interview with the Financial Times, celebrated hedge fund manager Kyle Bass said he believes the U.S. economy will fall into a recession by mid-2020 and the Federal Reserve will be forced to cut its benchmark fed funds interest rate all the way to zero, where it will remain for the foreseeable future. According to Bass, “As we have all learned, once an economy falls into the tractor beam of zero rates, it’s almost impossible to escape them.” Although Bass seems to be focusing more on a broad economic slowdown, a recent report by FTI Consulting highlighted the fact that U.S. online retail sales have slowed for four straight quarters and may continue to slow as the industry matures.
Libra: Facebook (FB, 203.81) was on Capitol Hill yesterday to discuss its new cryptocurrency with lawmakers. Casual observation would suggest it didn’t go well. Democrats seemed united against the idea; the GOP was divided. One item to consider; the unofficial motto of Silicon Valley is “move fast and break things.” It appears that the company didn’t fully consider all the issues surrounding the impact of Libra. The history of the financial markets show the impact of innovations that go awry and given the reach of social media, an unexpected problem could have a global impact.
A budget deal? There are reports that House Democrats are close to an agreement with the Treasury over a two year budget deal. Although there is still a chance that negotiations fail, this news does increase the odds that a debt ceiling crisis will be averted.
A spat between Japan and South Korea: One of our positions is that America’s success as a hegemon was through the “freezing” of historic friction points in Europe and Asia. Specifically, the U.S. took over the security of Europe to resolve the German problem and demilitarized Japan to eliminate the island’s fear of being cut off from natural resources. In both cases, nations that had previously dominated their regions became docile and prevented WWIII. Now that the U.S. is questioning the need to maintain hegemony, these previously frozen conflict zones are showing signs of thawing. A case in point is developing between South Korea and Japan. The Korean peninsula has been an area of contention for centuries between China and Japan. If China controlled the area, it was only a short boat ride away from invading Japan. If Japan controlled the peninsula, it had a foothold into further encroachment into China.
Needless to say, Koreans were never comfortable with the hegemonic designs of either China or Japan. The U.S. forced South Korea and Japan to get along despite deep resentment of the Koreans over their treatment during Japanese occupation. Over the years, both nations arranged to overcome latent hostility. In 1965, both nations agreed to waive reparations. But recently, South Korean courts have ruled that the 1965 agreement does not eliminate individual claims of reparations against Japan by individuals. As a result, courts there have ordered the seizure of Japanese company assets. Japan is retaliating by applying trade embargos on key technology components. South Korea appears to be digging in for a longer fight. The South Korean finance minister, Hong Nam-ki, said his government is working on a plan to reduce the country’s reliance on Japanese manufacturing inputs and make its own producers more independent.
A key to peace in the region has been the ability of the U.S. to force cooperation among allies. However, as the U.S. signals withdrawal, old conflicts emerge which will divide former allies (albeit forced ones) and allow China to exploit these divisions to expand its power and undermine American influence in Asia. An additional observation; this action adds to the growing use of protectionism and reduced globalization, which will have major implications for the global economy going forward
Odds and ends: It appears Spain’s PM Pedro Sanchez won’t be able to form a government. Sanchez’s Socialists won the most seats in elections last April but was 53 seats short of a majority. He has, so far, been unable to find a coalition partner to form a majority government. If he cannot, he will either try to govern with his current minority or call new elections. Although Japan is known for its lack of immigration, there are signs that its rapidly aging population is leading the island nation to open up to foreigners. The current foreign-born population in China is now 2.1% (the U.S. is around 15%).
by Bill O’Grady, Thomas Wash, and Patrick Fearon-Hernandez, CFA
[Posted: 9:30 AM EDT] It’s July! The trading deadline looms in baseball and a few deals (two involving our beloved cross-state team) have already occurred. Markets, on the other hand, are very quiet. Here is what we are watching today:
The EU vote: The EU Commission presidency vote happens late today and the current candidate, German Defense Minister Ursula von der Leyen, is talking to various groups trying to cobble together enough votes to take office. She needs 374 votes to win, but anything less than 400 will tend to reduce her mandate. The vote is expected to be very close. In her last speech before the vote, Ms. von der Leyen pledged to push through a new EU carbon tax and achieve carbon neutrality for the EU by 2050. She also backed EU-wide unemployment insurance and promised to punish international technology firms that “play” the EU tax system. Ms. von der Leyen is expected to win with the support of Europe’s mainstream parties, though she has gotten significant pushback from many in the center-left, especially the German SPD. She has shunned giving the Greens any specific role in government. If she loses, it will plunge the EU governance into uncharted waters. It is unclear if there is any consensus on another candidate. If she is rejected, it may put downward pressure on the EUR
While the legislators will also soon be voting on a new leader of the European Central Bank (former International Monetary Fund Chief Christine Lagarde), it’s important to remember that none of the new leaders will have carte blanche in their roles. As an example of that, Banque de France Governor François Villeroy de Galhau said at a conference today that monetary policy shouldn’t be dependent on market expectations. The statement was seen as pushing back against expectations that the ECB will loosen policy at its upcoming meeting.
Libra: We have had concerns about the rise of cryptocurrencies for some time. Although the coins might have some worth as a store of value asset and do help citizens evade capital controls, they are also useful for transactions in the black market. Ransomware threats often require payment in cryptocurrencies. However, what has surprised us is how governments have generally not reacted to the potential sovereignty threat that cryptocurrencies represent. One of the important roles of government is the creation of currency; giving that up to the cryptocurrency market opens up the possibility of private money and the loss of state power. Facebook’s (FB, 203.91) proposed foray into the cryptocurrency market appears to have caught the attention of Washington. The SEC is considering if it should regulate Libra, essentially deciding if Libra is a security. The Treasury is also expressing concern, with the Treasury secretary warning that Libra may be a “national security issue.” There is even talk of banning tech firms from offering any financial services. Regulation may not kill Libra but making it palatable to regulators will likely undermine the attractiveness of cryptocurrencies, in general, which comes from their anonymous nature.
Central bank weapons: Central bankers around the world are quietly preparing for the next downturn. Since interest rates are already low, unconventional policies will likely be necessary to stimulate growth. The ECB is considering adding unsecured bank debt to the assets it will buy in a downturn. The Fed is considering the launch of a repo facility that would allow the central bank to accept Treasuries as collateral if money market rates rise a certain level above the policy rate. The fact that such measures are under consideration suggests the developed world central banks are concerned that conventional monetary policy will not function well in the next downturn.
Brexit: Both candidates for leadership of the Tories are pushing for no backstop in Northern Ireland. It might be possible to put a trade border inside Ireland to allow the physical border to be open between the U.K. and Ireland, but the problem is that such an action would effectively move the border of the U.K. further into what is now the Republic of Ireland. We don’t see the EU giving that to Britain.
Meanwhile, here’s a new word to watch—proroguing—which is when the executive closes Parliament, ostensibly to implement policies favored by the executive but opposed by the legislature. This idea has been circulating among Brexit supporters as a way to prevent Parliament from preventing the country from leaving the EU. Proroguing outside of normal recesses is constitutionally tricky. Essentially, it requires the Queen to shut down Parliament at the request of the PM. We have doubts Queen Elizabeth would take this action. After all, such a move would rekindle republicanism, which wants to end the royals altogether. As the chances of a hard Brexit increase, the pound continues to weaken today to its lowest level since April 2017.
Greece: In a sign of improved investor sentiment toward Greece and its new center-right government, the government is planning to sell a new seven-year bond at a yield of just 2.1%, a modest 2.6% spread above comparable German debt and barely more than the U.S. Treasuries of the same maturity. That comes as loosening monetary policy has driven yields to below-zero in a range of emerging markets. All the same, in spite of those signs of positive sentiment, there are reasons to maintain caution regarding the emerging markets, especially considering the evolving global backdrop of trade protectionism and a reversal of globalization, policy turmoil in places like Turkey and Mexico, and the recent strength in the dollar.
Bulgaria: Interior Minister Mladen Marinov said Bulgaria is undergoing a massive hacker attack from a Russian website, including the release of millions of emails with stolen personal financial data and statements calling for Bulgarian Finance Minister Vladislav Goranov to resign. According to Marinov, the attack suggests Russian revenge for Bulgaria’s recent decision to buy F-16 fighter jets from the United States.
China: The Chinese government pushed back against comments from President Trump, who argued that the 6.2% GDP growth in Q2 is evidence that the Chinese economy is suffering and that Beijing would be wanting to make a trade deal with the U.S. China’s fiscal spending in H1 rose 10.7% as the government moves to bolster growth. The government yesterday issued a new policy prohibiting both central and local agencies from providing subsidies or loans to support state-owned companies that otherwise wouldn’t be financially viable, i.e., “zombie enterprises.” The communiqué said the policy aims to make it easier to close down such zombies and better allocate resources, but China will probably also tout it in order to diffuse U.S. criticism about unfair subsidies for state-owned exporters. The problem is that local governments will still be the ones deciding whether or not firms are viable, and they’ll still have an incentive to keep the zombies alive. Top-level trade negotiators from the United States and China plan to talk by phone again this week, with U.S. officials expressing optimism that the conversation will lead to new face-to-face negotiations, but China’s hardline Commerce Minister Zhong Shan warned that China will “stand firm in defending the interests of our country.”
Although Russia hasn’t been in the Western news very much recently, there’s been plenty of action “under the radar” related to the country’s regional and municipal elections this fall. On September 8, governors will be elected in 16 of the country’s 85 regions, including the important city of St. Petersburg. Legislative assemblies will also be elected in 14 regions, the capitol Moscow, and many other municipalities. In this week’s report, we’ll review the Russian government’s security goals and show how domestic political security is one of its most important priorities. We’ll also discuss the domestic political challenges faced by the government and how it is attempting to control the regional and local elections to ensure President Putin and his United Russia Party retain power. As always, we’ll conclude with market ramifications.
Russia’s Traditional Security Goals
In recent years, we’ve explored Russia’s security concerns in detail (see our Weekly Geopolitical Report from February 8, 2016). We’ve emphasized that Russian security concerns stem largely from the fact that the country has few natural defenses and is essentially landlocked. Russia’s European territory is open to invasion through the northern European plain, as illustrated by the invasions of Napoleonic France and Nazi Germany. Meanwhile, Russia’s primary outlets to the sea can be blocked with relative ease. Such landlocked isolation, restrained foreign trade, and limited arable land have left Russia relatively insular and poor, with an economy focused on natural resources.
by Bill O’Grady, Thomas Wash, and Patrick Fearon-Hernandez, CFA
[Posted: 9:30 AM EDT] Happy Monday! China’s GDP came in on expectations but the trend is clearly showing that growth is slowing. The EU Commission vote is this week. Global debt is growing. Tropical Storm Barry is now moving into Missouri. Here is what we are watching today:
China’s GDP: China Q2 GDP came in on expectations at 6.2%. China’s GDP almost always comes in on forecast because the government can set the growth rate by taking on more debt. But, the fact that the Xi regime accepted growth this low does suggest the government is trying to slowly reduce the glide path of growth. The reading in Q2 is the slowest growth in nearly three decades. Weaker exports were partly to blame for the slowdown. In general, China can probably only grow at around 3.5% to avoid adding to debt. We believe Xi has the power to reduce growth to that level but he wants to get there slowly in order to avoid an abrupt drop in output. Given that he has the ability to stay in power indefinitely, he may be around long enough to lower China’s growth to a sustainable pace without something that looks like a recession.
Hong Kong: Knowledgeable officials in Hong Kong say the territory’s chief executive, Carrie Lam, offered to resign several times in recent weeks in the midst of massive protests against her proposed bill to allow extraditions from Hong Kong to China. However, the officials say Beijing refused to accept the resignation, telling Lam to stay in her post “and clean up the mess she created.” Meanwhile, protestors continue to agitate against the extradition bill and other grievances, including a near-riot in a luxury shopping mall last night. While Lam remains in charge, the incident confirms that her days are numbered and that the political situation in Hong Kong is likely to remain unstable for the foreseeable future.
Global Monetary Policy: The acting head of the International Monetary Fund (IMF), David Lipton, offered his backing for looser monetary policy by the major central banks, such as the Federal Reserve and the European Central Bank. In an interview with the Financial Times, Lipton said, “If the economy needs support, you provide support . . . It’s more important than it’s been in a long time to avoid a recession, to be careful about any actions that might trigger a downturn.” We already believe more loosening is on the way – including a likely interest rate cut by the Federal Reserve at the end of the month – but Lipton’s statement will help give monetary authorities political cover to proceed with the moves in spite of skepticism among some policymakers.
United States-Turkey: Officials from the State Department, Pentagon and National Security Council have drawn up a list of proposed sanctions against Turkey for its purchase of Russia’s S-400 air defense system, the first deliveries of which began on Friday. The proposed sanctions would have to be approved by President Trump, but officials say the United States won’t make a public reaction to the S-400 deliveries until sometime after today. Sanctions would likely ratchet up tensions between the countries and present further headwinds for the Turkish lira and Turkish assets. Another problem for Turkey is that there are rising tensions over natural gas drilling in waters off of Cyprus. The island is divided between Turkey and the EU and the former is drilling off waters that it claims, which are not globally recognized. The EU is threatening to cut funding for Turkey.
Russia-Ukraine: In a sign of at least some thawing of relations between Russia and Ukraine, an official at the Russian Ministry of Foreign Affairs said the two governments are discussing the return of two dozen Ukrainian sailors who were seized by Russia last year. The development comes after the new Ukrainian leader last week suggested multilateral talks on Russian-Ukrainian peace, and President Putin said he would be open to the idea under certain conditions.
Mexico: On the other hand, Mexico’s economy appears to be falling into recession. Clearly, the trade conflict with the U.S. is having an adverse effect on investor sentiment in Mexico. However, another factor could be AMLO’s policy of cutting government spending on the bureaucracy. One of AMLO’s campaign promises was to move spending away from the bureaucracy to the poor. However, this has led to the reduction of some basic services, such as firefighting. Although there is an element of AMLO’s austerity that is going to be popular, it is going to be difficult to determine what activities are wasteful and unnecessary and what are critical. While no one would argue that police services are needed, there may be questions on whether new cruisers are necessary. Once public investments are questioned, over time, such investments decline and eventually public workers won’t have the tools necessary to do their jobs. It is possible that the cuts to government spending have occurred before the spending was shifted to the poor; if that’s the case, then the government sector will be a drag on the economy.
U.K. makes an offer: The U.K. has offered to release the tanker it holds if Iran doesn’t deliver the oil to Syria. It isn’t clear what kind of guarantees Tehran can offer to satisfy the British but it does look like both sides are trying to ease tensions.
Debt: The Institute for International Finance (IIF) is a bank-owned body that conducts research on international financial matters. One of the tasks the IIF performs is to monitor global debt levels. The IIF reports that global debt rose $3.0 trillion in Q1 to $246.5 trillion. With global GDP estimated to be around $85 trillion, world debt/GDP is around 290%. Emerging market debt has hit a record high. One side effect of low interest rates is that they encourage the expansion of debt levels, making the global economy vulnerable to rising interest rates.
The recent testimony from Chair Powell to Congress made it quite clear that the U.S. central bank is likely to cut rates at the end of July. For the equity markets, the key issue is whether the shift away from tightening to easing will be enough to avoid recession. If the rate cut(s) in the coming months reduce the odds of recession, we could see the expansion continue and the Fed may have engineered a rare “soft landing.” On the other hand, it is quite possible that monetary authorities have raised rates too much and have waited too long to ease policy; if so, then a recession may be unavoidable.
This chart shows two business cycle indicators, one from the New York FRB and the other from the Atlanta FRB. The former predicts the business cycle a year ahead and is based on the yield curve; the latter is coincident and based on GDP. We overlay the two, using the New York number as a warning and the Atlanta index as confirmation. The New York number has crossed the 30 threshold, which has been a signal of recession in the past with no false positives. And, even rate cuts haven’t prevented recession once the 30 threshold has been crossed. At the same time, we have not seen confirming data in the national accounts (GDP) data. Thus, recession may be in the cards, although the risk isn’t imminent; the downturn may still be two years away and it is possible it could be avoided. After all, every cycle is unique.
This chart shows the dilemma for equity investors. In this chart we examine the average total return for the S&P 500 on a yearly basis, with the data indexed to the first rate cut, a year in advance of the cut and two years subsequent. The data shows that equities tend to perform very well if recession is avoided, roughly earning 20% in the first year after the cut and nearly 50% over two years. However, if a recession occurs, declines in excess of 20% are possible.
Although the NY Fed’s indicator has a strong track record, each business cycle is different, and it is possible that a recession can be avoided. This analysis does suggest caution, although most safety assets have performed very well already, thus it may be too soon to fully de-risk portfolios. In the immediate term, however, there is little cause to exit the equity markets, but vigilance is clearly necessary.
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