Year-to-date, Roosevelt Investments has seen equities move sharply higher and then drop, likely due in part to the shivers of the coronavirus. Bond yields have declined, providing price performance, but the yield curve also inverted briefly. We believe that this is either a sign of economic fragility, or a mixed signal of flight to quality in an uncertain world.
While investors would love another year of continued economic growth, low inflation, and positive market returns, January appeared to include much data to both support and challenge this potential. Economic data has been good, but global and domestic challenges remain.
In the Middle East, an escalated conflict with Iran may have looked evident, then it eased off just as quickly. Meanwhile, the US and Israel proposed a new peace plan for the Palestinians, which is backed by some Arab countries. As always, this is a developing situation, overall the news of a new peace plan seems to be a move in a positive direction.
We believe China is a bigger story. While we are starting to get more clarity on the coronavirus, economists have also been marking down China’s growth. More confounding than an epidemic is contemplating how much more the world’s second largest economy might become isolated from the rest of the world.
In the US, we saw that job creation in 2019 continued to be greater than population growth. Because of this we believe that most investors have expected that the US economy will continue along a 2% growth path for 2020. The recent “phase one” trade deal with China alleviated one of the biggest threats to domestic economic growth, as we see it. The Chinese agreed to buy soybeans and pork from the US and the US agreed not to raise tariffs on a substantial number of Chinese exports. We believe that even though the deal lacked as much progress as was needed, it set the right tone and the two countries are seemingly talking to each other.
All evidence seems to indicate that the Federal Reserve’s default position is to remain on the sidelines until glimmers of inflation appear. We think that the bond market has perplexed investors for years, as historically low rates have remained. Much of this is a global phenomenon of limited inflation coupled with aggressive central bank policies to stimulate borrowing and investing, in our opinion. Cross-border economic flows being what they are, we think that the US cannot isolate itself from these issues. Interest rates may have difficulty climbing higher for some time.
However, the path of a virus threatening global growth wasn’t in the markets’ initial 2020 calculations. Could we actually expect the Federal Reserve to ease rates? The market pressures of ten-year US Treasury yields trading on top of the effective Fed funds rate - meaning there is no slope to the yield curve - could lead to rates easing. A decision by the Federal Reserve to ease rates could depend on the breadth and duration of our global viral pandemic.
The oil market may provide some clues of an interest rate decision by the Federal Reserve, with crude prices down about 20% in the last month. While oil prices had been volatile when tensions with Iran were more obvious, we think that oil prices are also a good coincident indicator of the global economic outlook. With the Saudis apparently contemplating an output reduction, we think the signal of a rise in oil prices should be taken seriously.
However, much of this is about a virus literally passing through the system. At some point, it will. We believe that the underlying profitability of firms, an environment of low inflation, and an accommodative Federal Reserve will be seen as supportive to the economy and to market valuations.
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