In this month's Economic Outlook, Chief Investment Officer Greg Sweeney gives perspectives on Federal Reserve policies, expectations for interest rates and inflation, and what's going on in national and global markets.
Federal Reserve Monetary Policy
The market expects the next Federal Reserve interest rate increase to be announced December 13. That would increase the top range of the Fed fund rate from 1.25 percent to 1.50 percent.
The year-over-year inflation rate for September, the latest data available, was 2.2 percent, pushing above the Fed’s target 2 percent inflation rate. This is what we expected, and we anticipate the rate will remain above 2 percent when October’s inflation rate is announced November 15. The Fed prefers to use personal consumption expenditures (the measure of consumer spending on goods and services) to measure its inflation target. That figure is 1.32 percent.
Consumer purchases increased 1 percent last month, and surveys indicate consumers expect to spend more during the holidays this year. However, this increase may overstate the strength of the consumer. Even though unemployment is at a 16-year low, it looks like the increased spending came at the expense of reduced savings. This is not unusual due to the storms in Texas, Florida and Puerto Rico. We continue to see near-term strength in the labor market, suggesting the unemployment rate could go even lower than its current 4.3 percent rate.
Tax reform continues to be verbal banter rather than reality. As we observed early in the year, one of the main deterrents to passing a tax deal is the deficit level. Another main sticking point is that tax reform would cut taxes for the rich. Because of our progressive tax system, tax cuts for the middle class also benefit the rich, Office of Management and Budget director Mick Mulvaney explains in a story in the Washington Examiner. Mulvaney also points out that the top 20 percent of income-tax filers pay 95 percent of income taxes.
The duration of the Bloomberg Barclays Government/Credit index is 6.58. Five years ago, it was 6.01. As interest rates have remained low, bond issuers looking to lock in favorable interest rates have issued longer bonds. Duration is a measure of risk for bonds. As it lengthens, the market value of a bond becomes more sensitive to changing interest rates. A longer-duration bond will lose more market value than a shorter-duration bond for any given rise in interest rates. The reverse is also true. With the 30-year decline in interest rates at an inflection point, investments that match these popular fixed-income indexes may have become more risky than investors realize.
Bell’s approach to fixed income is to capture attractive bond yields while maintaining a shorter duration to insulate some of the volatility that comes with changing market values.
The value of the stock market continues to push higher. The price per share of major market indexes seems to reach records daily, while the sales from those same companies lag their share price appreciation considerably. The current price per share of the S&P 500 compared to sales per share is 2.13 times greater. The only time it has been higher was during the tech stock bubble. Charts like this lead us to question market valuations. To help diffuse some of this condition, we hold equity allocations in value stocks, but that has been little help so far this year, with the market continuing to favor growth stocks and driving price/earnings ratios of companies like Amazon to 264 times and Netflix to 156 times or Tesla to infinity (because it has never had any earnings). We expect to maintain our allocation to the portion in value stocks as part of a diversified stock portfolio.
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