Q4 2017 October 12
ECONOMIC FORECAST
DBFitzpatrick
REGISTERED INVESTMENT ADVISORS
INSIDE THIS ISSUE:
Fixed Income: Change at the Fed Could Impact Interest Rates
4—6
Equity Bull Market Continues
6—7
DB Fitzpatrick 800 W. Main Street, Suite 1200 Boise, Idaho 83702 (208) 342-2280 www.dbfitzpatrick.com
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ECONOMIC FORECAST | Q4 2017
FIXED INCOME: CHANGE AT THE FED COULD IMPACT INTEREST RATES The U.S. Treasury yield curve
leadership team. Yellen’s current
during the tenures of Yellen and Ben
steepened in September as inflation
term as chair will end in early
Bernanke, and are viewed by investors
breakeven rates rose, tensions with
February and President Trump has
as quite hawkish. Jerome Powell, a
North Korea diminished, and the
not yet announced her replacement.
current member of the Fed’s Board of
ultimate damage wrought by
The president has not publicly ruled
Governors with a reputation of being
Hurricane Irma was less than feared.
out appointing Yellen to another
moderately dovish, is also rumored to
The other important news in the fixed term, but given his tough criticisms of be a candidate. There are other income market during the month was her during last year’s campaign and
rumored potential nominees with little
a reiteration by Federal Reserve chair
Yellen’s recent defense of increased
or no monetary policy track record,
Janet Yellen that the Fed is planning
financial regulations it seems likely
such as White House adviser Gary
to raise the fed funds rate four times
that President Trump will decide to
Cohn, and investors are largely
by the end of 2018. Yellen also
nominate someone new. Two of the
uncertain regarding their philosophies
pledged that the Fed will press
people the president is rumored to be and outlooks. At present, Warsh
forward this month with its plan to
considering – Kevin Warsh and John
appears to be the favorite for the top
begin unwinding its $4.5 trillion
Taylor – have been critical of the
spot.
balance sheet. $6 billion worth of
Fed’s quantitative easing policies
maturing Treasuries and $4 billion of agency MBS will be allowed to roll off the balance sheet monthly, with both of these figures set to increase during the next year. Barring an unforeseen shock to the economy during the next few months it appears likely that the Fed will raise
the fed funds rate in December and will stick to its plan to begin gradually unwinding its balance sheet. The exact pace of monetary tightening in 2018, however, is less clear as there is significant uncertainty regarding the makeup of the Federal Reserve’s new
5 President Trump needs to fill three additional vacancies
faces significant turnover at the top of its organization
at the Federal Reserve Board, including the spot of Vice and some of the leading contenders for the top post are Chair as the highly respected academic economist and
significantly more hawkish than Ben Bernanke, Janet
Yellen ally Stanley Fischer recently announced his
Yellen, and Stanley Fischer. This, at the same time the
retirement. How President Trump decides to move
Fed begins to implement its balance sheet reduction
forward with these nominations will have big
plan, could lead to some significant volatility in the fixed
implications for monetary policy, interest rates, and
income markets during the coming months.
economic growth during the next few years. The new Fed leadership team will undoubtedly face difficult choices as it attempts to navigate the unwinding of the Fed’s $4.5 trillion balance sheet – something never before attempted. Even with the potential for more hawkish leaders at the
In another event that could impact interest rates, the White House is now promoting an outline of a tax reform package and there appears to be a reasonable chance that something meaningful will be enacted. The White House is aiming to lower the marginal income tax rate for many Americans, lower the corporate tax rate to
top of the Federal Reserve, investors remain skeptical of roughly 20%, and encourage U.S.-based corporations to Yellen’s announced plan to raise the fed funds rate four
bring money earned overseas back to the U.S.
times during the next year. As calculated using Treasury Discussions in Congress regarding the plan have only futures prices, investors currently see a 77% probability
recently begun and there is significant uncertainty
that there will be a rate hike in December, but just a
regarding what (if any) reforms will ultimately be
55% probability of a second hike occurring by next
implemented. The potential exists, however, for some
August. Investors see less than a 10% probability that
changes that could provide a modest boost for the U.S.
the Fed will be able to raise the fed funds rate four times economy and might help push interest rates higher. by the end of next year (while seeing a 4% probability of no change at all to the fed funds rate from its current level). A disconnect between the announced long-term plans of Fed policymakers and what investors expect to actually happen has been a mainstay of market dynamics during the last several years. A difference now, however, is that the Fed
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ECONOMIC FORECAST | Q4 2017
Given the dynamics listed, we believe the level of the
factor. There is a good chance the yield curve will
U.S. Treasury yield curve will drift higher in the coming
continue to steepen, but this will depend largely on what
months. The potential for a significant philosophical
tax reform package Congress passes and the exact
change among the Fed’s top leadership is the biggest
makeup of the new leadership team at the Federal
factor driving this forecast, though potential for the
Reserve.
implementation of tax reform is another significant
EQUITY BULL MARKET CONTINUES Equities rose again in the third quarter is up 20.5% year-to-date when
defensively, with full allocations to
with international stocks leading the
measured in U.S. dollars, but has
less cyclical sectors such as consumer
way. The MSCI Emerging Markets
returned just 7.7% when measured in staples and healthcare, and an
Index and MSCI EAFE Index (which euros.
underweight position to international
measures international developed
stocks. The U.S. dollar has fallen
stocks) returned 8.0% and 5.5%
The U.S. and global economies are
considerably this year but may rise in
during the quarter, while the S&P 500 gaining traction and corporate
the coming months if U.S. Federal
(domestic stocks only) returned 4.5%. earnings results this year have been
Reserve policymakers move forward
The MSCI All Country World Index,
with their plan to tighten monetary
solid, but the bull market in equities
a measure of the global stock market, has gotten quite long in the tooth and policy. Domestic equities are likely to has returned 17.7% year-to-date,
an eventual pullback should be
outperform emerging market and
while the S&P 500 has returned
expected. Consequently, our equity
international developed stocks if the
14.2%. The falling U.S. dollar (down
portfolios are positioned somewhat
dollar strengthens.
9.0% this year versus a basket of ten leading global currencies) has been the main factor explaining the recent disparity of foreign and domestic stock performance. The MSCI EAFE Index, for example,
7 Equity valuations remain elevated. The S&P 500 and MSCI All Country World Index are trading at 19.4 and 17.3x expected full-year 2017
earnings, which represent full valuations. These valuations may come under increased scrutiny during the next 3-6 months. The prospect of higher interest rates — possibly caused by policy error — and a reset of equity
and bond prices is real. In the present environment, some caution is in order.
— Brandon Fitzpatrick
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ECONOMIC FORECAST | Q4 2017
THIS PUBLICATION IS FOR INFORMATIONAL PURPOSES ONLY. THIS PUBLICATION IS IN NO WAY A SOLICITATION OR OFFER TO SELL SECURITIES OR INVESTMENT ADVISORY SERVICES, EXCEPT WHERE APPLICABLE, IN STATES WHERE D.B. FITZPATRICK & COMPANY IS REGISTERED OR WHERE AN EXEMPTION OR EXCLUSION FROM SUCH REGISTRATION EXISTS. INFORMATION THROUGHOUT THIS PUBLICATION, WHETHER STOCK QUOTES, CHARTS, ARTICLES, OR ANY OTHER STATEMENT OR STATEMENTS REGARDING MARKET OR OTHER FINANCIAL INFORMATION, IS OBTAINED FROM SOURCES WHICH WE AND OUR SUPPLIERS BELIEVE RELIABLE, BUT WE DO NOT WARRANT OR GUARANTEE THE TIMELINESS OR ACCURACY OF THIS INFORMATION. NEITHER WE NOR OUR INFORMATION PROVIDERS SHALL BE LIABLE FOR ANY ERRORS OR INACCURACIES, REGARDLESS OF CAUSE, OR THE LACK OF TIMELINESS OF, OR FOR ANY DELAY OR INTERRUPTION IN THE TRANSMISSION THEREOF TO THE USER. THERE ARE NO WARRANTIES, EXPRESSED OR IMPLIED, AS TO ACCURACY, COMPLETENESS, OR RESULTS OBTAINED FROM ANY INFORMATION CONTAINED IN THIS PUBLICATION. NOTHING IN THIS PUBLICATION SHOULD BE INTERPRETED TO STATE OR IMPLY THAT PAST RESULTS ARE AN INDICATION OF FUTURE PERFORMANCE. ALL RETURNS ARE MODEL RETURNS FROM A COMPOSITE.
DB Fitzpatrick 800 W. Main Street, Suite 1200 Boise, Idaho 83702 www.dbfitzpatrick.com | (208) 342-2280