Global markets were roughly unchanged last week (S&P500 +0.1%), but volatility picked up as investors appear to be increasingly focusing on a more hawkish Fed and other key central banks talking that direction as well. This tone shift is probably appropriate based on sound economic readings being more normal including (actually low) unemployment rates, steady inflation, and reasonable economic growth; conditions that cannot be described as anything like a crisis or warranting of extraordinarily accommodative monetary policies in which they were implement. But the prospect of diminishing monetary stimulus introduces anxiety for those who firmly believe that asset prices have largely moved over the last 8 years due only to that central bank support. In recent weeks, US equities have struggled for direction, but do feel to be awakening from an extended period of very small intra-day trading ranges. In similar fashion, international markets have also slowed their pace of robust progress that was enjoyed through the first five months of 2017. Interestingly however, the conflicting narrative for economic conditions coming from rising equity prices (suggesting economic improvement) but slipping bond yields and flattening yield curves (which would suggest weakening forward outlooks) appeared to revert a bit last week and in short-term support to the more bullish case.
On the economic front, the big news out last week was the much better than expected employment report for June. Not only was the headline number of jobs added very strong, but there were upward revisions to prior month readings; the details of the report were equally encouraging with the average workweek increasing as well as workforce participation. In addition, surveys of corporate managers across a variety of industries broadly reflect a favorable environment not just in the US but abroad as well. At the same time however, oil prices continue to plumb low levels; two years ago the narrative on negative price action from oil was slumping global demand and created spillover caution and worry over what it suggested about the broader economic climate. Today the markets seem to be maintaining the perspective that falling prices are a function of too much supply rather than a more troublesome indicator. Yet, the price bears watching as it historically has translated into higher borrowing costs for much of the high-yield issuer universe and increased their refinancing risk. We also see
Bringing it all together, what appears most clear is that we are at the onset of a new monetary environment; more mixed than witnessed over most of the last 8 years wherein everything seemed to error on the side of being too easy. More immediate term, corporate earnings season for the now complete 2Q looks to commence this week as well; many anticipate that it will be another quarter where, not unlike the favorable 1Q period, will show companies posting results that well exceed year-ago levels. More uncertain is how reported earnings will stack up against analyst expectations which have been ratcheted up after the 1Q observation that year-ago levels still make for relatively easy comparison (so how much of a beat is already priced-in?). And while the US Fed has been telegraphing its desire to normalize monetary policy for well more than a year, the jury is out on how markets will react to the change in tone and how soon it might morph into action from the ECB (Europe: perhaps the 2nd most influential central bank in the world). We should be careful to remind ourselves that rate increases should not be viewed as a negative when done prudently or carefully as seems to be the appetite; in direct response to improving economic growth and in prevention of too strong price inflation. So long as central bankers do not collectively create an environment wherein financial conditions are excessively tight such that it restricts growth or causes something to break, higher interest rates and returns on money are a good thing for investors. With global real short rates still well-negative (below the pace of reported inflation), it is hard to argue that financial conditions themselves are anywhere near tight; rather the regulatory environment and uncertainty are arguably what has created tight financial conditions and to a large extent limited the effectiveness of monetary policy. From that perspective, it is important that fiscal policy become more sensible (not restricting the ability to borrow for those who show the ability and desire to repay, while excluding access to those who are clearly not in a position to do so). Rising rates are generally in response to an improving growth outlook.