Financial Markets Outlook 10th Annual Rocky Mountain Economic Summit Victor, Idaho July 12, 2018 Bill Kennedy, CFA Chief Investment Officer
Investment Observations 1. Global liquidity is shrinking 2. Real interest rates are rising 3. This economic cycle has another year to run but a U.S. recession is highly likely in the next three years 4. Coming populist backlash
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Global Liquidity is Being Drained
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Global Liquidity: Central Bank Liquidity is Shrinking Central bank asset growth rate is -1%; QT is working Cumulative assets of the top 6 global central banks (US$ billions) Source: St. Louis Fed, Fieldpoint Private 25,000
Central Bank Assets % YoY 25%
20%
20% 20,000
15%
15%
13%
10%
7%
SNB
ECB
BOJ
PBOC
Fed
11%
9%
5%
BOE
3%
3%
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15
$21.3 trillion
$20.1
0% -1%
-5% 15,000
10
11
12
13
16
17
18 (est)
10,000
5,000
0 2004
Source: Citi Research, Bloomberg, Fieldpoint Private 05
06
07
08
09
10
11
12
13
14
15
16
17
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18 (est)
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Global Liquidity: Shortage of U.S. Dollar Liquidity
Tax Reform
Source: Citi Research, Bloomberg, Fieldpoint Private
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Real Interest Rates are Rising
Positive real yields
Negative real yields
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Higher Real Interest Rates = Lower Asset Values
Higher discount rates decrease valuations
Building blocks of the discount rate EQUITY CREDIT SOVEREIGN
Discount Rate
Asset Fair Value Real policy rate
Inflation premium
Term premium
Credit risk premium
Equity risk premium
Source: PIMCO, Fieldpoint Private
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This Is The Second Longest Cycle on Record
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U.S. Economy Consistent With Our 3% Growth Outlook U.S. economic and inflation data is weakening
No signs of an immediate recession
Citi Economic Surprise Index, Citi Inflation Surprise Index, U.S. Source: Bloomberg, Citigroup, Fieldpoint Private
U.S. durable goods new orders (ex transportation) Source: Bloomberg, US Census Bureau, Fieldpoint Private
Retail and consumer spending are soft. Manufacturing shifted into high gear with a pick up in industrial activity. Higher goods production is leading to higher freight volumes. Loan demand is picking up. Banks are competing, but funding costs are rising faster than lending rates = margin squeeze (lower NIM). Delinquency rates are stable. Prices already rising for steel, aluminum, lumber, cement, labor, construction and transportation. Tariffs will raise prices for equipment/machinery and hurt prices for agricultural commodities. Please See Important Disclosures in Back of Presentation
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Global Economic Momentum Slowing (OECD Leading Economic Indicators)
AUS AUT BEL CAN CHE CHL CZE DEU DNK ESP EST FIN FRA GBR GRC HUN IRL ISR ITA JPN KOR MEX NLD NOR NZL POL PRT SVK SVN SWE TUR USA
1Q17 1.65 1.31 -1.79 1.07 1.39 -0.51 -1.31 1.39 1.08 1.44 -1.43 1.07 1.15 0.56 -0.71 1.27 1.02 1.16 -1.20 1.00 1.33 -1.23 1.24 1.02 1.40 -1.92 1.84 -0.87 0.63 1.25 1.74 1.01
2Q17 0.54 1.25 -1.04 0.94 1.29 1.64 -1.32 1.42 1.24 -1.77 -0.75 1.29 1.37 -1.40 1.22 1.03 -0.91 -1.60 1.83 1.32 0.20 -0.99 0.94 0.26 1.45 -1.56 1.53 1.69 -1.53 0.94 1.48 0.14
3Q17 -1.51 1.27 1.77 1.54 1.28 1.23 -1.01 1.24 0.96 -0.59 1.69 0.77 0.83 -1.65 -1.76 0.87 -1.47 0.04 1.45 1.21 -1.62 -1.14 1.48 1.78 1.37 -1.14 0.37 1.21 -0.35 -1.39 0.99 1.90
4Q17 -1.60 1.19 1.01 0.56 0.72 1.16 -1.76 0.48 -0.61 1.25 -1.87 -1.76 -1.84 -1.39 -0.95 -1.68 -1.49 1.45 0.93 -1.62 -1.39 -1.70 0.90 1.37 0.84 -1.00 -1.56 0.89 1.02 -1.60 -1.58 1.48
1Q18 -1.44 0.08 -1.78 -1.66 -1.71 1.13 -1.21 -1.66 -1.66 -1.82 -1.45 -1.56 -1.56 -1.47 1.62 -0.20 -1.54 0.72 -1.72 -1.59 -1.23 -0.89 -1.78 0.75 1.89 -0.56 -1.32 -1.75 -1.75 -1.26 -1.51 1.27
2Q18 -1.49 -1.90 -1.67 -1.67 -1.81 -0.23 -1.20 -1.54 -1.65 -1.11 -1.43 -1.44 -1.65 -0.97 -0.52 -0.18 -1.43 1.76 -1.75 -1.09 -1.17 0.71 -1.44 0.30 0.87 2.02 -0.08 -1.82 -1.47 -0.95 -1.57 0.95
LEI momentum is slowing
LEI momentum is accelerating
Source: OECD, Fieldpoint Private Please See Important Disclosures in Back of Presentation
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The Rise of Populism
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Drivers of Populism: Hollowed-Out Living Standards Real Disposable Personal Income per Capita Ten year % change, a.r. 1970-2018 Source: Federal Reserve Bank of St. Louis, Fieldpoint Private 5%
4%
3%
2%
1%
0%
Source: Hoisington Investment Management, Quarterly Review and Outlook – 4Q2016 Please See Important Disclosures in Back of Presentation
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Drivers of Populism: Broken Social Contracts
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Manifestations of Populist Backlash •
Protectionism and de-globalization
•
Economic nationalism
•
Aggressive fiscal spending
•
Loss of central bank independence
•
Wealth redistribution from winners to the losers of globalization and digitalization
•
New and higher taxes on wealth / assets
•
Universal basic income
Lower Growth + Higher Inflation = Stagflation!
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Investment Outlook – 12 Month View The Three “D’s” 1. Summer Doldrums 2. Trade Détente 3. Deliverance (2019)
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Fieldpoint Private Risk Radar This chart shows the number of standard deviations from the mean each metric is on a given day
Elevated risk
Unusually quiet
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Assets Behave Differently Across Macro Regimes
4Q18 3Q18
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Different points of the cycle require different allocations
Early cycle
Low quality / high beta stocks Industrials Emerging markets HY credit Hedged equity Private equity
Mid cycle
Growth stocks Tech Banks IG credit Converts/Preferred Hedged equity Commercial real estate
Late cycle
Cash High quality / low beta stocks Insurance stocks Floating rate notes Hedged credit Commodities including gold
We are here
Source: Fieldpoint Private
Internal Use Only Please See Important Disclosures in Back of Presentation
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Commodity Prices Relative to Stocks are at Multi-Decade Lows
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Commodity Prices are Already Low
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Key Takeaways 1. We have entered the dark phase of central bank intervention – the unwinding. Monetary normalization will test the financial system through a series of mini-crises and market turbulence. 2. Global liquidity is shrinking due to (a) quantitative tightening (QT) and (b) tax reforms. This is putting upward pressure on the U.S. dollar, a major risk to the dollarized global economy. We expect weaker USD post midterms. 3. Real yields will rise as monetary policy normalizes and fiscal policy picks up. Expect lower returns and higher volatility of asset prices. There will be greater differentiation between good and back capital allocators. Active management will begin to outperform index-based investing. 4. This economic cycle has another year to run but a U.S. recession is highly likely in the next three years The corporate profit cycle is alive and well until wage growth reaches 4%. The credit cycle will turn before the equity cycle. 5. A populist backlash will manifest itself through economic nationalism, protectionism, increased fiscal spending, and loss of central bank independence 6. Near-term outlook: the three “D’s” - doldrums, détente and deliverance.
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The Time to Prepare for a Bear Is Before It Arrives
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