A Cautious Start to 2015

Market Commentary

  • Central bank policies remained divergent in early 2015, as low inflation and slow labor market gains were further complicated by different stages of economic recovery.
  • Fixed-income market performance was mostly positive, led by U.S. dollar-denominated debt; local-currency debt was marginally negative.
  • Global equity markets decline; the health care sector performed best, while energy remained the worst performer.
Economic Backdrop

A range of monetary policy stances was on display during the first month of 2015. Major central banks faced a challenging combination of falling inflation (or even deflation), slow labor-market improvement, and economies at different stages of recovery. In a departure from recent split panels, the Bank of England's Monetary Policy Committee voted unanimously to keep rates unchanged for the seventieth consecutive month. A European Central Bank decision to initiate a 1 trillion Euro asset-purchase program, which will include government and private sector debt securities, was scheduled to begin in March. However, the announcement was preceded by the Swiss central bank's decision to remove a cap on the value of its currency against the euro, and followed by revelations that Greece's new Syria-led government intended to change the terms of the nation's sovereign debt repayments. Both developments have challenged euro zone stability. The U.S. Federal Reserve remained on hold, as the bank's Federal Open Market Committee reiterated its patient posture, implying benchmark interest rates would remaining near zero at least through its next meeting and perhaps longer. The Bank of Japan maintained its annual 80 trillion yen asset-purchase program, but adjusted near-term inflation estimates downward.

Extraordinarily strong sentiment persisted among U.S. consumers during January for the sixth consecutive month, according to the University of Michigan, reaching the highest assessment of current conditions since 2004. Initial jobless claims were volatile and started the year somewhat positive as holiday-season hires stayed on the job, but elevated to multi-month highs by mid-January before falling to the lowest level in almost 15 years. U.S. payrolls expanded in December and the unemployment rate edged down to 5.6%, while wage growth declined. Employment costs rose 0.6% during the fourth quarter, slightly below the third-quarter rate. U.S. manufacturing growth settle in January to its softest reading in a year, according to 'Markit'. Falling oil prices not only contributed to energy-sector weakness, but also to the first decline in input prices in over two years. Similarly, the Philadelphia Federal Reserve's business conditions survey indicated a manufacturing falloff in January for the second consecutive month. Mortgage applications began January at multi-year highs, based primarily on refinancing activity that was driven by declining interest rates. Growth was evident in December for new and existing home sales and housing starts, although pending sales tapered off. The U.S. economy grew by 2.6% annualized in the Fourth quarter, more slowly than the third quarter's 5% annualized rate. Eurozone industrial production was anticipated to reach multi-month highs in January on modest gains stemming primarily from strong manufacturing orders, as input costs decline. Manufacturing activity rose in December, as orders increased from stall speed during the fall. Accordingly, economic sentiment edged upward in January. The incremental rise was attributed largely to improved sentiment in the consumer, retail and industrial sectors, while the construction and services industries remained weak.

Consumer confidence continued to increase in January, potentially due to lower energy costs. While spending has not yet increased relative to confidence, consumers are at their most confident level since July.

The jobless rate slipped in December to 11.5%, the lowest since 2012, marking the first employment gain since August 2014.

A strong U.S. dollar combined with weak commodity prices has increased investor concerns over deflation risk. A disinflationary, rather than deflationary, environment is still a base case scenario for emerging markets (EM) in 2015, as EM central banks still have plenty of room to ease their monetary policies. However, aggressive rate cuts are not likely, as many EM governments are aware that structural reforms are the key to more sustainable economic growth in the future.


The GOP Can No Longer Blame Harry Reid for Obamacare

Here is where Obamacare, like Mistletoe growing on a tree, may have reached its limit. Already, some 25% of the uninsured are choosing not to enroll, preferring the (tax) penalty to the premiums. What happens when people simply cannot pay? How much more can Obamacare bleed from taxpayers, productive businesses and Americans who are not yet destitute? And what happens when the medical system cannot sustain the load any longer? This is a huge national problem. If the GOP doesn't address this, who will. Having won the Senate, Republicans can no longer blame Harry Reid for their failure to repeal or defund Obamacare. They can't just take symbolic votes and complain at least (not too loudly) when bills get bottled up in the Senate. It's on them now. Obamacare is extremely unpopular. Millions have already been hurt by it, and the real pain is still coming. Millions of insurance cancellations, IRS penalties and sticker shock for renewal premiums are about to hit. And that's just the financial pain. Loss of access to physicians and hospitals and the diversion of physicians' attention to compliance regulations instead of patient needs. It's also harder to blame the government instead of doctors. Against the government, there is nowhere to turn.

Not all of these problems are from Obamacare alone, but can be also traced to previous laws such as the HITECH Act and other "incentives" for physicians to buy expensive error-ridden computer systems and follow protocols - or else be punished. Every mandate, and every dollar taken from the taxpayers, is income to somebody: managed-care cartels, information technology vendors, government bureaucracies, etc. With every day that passes, Obamacare thus becomes more deeply rooted and harder to extirpate. And then there's the reckless disregard for the law that has characterized implementation: selective waivers, politically motivated delays and blatantly rewriting the law to provide taxpayer subsidies explicitly forbidden in exchanges not created by states. Congress needs to start now and pass well-publicized bills to mitigate damages, pending repeal.

Current U.S. Economy

By most measures, the U.S. economy is continuing to do quite well. Accelerating job gains and increased income have helped boost the confidence of American consumers, as well as prospects for sustained growth. While the large decline in oil prices and the rise in the dollar are producing both winners and losers, we believe these factors are a net benefit to the U.S. economy, given its domestic consumer orientation. Although manufacturing can be expected to suffer somewhat in coming months, and net trade will be a drag, the collective benefits of both to the much larger domestic sector of the economy should help ensure that overall U.S. growth remains strong. The diverging fortunes of domestic demand and net external demand are already being reflected in recent data releases. Business surveys within the manufacturing sector indicate that conditions have slowed. With its larger exposure to trade and inputs into the oil sector, the stronger dollar is making U.S. exports more expensive overseas. At the same time, demand for them continues to be sluggish. While global indicators have shown signs of improvement, and the recent rebound in oil prices has reduced downside risks, I believe the outlook outside of the U.S. remains weak. However, there are some early positive signs coming from Europe.

I am skeptical about quantitative easing improving economic growth in Europe, where long-term structural problems cannot be resolved by a flush of liquidity. The last-minute agreement to the latest Greece crisis is yet another example of European policy-makers' resolve to avoid a day of reckoning. This serves as a reminder of how a currency union without a complete banking, political, and fiscal union is not viable long-term, particularly given the economic imbalances between the weaker peripheral nations and the stronger nations in the core. The Euro has now dropped to $1.10 to the U.S. dollar.
Disclosure - This material represents an assessment of the market environment at a specific point in time and is not intended to be a forecast of future events, or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding the funds or any stock in particular, nor should it be construed as a recommendation to purchase or sell a security, including future contracts.

Past performance does not guarantee future results.