Three Trends To Watch For The Rest Of 2016

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MMM Newsletter and Website Header 10.2.15I hope you had a great weekend! It is almost time to start thinking about your Halloween costume!

LRPC’s Monday Morning Minute for this week, “Three Trends To Watch For The Rest Of 2016” (presented below) comes to you courtesy of Lord Abbett. As an independent, objective Registered Investment Advisory firm, Lawton Retirement Plan Consultants, LLC has access to research from many sources. Be assured that I will share enlightening, useful information with you each week. If you are short on time, make sure you take a look at each of the headings

What’s going to happen in the markets for the rest of this year? Take a look below at what economic trends the experts from Lord Abbett think we should focus on.

Have a wonderful week!

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Three Trends To Watch For The Rest Of 2016

By Zane E. Brown, Lord Abbett

In Brief

  • Summer 2016 has been anything but quiet for investors, with the “Brexit” vote, troubles in the Italian banking sector, expectations of U.S. economic improvement, and the prospect of a U.S. interest-rate hike dominating the headlines.
  • With investors focused on how the rest of 2016 could play out, we have identified three economic trends to keep an eye on in the coming months: 1. Both the U.S. economy and U.S. Federal Reserve policy seem headed higher, 2. Key economies outside the United States seem at greater risk, 3. Central bank policy responses could perpetuate “lower for longer” rate.
  • The key takeaway — U.S. economic resilience, the likelihood of slower growth elsewhere, and “lower for longer” monetary policy among developed countries could encourage investors to reposition their portfolios during the remainder of 2016.

With the U.S. Labor Day holiday over and the kids back in school, financial markets are taking stock of Summer 2016. If investors were expecting a quiet, uneventful season, they were disappointed. The global investment environment has changed meaningfully since June. The surprising decision by Britain’s voters to opt for “Brexit” in late June, continuing troubles in the Italian banking sector, expectations of better second half growth in the United States, and renewed likelihood of a rate hike by the U.S. Federal Reserve (Fed) suggest investors may want to perform a post-Labor Day check-up on their portfolios.

What are the important economic trends they should be watching as we head into the year’s home stretch? And how might they wish to position their portfolios? Here, we’ll attempt to answer those questions.

Trend #1: Both the U.S. economy and Fed policy seem headed higher

Evidence of economic growth in July and August suggest stronger second-half gross domestic product (GDP) growth in the United States than the 1% average of the past three quarters. Inventories, which subtracted 1.26% from second-quarter GDP and have been declining for three quarters, should stabilize if not reverse. Similarly, business investment could benefit from oil price stability, as evidenced in recent improvements in the number of oil and gas rigs in operation. In other areas, recent releases suggest housing remains a source of strength, while expectations that government spending may increase imply hope for additional support later this year.

Most relevant to the economy, as well as Fed policy, is persistent job growth and the accompanying wage improvement. With consumption accounting for nearly 70% of U.S. GDP, the combination of continued job growth and higher wages provides core strength to the resilience that defines the U.S. economy. Persistent strength in the world’s largest economy, rooted in jobs growth and rising wages, resonates with policymakers hoping to normalize interest rates. Futures market indications of rate-hike probabilities of 62% in December (according to Bloomberg), are far different than the zero chance seen just after the Brexit vote in June.

Also different than the early days of summer is the Fed’s discussion of the natural rate of interest, or r-star (r*).  (The natural, or neutral, interest rate refers to the real fed funds rate plus an adjustment for long-term inflation.) In fact, there was no discussion of r* in June. The reappearance of r* on the policy radar is important because it reframes the Fed’s perception — and therefore, investment strategy considerations — about how much and how rapidly rates need to move to normalize.

If the Fed concludes, as comments surrounding its August symposium in Jackson Hole, Wyoming, imply, that r* is lower than it has been historically then current monetary policy is not ultra-accommodative, only modestly accommodative. The concept of “lower for longer” can now be appropriate policy if the Fed has a lower final target for rates. A slow pace of rate hikes with a much lower target end rate reduces the potential damage to bonds during this rate cycle and allows investors greater comfort with equity valuations that compare favorably to a lower rate regime.

Trend #2: Key economies outside the United States seem at greater risk

Since the beginning of summer, several key developments have increased the likelihood of economic slowdown in specific regions, as well as globally. Recent developments that carry potential negative economic consequences include Brexit as well as Italy’s banking crisis. The absence of politically expedient solutions to these issues suggests at best, continued uncertainty that dampens business investment and consumer spending and at worst, culmination in an event of serious economic downturn.

The flurry of concern following Brexit subsided quickly but the unavoidable negative economic impact on the United Kingdom has barely started. The glacial approach to negotiations with the European Union has, in the short term, enabled U.K. exporters to take advantage of a weak currency, but it also has increased business uncertainty that will likely be expressed in delayed hiring and reduced investment. In anticipation of acrimonious negotiations and potential “outsider” status with regard to exporting to EU countries, London-based companies are considering their own exit. For example, Vodafone, a multinational telecommunications company, has announced consideration of such a move. U.S. and international banks have announced possible moves. Auto manufacturers in the United Kingdom export more than they sell domestically; a significant tariff on exports to EU countries could shift production and company headquarters from the United Kingdom to an EU country such as Spain.

Such exits will no doubt continue to erode support for U.K. real estate, both commercial and residential. Already we have seen that for July, the first full month after Brexit, the Bank of England reported that U.K. mortgage approvals dropped 12.4% year over year, to the lowest level in 18 months. In addition, a weak currency will increase the cost of imported goods, crimping consumption. A recession in the U.K. seems hard to avoid.

The United States is not heavily dependent on the United Kingdom as an export market, so a U.K. slowdown should have little direct impact on the U.S. economy. The European Union, on the other hand, is an important U.K. trading partner. Trade tariffs on both sides of the U.K. /EU border will increase costs and dampen trade. Slower regional growth seems likely. There will be investment opportunities as these developments unfold. For example, U.K. exporters that target countries other than the EU seem poised to perform well. U.S. domestic companies will remain largely unaffected, while exporters that compete with U.K. companies and multinationals with important revenue sources in the United Kingdom stand to be compromised by the effects of the pound’s devaluation.

In another important development, Italy’s banking crisis coincides with a constitutional referendum, the combination of which could create new instability in the EU. With €350 billion of non-performing loans, or 18% of total loans outstanding, Italian banks need a bailout. EU rules demand that a bailout cannot take place unless bondholders absorb some of the loss. Unfortunately, 45% of Italian bank debt is held by individuals who stand to lose a substantial portion, if not all of their investment, according to Bloomberg. If no accommodation is made to avoid such losses and Brussels essentially blocks an Italian bank bailout, Prime Minister Matteo Renzi’s party could be voted out at the next election and possibly replaced with the Eurosceptic Five Star Party, a populist movement started nearly seven years ago by Beppe Grillo, a popular comedian and blogger, and Gianroberto Casaleggio, an Internet strategist.

Such a vote may not have to wait for general elections. Renzi has promised to resign if his proposed upcoming referendum on constitutional reform is not passed. In addition to Brexit, we could see discussion of “Italeave,” a prospective departure from the European Union. Because Italy’s exit would accelerate the viability of EU dissolution, this complex issue will somehow get resolved. However, plan on volatility in the interim, with the Euro as well as bank stocks bearing the brunt. In addition, expect little growth from Italy as banks, even recapitalized, seem unlikely to lend aggressively.

Trend #3: Central bank policy responses could perpetuate “lower for longer” rates

Key global developments have reinforced accommodative monetary policy among developed countries. Concerns about Brexit dampened the Fed’s enthusiasm for raising rates in July while the Bank of England responded to Brexit with one rate cut so far; another is expected later this year. If Brexit negotiations lead to trade barriers between the United Kingdom and the European Union, or weak growth is otherwise assured, expect the European Central Bank to extend its quantitative easing (QE) beyond its soft end date of March 2017. The Italian banking crisis could encourage more aggressive negative interest rate policy (NIRP) by the ECB. Japan has left its options open with regard to increasing both NIRP and expanding QE, hoping for evidence that something will help growth, or at least weaken the yen.

Even in the United States, where the Fed hopes to normalize rates, discussion about a lower neutral interest rate reduces the slope and the long-term target of their rate hike path. Such an approach, combined with demand from global investors seeking the higher yields available in the United States, should support prices of U.S. fixed income and likely flatten the yield curve as the Fed adjusts short rates higher.

Economic trends — Investment conclusions

“Lower for longer” may be anathema for insurance companies and may create a difficult environment for some banks, but U.S. fixed-income investments are poised to benefit, as are U.S. equities, whose valuations are based on low-yielding bond alternatives. Similarly, Brexit and problems with Italian banks will impede regional and to some extent global growth, but collective monetary policy and some potential fiscal stimulus should help mitigate any slowdown. In the United States, a consumer-driven economy should maintain much of its immunity to adverse foreign developments as it continues to muddle along with help from persistent job growth, modest wage increases, a cautious Fed, and potentially some fiscal stimulus in the form of infrastructure spending and corporate tax changes.

U.S. economic resilience, the likelihood of slower growth elsewhere, and “lower for longer” monetary policy among developed countries are the key themes that emerged over the eventful summer of 2016. These developments could encourage investors to reposition their portfolios to capture the investment consequences of a changed environment.   

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About LRPC’s Monday Morning Minute
Lawton Retirement Plan Consultants, LLC (LRPC’s) Monday Morning Minute is crafted to provide decision-maker’s with important information about the economy, investments and corporate retirement plans in a format that allows a reader to consume the information in less than 60 seconds. As an independent, objective investment adviser, LRPC has access to many sources of research and shares the best and most relevant information with its readers each week.

About Lawton Retirement Plan Consultants, LLC
Lawton Retirement Plan Consultants, LLC is a Milwaukee, Wisconsin-based independent, objective Registered Investment Advisory (RIA) firm providing investment advisory, fiduciary compliance, employee education, vendor management and plan design services to retirement plan sponsors. The firm currently has contracts in place to provide consulting services on more than $400 million in plan assets. For more information, please contact Robert C. Lawton at (414) 828-4015 or bob@lawtonrpc.com or visit the firm’s website at http://www.lawtonrpc.com. Lawton Retirement Plan Consultants, LLC is a Wisconsin Registered Investment Adviser.

Important Disclosures
This information was developed as a general guide to educate plan sponsors and is not intended as authoritative guidance, tax, legal or investment advice. Each plan has unique requirements and you should consult your attorney or tax adviser for guidance on your specific situation. In no way does Lawton Retirement Plan Consultants, LLC assure that, by using the information provided, plan sponsor will be in compliance with ERISA regulations. Investors should carefully consider investment objectives, risks, charges and expenses. The statements in this publication are the opinions and beliefs of the commentator expressed when the commentary was made and are not intended to represent that person’s opinions and beliefs at any other time. The commentary does not necessarily reflect the opinion of Lawton Retirement Plan Consultants, LLC and should not be construed as recommendations or investment advice. Lawton Retirement Plan Consultants, LLC offers no tax, legal or accounting advice and any advice contained herein is not specific to any individual, entity or retirement plan, but rather general in nature and, therefore, should not be relied upon for specific investment situations. Lawton Retirement Plan Consultants, LLC is a Wisconsin Registered Investment Adviser and accepts clients outside of Wisconsin based upon applicable state registration regulations and the “de minimus” exception.

Additional Important Disclosures
A Note about Risk:  Forecasts and projections are based on current market conditions and are subject to change without notice. Projections should not be considered a guarantee. The Fed funds rate is the interest rate at which a depository institution lends immediately available funds (balances at the Federal Reserve) to another depository institution overnight. Gross domestic product (GDP):  The monetary value of all the finished goods and services produced within a country’s borders in a specific time period, though GDP is usually calculated on an annual basis. It includes all of private and public consumption, government outlays, investments and exports less imports that occur within a defined territory. The opinions in the preceding commentary are as of the date of publication and subject to change based on subsequent developments and may not reflect the views of the firm as a whole. This material is not intended to be legal or tax advice and is not to be relied upon as a forecast, or research or investment advice regarding a particular investment or the markets in general, nor is it intended to predict or depict performance of any investment. Investors should not assume that investments in the securities and/or sectors described were or will be profitable.  This document is prepared based on information Lord Abbett deems reliable; however, Lord Abbett does not warrant the accuracy or completeness of the information. Investors should consult with a financial advisor prior to making an investment decision.