Jonathan Marriott – Chief Investment Officer, LGT Vestra
The Federal Reserve kept rates on hold this month, what is the outlook for the rest of this year?
The Federal Reserve (Fed) raised rates at its March meeting and was not expected to make a move at this meeting. There was no press conference but the statement following the meeting had some interesting observations. This meeting follows the release of disappointing annualised first quarter growth data which came in at 0.7% quarter on quarter. The Fed noted that “the Labour market has continued to strengthen even as economic activity has slowed”, but more significant was that they deemed the slowing growth in the first quarter as “transitory”. They referenced the solid growth in consumption and that inflation continued to run somewhat below the 2% target; however, market and survey measures of longer-term inflation were little changed. In light of this outlook, the Fed continues to expect that “economic conditions will evolve in a manner that will warrant gradual increases in the federal funds rate”.
The market reaction was to price in a June rate hike as a done deal, with the probability from the futures market moving from 67% to 97%. The third rate hike is priced in for later this year, most likely in December. We will watch labour market and inflation indicators for a pick-up in actual or expected inflation, but for now we can expect the Fed to raise rates gradually and in line with market expectations.
The MSCI World Equity index has been up six months in a row, can this continue?
No market goes in one direction continuously and whilst up six months in a row represents a very solid performance, it is not that exceptional. In 2003/4 the index recorded eleven positive months in a row. There have been periods in the past where the market has risen for long periods with only a few isolated negative months. Many people are concerned that equity markets have become expensive. The MSCI world, in dollar terms, is up 175% from the lows of the financial crisis. However, relative to the pre-crisis peak in 2007, it is only up 12%. Markets tend to peak when very few people are concerned and to quote Alan Greenspan “irrational exuberance” takes over. He first used the expression in December 1996 three years before that bubble burst. At that time the MSCI world index was 80% below its subsequent peak and only 12% above the post bubble low.
In short, the answer to the question is yes it can continue. However, we may expect periods when confidence fades and markets correct but it will be difficult to trade these moves and the opportunity cost of not being invested may be large. With elevated investor cash levels, we are likely to continue to see investors buying dips which may limit the downside. Most measures that indicate that the market is expensive look at earnings relative to historic averages. If you review the earnings return for equities relative to long-term interest rates then they continue to seem attractive in comparison to bonds. Interest rates are rising slowly in the US and, in the long-term, they will move higher elsewhere in the world but we anticipate that the next peak in global rates will be lower than in the past. Thus, while we may see corrections in the equity markets, we still believe one needs to remain invested.
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