4th Quarter Market Commentary: What To Expect When You’re Expecting


October 9, 2015

Written by Nathan Erickson, CFA®, CAIA, Chief Investment Officer

Anyone who has had children or grandchildren in the last few decades is probably familiar with the book “What to Expect When You’re Expecting,” a guide to the questions new moms and dads have from the beginning of a pregnancy through the first few months after birth. It is laid out in a month-by-month format, with each month providing information based on the following statements: “What You May Be Feeling, What You Can Expect, and What You May Be Wondering About.”

What is Happening with the Fed?

Followers of financial market news may see similarities between the book and how markets seem to act regarding Federal Reserve Policy. The market seems to be quite emotional, trying to figure out what to expect from the Fed, wondering about all the data points and how they will be interpreted. Historically, the formula seemed fairly simple. Students of economics and frequent readers of the Wall Street Journal are likely very familiar with what the Fed’s key data points are regarding the Fed Funds rate policy. The standard statement the Fed has issued is as follows:

“The committee anticipates that it will be appropriate to raise the target range for the federal funds rate when it has seen further improvement in the labor market and is reasonably confident that inflation will move back to its 2 percent objective over the medium term.”[1]

That sounds pretty straightforward; the key drivers to raising rates are the labor market and inflation. It almost sounds like something one might find in the above referenced pregnancy guide – “If your water breaks and you’re having contractions, you’re probably in labor and should go to the hospital.”

The common logic in economics is that the Fed raising rates is a reflection of the committee’s belief that the economy is strong, and in some cases a precautionary measure to ensure growth and inflation do not get out of control. If the labor market is healthy and inflation is positive, that indicates a strong economy. While the recent economic recovery has been substantially different than previous recoveries, the logic remains intact that the Fed will only raise rates if they believe the U.S. economy is strong enough to support it.

Given the Fed’s previous guidance, market participants have been watching these data points closely leading up to the Fed meeting September 16-17. There was reasonable confidence that the Fed would indeed raise rates; however, the Fed chose not to raise rates in September, and the volatility we have experienced since that point primarily reflects the uncertainty that has been created around the committee’s decision to introduce other factors into the equation:

“Recent global economic and financial developments may restrain economic activity somewhat and are likely to put further downward pressure on inflation in the near term. Nonetheless, the committee expects that, with appropriate policy accommodation, economic activity will expand at a moderate pace, with labor market indicators continuing to move toward levels the committee judges consistent with its dual mandate.”[2]

The key word in the above statement is “global.” Foreign markets, particularly emerging markets, experienced substantial volatility in the 3rd quarter, which was driven primarily by changes in expectations of growth in China. The Fed introduced concern that a slowdown in China may impact growth and inflation in the U.S.; therefore, they did not raise rates.

What You may be Feeling

If we respond to the first statement from the first paragraph on behalf of the market, the market feels confused and uncertain. If labor markets and growth are improving, that implies inflation will pick up, which means the economy is doing better. However, not raising rates implies that the Fed lacks confidence in the U.S. economy’s improvement. Where markets thought there was some certainty, there is now more uncertainty.

What You can Expect

As investors, what can we expect? Unfortunately, without clarity on what really matters in the Fed’s decision making process, we can expect more uncertainty leading to more volatility. The Fed has stated that they expect to raise rates in 2015, and there are two opportunities to do that: the October meeting and the December meeting.

What You May be Wondering

There are many things market participants are wondering about. What if emerging markets are volatile again? What impact will the fact that 2016 is an election year have on policy decisions? What if there is a government shutdown? What if labor market data points are weaker than expected?

Fortunately for Miller Russell Associates and our clients, the uncertainty in markets does not mandate a change in our asset allocation decisions. Regardless of whether the Fed raises rates in 2015, 2016, or later, our clients’ portfolios are positioned for the current low growth environment which may persist for some time. While markets, like the pregnancy guide, are focused on a short window of time, our portfolios are focused on long-term growth. Similar to raising a child from birth to adulthood, we know there will be tough moments. The key is not to avoid them but to navigate them appropriately and remain focused on the end goal.

With that in mind, our greater concern continues to be the low returns we expect from traditional markets over the next several years. Until the economy strengthens and interest rates go up, investors are no longer receiving a portion of return that used to exist, namely a risk-free rate and a growth premium. It is our job as your advisor to address these longer term problems, which we have done through some of the investments in multi-strategy such as reinsurance, the best performing asset class year to date. However, we don’t believe portfolios are ever “perfect,” and our work is never done. This quarter, if you haven’t already, you will hear about another opportunity to consider that we expect will improve the risk/reward trade-off in fixed income. As fiduciaries and stewards of your capital, it is our belief that these efforts reflect our highest objective – to add value to your portfolio and increase the probability of meeting your long-term investment objectives.

[1] “When Will the Fed Raise Rates?”. The New York Times. October 2, 2015. http://www.nytimes.com/interactive/2015/business/economy/fed-interest-rates.html?_r=1

[2] “When Will the Fed Raise Rates?”. The New York Times. October 2, 2015. http://www.nytimes.com/interactive/2015/business/economy/fed-interest-rates.html?_r=1

To view a downloadable version of the Q4 Market Commentary please click here.

Written By

Mark Feldman

Nathan Erickson

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