Yahoo Finance 3 top strategists debate the impact of the Fed, the election and earnings
The final three months of 2016 comes with the answers to many lingering questions. We’ll get the results of a contentious presidential election in the US, an assessment of third quarter corporate financial health, and—if the markets are right—the first rate hike from the Federal Reserve since December.
So as the fourth quarter kicks off, what should we expect into the end of 2016 and next year?
To help tackle the biggest questions facing the market, three top experts joined Yahoo Finance for a roundtable discussion: Torsten Slok, Chief International Economist from Deutsche Bank; Gina Martin Adams, Head of Equity Strategy at Wells Fargo Securities; and Jonathan Golub, Chief Equity Strategist at RBC Capital Markets.
Fed expectations
The Fed—and commentary from Chair Janet Yellen along with other members—have continued to drive markets. After the Fed passed on raising rates at their meeting in September, the market’s expectations for a rate hike by December have climbed to over 50%.
Slok, Golub and Adams agreed expectations of a 25 basis point rate hike are largely priced into the markets, but Slok explained the lower-for-longer rate environment reflects a Fed that has been too optimistic for too many years.
As seen in the chart below, expectations for rate hikes were significantly higher going back several years.
“A striking development over the last five or six years has been that continuously the Fed has said rate hikes are just around the corner,” Slok said. “But again and again, we have seen that they haven’t been able to deliver on that because the economy didn’t quite perform as they expected … That’s why I think there is this point where the market is not believing that rate hikes are coming. There’s an incredible amount of skepticism around whether the Fed will actually hike and what the speed of rate hikes will be.”
Slok added there is a lot at stake if the Fed doesn’t hike in December, particularly after holding off in March because of China, holding off in June because of Brexit, and holding off in September because of still-low inflation.
Adams added the biggest long-term threat is the flattening of the yield curve, which could result in what’s called an “inverted yield curve”—where long-term debt has a lower yield than short-term debt. This is often a leading indicator of recessions.
“If the 10-year only rallies on a Fed rate hike and the yield curve flattens even more … it means something more about the broader economy,” Adams said.
That said, with the Fed’s dual mandate almost achieved—full employment and 2% inflation—the Fed’s credibility is on the line this December, according to the panelists.
The Trump-Clinton factor
Meanwhile, the continued low-growth macro environment despite an accommodative Fed has been a focus of the contentious presidential race between Donald Trump and Hillary Clinton.
Slok argued that the election won’t have much of an impact on markets, particularly given the low likelihood of new legislation given a divided Congress and continued gridlock. Golub, meanwhile, added that Trump’s policies could significantly impact markets. And Adams pointed out particular sector risks, with healthcare and financials to the downside and late-cycle sectors like industrials to the upside. Of course, protectionist rhetoric and potential policies could impact international conglomerates.
One thing both candidates seem to agree on is fiscal stimulus, which Golub explained may be necessary to drive markets, even as it may not solve underlying structural issues with the economy.
“Even if we have a big push on Keynesian stimulus or infrastructure build, I still think that the underlying backdrop is a tough one in terms of growth. I do think over the next couple of years we are going to see a pickup in economic stimulus. We’re seeing it already in Canada under Trudeau, in Japan under Abe, we’re seeing it in China. There’s buzz about this in Europe, the UK and the US…I think this may be most important story in 2017.”
Earnings season kicking off
Meanwhile, with earnings season just weeks away, there may be hope for company commentary to once again take the driver’s seat. At least market participants are eager for that, according to the panelists.
“We’ve had this ‘earnings recession‘ but the market would like to see those numbers back in positive territory, and from a sentiment point of view, that’s something that’s going to be important to see,” Golub said.
Slok echoed the eagerness of market participants to return to focusing on long-term fundamentals rather than short-term swings in sentiment.
“When I meet with equity investors, I sense there’s some frustration here that a lot of what’s been driving the equity markets for the last many years has been the macro and the Fed,” Slok said. “People I meet say something along the lines of ‘can we please go back and look at earnings as the driver of the market instead of having Fed speak and Fed meetings and the ECB meetings and other macro events being the risk-on, risk-off trade. So that it comes back to really what we all really would prefer—namely that company valuations are really driven by what is the profitability and earnings of the company.”
Groups that could be particularly well positioned ahead of earnings are late-cycle industries, according to Adams. These include energy, materials and industrials. Adams argues they are well-positioned for more growth relative to more defensive sectors like the telecoms and utilities, which outperformed in 2016.
Nonetheless, all sectors may remain in the cross-hairs of Fed commentary and election prognoses—at least for the next couple of months.
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