Good afternoon and happy New Year! 2020 is off to a roaring start, and pundits have begun drawing comparisons between the potential of the decade ahead while taking a look back 100 years ago. Let’s start with today’s assessment of the US labor market.
The Bureau of Labor Statistics reports December hiring activity totaled 145,000, cooling a bit after November’s reported payroll expansion of 256,000. Unemployment held steady at 3.5% month over month, while U6 ticked down 0.2% over the same timeframe. Hourly wages increased 2.9% year over year, signaling diminishing pressure on employers to pay up. Of course, that is unless you happen to be Taco Bell.
Moderation in headline hiring in the US pressured rates on 10- year treasuries lower. The dollar gave up overnight gains relative to peers, and equities remained steady following the weaker than expected data in light of yesterday’s dovish commentary from Fed vice- chairman Richard Clarida. The Fed has noted downside risks to its economic forecast and sees little reason to alter its course at the present time. In short, the three interest rate cuts (the polar opposite of what was proposed roughly one year ago) and balance sheet expansion (again, at the opposite end of the spectrum from the forecast this time last year) have provided adequate cushion to sustain the recovery. For our part, we see 2020 as a year in which economic fundamentals will likely firm relative to the weakness encountered during Q3 of last year. As long as recession remains at bay, equities are the place to be.
Geopolitics grabbed the spotlight to start the year. Iran’s second most powerful man is no more; the retaliation from Tehran has thus far has been muted relative to what could have been. Iran has labeled the Pentagon a terrorist organization and Qasem Soleimani is now considered a martyr by the Iranian public. President Trump called for additional sanctions in response to a missile strike on two US-Iraqi military bases in which there were no American casualties. Importantly, he also seemed to call on NATO allies to proceed with a multi-lateral approach in handling current hostilities in the Middle East. Tensions remain high though and Iran has vowed that its rocket attack is only the beginning of a larger operation. In the commodity complex, oil has retreated to pre-crisis levels, effectively giving back its “fear premium.”
While fundamentals will likely improve in 2020, it is unlikely that we will see a tremendous resurgence in GDP on a domestic or global level. We seem to have reverted back to the “muddle through” days of yesteryear. Rather than a reversion to the roaring 1920’s, TWP views the dynamics underpinning today’s investment climate as substantially different. Certainly, similarities can be drawn regarding populist politics and tariffs, but there are a number of differences that are much more significant in our view, not the least of which are the great inflation riddle and conventional/unconventional monetary policy.
The likelihood of rampant inflation is negligible in our view and central bank involvement in the financial system is ever- present. In a sense, the use of central bank balance sheets has become the financial equivalent of penicillin. It would stand to reason that inflation would be more of a concern with a backdrop of low rates and steady economic growth. However, anchoring our long- term inflation outlook are the powerful forces of global demographics and ubiquitous applications of today’s technology.
A stronger dollar is in and of itself deflationary in the current environment. The Fed’s three “insurance” cuts and balance sheet expansion (a la the repo market) will likely apply incremental downside pressure on the greenback on a trade- weighted basis as the delta of rate differentials between the US and other developed economies becomes more pronounced. This backdrop is relatively benign for risk assets, though valuations by any metric remain full. As a result, Total Wealth Portfolios have harvested tactical gains achieved during Q4 2019. We will be looking for additional opportunities in 2020. Happy New Year!
Market Outlook: Bearish USD, Neutral Duration, Bullish Equities