Several weeks ago, I lay in bed fast asleep – no doubt dreaming about stock rallies and lifelong bull markets – when I was woken by a noise from down the hall. My two-year-old, who is typically a great sleeper like his Dad, had woken up at 3 a.m. and was calling frantically for ‘Mama’ and ‘Dada’. I sat up in bed, mumbled to my wife “I’ve got this one” and sleepily trudged down the hallway. After a few moments of soothing talk, my son’s mood instantly changed, and he excitedly pointed to his bookshelf asking “read book?!” I immediately realized that I had fallen for one of the classic parenting blunders, and had walked directly into a 2-year-old’s trap. Defeated, I told him that we would read only one book, then it would be time to go back to bed. Of course, several minutes later upon finishing Bear Snores On, he pointed to his bookshelf again saying “That one! That one!”, and I couldn’t help but smirk and roll my eyes. If you know anything about children, you’ll know that they’ll always try to push boundaries and ask for more, whether it be reading books, eating a treat, or asking for more playtime before bed.
I use this example because, on September 18th, the Fed voted 7-3 to approve another 25 basis point (.25%) cut to the fed funds target rate. Many investors have since responded to this additional rate cut just like my 2-year-old would, saying “We want more!” Therefore, we’d first like to review the likelihood of future Fed rate cuts in 2019, then we’ll briefly review the divergence we are seeing in sentiment between consumers, investors, and CEOs.
The Fed – Reading the Tea Leaves
The rate cut announced on September 18th was widely anticipated by economists and investors alike. Therefore, prior to the vote, there was less near-term uncertainty because investors were able to factor the rate cut into their forecasts.
At first glance, the path ahead may be growing a bit murky as we are starting to see divisions emerge among the seventeen Federal Open Market Committee (FOMC) participants. After each Fed meeting, the FOMC participants are asked to provide their assessment on where the fed funds target rate should be moving forward. After this most recent vote in September, the member assessments were as follows:
- Raise the Fed Funds Rate from Current Levels: 5 Participants
- Keep the Fed Funds Rate at Current Levels: 5 Participants
- Lower the Fed Funds Rate another 25 Basis Points: 7 Participants
Seemingly, this would indicate a clear division among FOMC participants because 10 would like to see rates remain the same or move higher, while 7 would like to lower the fed funds target rate another 25 basis points (.25%). However, we must remember that, of these 17 FOMC participants, only 10 have voting rights. Based on recent voting patterns, we believe that a majority of the FOMC’s voting members would prefer an additional rate cut in 2019.
We also know that the Fed is ‘data dependent’, meaning that preferences may change as both the domestic and global economies evolve. Barring a swift and effective resolution to the U.S. / China trade war, it is difficult to envision a scenario where global growth improves significantly between now and the next Fed meeting on October 29th & 30th. Therefore, we believe it’s more likely than not that the Fed will approve an additional 25 basis point cut to the fed funds target rate in order to sustain the current expansion and push inflation closer to their 2% target.
Regardless of our projection for how the FOMC will vote, the prospect of another rate cut is ultimately considered an unknown. This, coupled with the U.S. / China trade war, continues to ratchet up levels of uncertainty in financial markets. Therefore, we anticipate additional volatility in equities over the coming weeks. If this rate cut does materialize, we expect that the fixed income portions of our portfolios to continue to perform well in the near term, and we feel that each Destiny Capital portfolio is appropriately allocated to capitalize on this. The performance in equities will continue to be heavily dependent on whether or not there is an easing of trade tensions between now and the end of the year, which is why effective diversification is paramount.
The U.S. economy is largely consumer-driven, as consumption makes up approximately two-thirds of domestic GDP. Clearly, this has been a positive for the United States, as consumer confidence continues to remain elevated relative to historical levels. Overall, consumers tend to focus on economic indicators such as the unemployment rate and wages, and lately, the United States has seen very low unemployment and improvements in wage growth. Therefore, you’d expect consumers to be feeling pretty good.
Conversely, we’ve seen a sharp decline in both Investor and CEO confidence over the last two years. Generally speaking, when compared to an average citizen, CEOs and investors tend to analyze data that paints a more complete, detailed and complex economic picture. Over the past year, we’ve seen negative trends emerge when analyzing global data, which clearly concerns CEOs, investors, and even the Federal Reserve. Furthermore, the U.S. / China trade war weighs heavy on the minds of CEOs and institutional investors alike so, until there is a trade resolution, we expect confidence levels to continue to decline. We expect this to have a negative impact on fixed business spending in Q4 and well into 2020.
When it comes to consumers, we may only see confidence wane when we begin to see wage freezes, layoffs and an uptick in the unemployment rate. While these types of events are not imminent, they are a possibility over the next year if we continue to see slow global growth and a protracted trade war. For now, however, consumer spending continues to provide a tailwind for the U.S. economy.
What’s on the Horizon?
On an ongoing basis, Destiny Capital’s Investment Committee constantly reviews and evaluates each client portfolio in an effort to minimize risk and maximize performance. However, this is a very exciting time of the year for the Investment Committee, as we are about to compile and analyze our annual Capital Market Assumptions for 2020.
Capital Market Assumptions are ex ante (forward-looking) statistics that are utilized in portfolio construction, and are produced on an annual basis. With these Capital Market Assumptions, Destiny Capital’s Investment Committee studies every asset class in the investable universe and then conducts in-depth analysis to assess the future risk and return probabilities for each asset. Using proven modeling techniques along with decades of investment experience, our Investment Committee then gauges which assets our clients should own, and in what proportions. Each portfolio is then further optimized based on the risk tolerance for each Destiny Capital client.
This, in part, is some basic insight into ‘how the sausage is made’ and how our team arrives at our high-conviction asset selections. We have a high degree of confidence in our current portfolio allocations, so we do not anticipate wholesale changes to client portfolios. However, upon completion of our Capital Market Assumption analysis, there may be adjustments made in order to maximize returns. We look forward to communicating the findings of our research in a future report.
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