Positive on US stocks as recession unlikely and record high corporate profits.
Overweight consumer staples, energy, and materials sector on low valuation.
Positive on US real assets as homes prices and median rent trends higher.
Positive on cash as bias towards rising rates persists on inflationary pressures.
Overweight emerging market stocks and USD bonds on low valuation.
Underweight financials, health care, and utilities on high valuation.
Underweight US stocks relative to international stocks on high valuation.
Underweight developed market bonds on exceptionally low yields.
US leading economic indicators still pointing to US expansion in 2019.
Real interest rates expected to rise on increasing deficit spending in the US.
Inflationary gap will likely push the Fed to remain overall restrictive.
Fed Funds forward curve suggests the Fed may pause rate hikes in 2019.
We are bullish on US stocks as we believe a recession is unlikely in 2019 and corporate profits continue making record highs. Long-term, we are underweight US stocks relative to developed and emerging markets on valuation. We see the cyclically adjusted PE ratio in the US to be significantly higher relative to other markets. We believe these valuation ratios will reach parity in the long run which would in our view lead to outperformance in international stocks relative to the US over the next decade. We think parity will coincide with higher growth in international markets relative to the US coupled with central bank easing in Europe, Japan, and China as the US pursues restrictive monetary policy. However, Europe and Japan may see limited long-term growth due to an aging population and lack of pro-growth policies.
We are overweight consumer staples, energy, and materials sectors and underweight financials, health care, and utilities based on valuation. Energy and materials have underperformed as crude oil entered into a bear market, but we believe the selloff is a long-term opportunity to buy low. We think the consumer staples sector is reasonably priced and a good defensive holding as fears of economic slowdown rattle markets. We believe valuations have gotten stretched in the financials, health care, and utilities sectors as their cyclically adjusted PE ratios are currently close to their 10-year range.
We see the U.S. economy continuing to grow with most of the Conference Board U.S. Composite of Economic Indicators showing positive trends. We assessed 18 out of 21 indicators showing a positive trend while three indicators show a neutral trend. We believe 2019 will see continued economic expansion although at a slower pace. Risks to economic growth in the US include the worsening of the US-China trade war, private sector crowding out as the federal government finances increasing deficit levels, and the potential for the Federal Reserve tightening too much too fast on interest rates and the balance sheet.
We are underweight developed market bonds on account of the extraordinarily low yields coming out of Europe and Japan as they consider ending their negative interest rate policy (NIRP) at some point in the future. Bond prices in these markets will likely suffer when they end NIRP and begin an interest rate hike cycle. Elsewhere, we are overweight emerging market USD bonds as they provide the highest yields given the expected risk.
We are neutral on the US bond market with the Fed Funds forward curve predicting no rate hikes in 2019. A flat yield curve is indicative of a possible growth slowdown but not a recession. We may see the Fed halt or reduce the pace of interest rate hikes in 2019. However, a positive CBO real output gap (% of GDP) will likely keep the Fed's foot on the monetary brake pedal as a positive output gap indicates inflationary pressure. Similarly, the exceptionally low unemployment rate and accelerating wage growth point to an inflationary environment.
We expect upward pressure on real interest rates as the federal government deliberately increases deficit spending to a projected $1 trillion deficit in 2019 and 2020. We believe this is a fiscal policy mistake as deliberate increases to deficit spending should not occur during an economic expansion. We think the short-run impact of deliberately increasing deficit spending will be a temporary increase in GDP growth. We believe the long-run impact will be a higher current account deficit, national debt buildup, higher interest rates, higher inflation, and private sector crowding out. This long-run impact would eventually lead to a restrictive fiscal policy and reduction of GDP growth canceling out any benefit initially gained. Forward CAPEX-to-sales rose after the Tax Cuts and Jobs Act (Trump Tax Cuts) was enacted as proponents had predicted. We still think these effects will be temporary as we see the CAPEX-to-sales ratio stalling and starting to decline back to pre-tax cut levels.
Notes: The Cyclical Indicator Approach
The composite economic indexes are the key elements in an analytic system designed to signal peaks and troughs in the business cycle. The leading (LEI), coincident (CEI), and lagging (LAG) economic indexes are essentially composite averages of several individual leading, coincident, or lagging indicators. They are constructed to summarize and reveal common turning point patterns in economic data in a clearer and more convincing manner than any individual component—primarily because they smooth out some of the volatility of individual components.
Historically, the cyclical turning points in The Conference Board LEI for the U.S. have occurred before those in aggregate economic activity, while the cyclical turning points in The Conference Board CEI for the U.S. have occurred at about the same time as those in aggregate economic activity. The cyclical turning points in The
Conference Board LAG for the U.S. generally have occurred after those in aggregate economic activity.
Source: The Conference Board.
This material is prepared by NR Capital Management, LLC and is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of July 2018 and may change as subsequent conditions vary. The information and opinions contained in this material are derived from proprietary and nonproprietary sources deemed by NR Capital Management, LLC to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by NR Capital Management, LLC, its officers, employees or agents. This material may contain ‘forward-looking’ information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the reader. Economic data cited herein are from Bloomberg, unless otherwise noted.