Times Are Changing
It has been ten years since markets slipped over the edge and our economy entered The Great Recession. The Federal Reserve, US Treasury and Congress coordinated policy to produce a lasting economic recovery. It has been slow, steady and very long by historical standards. One of the results has been multi-generational unemployment lows. Other key economic statistics such as consumer and producer price indexes (a measure of inflation) and GDP (broad measure of economic output) similarly point to success, not in just recovery, but in driving markets and the global economy to new highs.
The first steps taken to change the course a decade ago were dropping short-term interest rates to essentially zero percent and enacting a policy of quantitative easing (QE). The result was cheap funding, which repaired banks’ financials, enabling the industry to support business with very inexpensive loans. By in large, it was very successful, particularly when compared to the depression of the 1930s.
When data began indicating that these unprecedented policy maneuvers were succeeding, the policy began reversing. Starting five years ago, QE was phased out and the Fed started the process of raising short-term rates in the end of 2015. In three years, that rate has increased eight times and markets currently price in another four increases through 2019.
Today we have an interest rate structure that for the first time in a decade appears ‘normal’ or at least what may have passed as normal a decade ago. From a policy standpoint, what contributed to growth has run its course in our opinion and what got us here is not going to propel us going forward. We are at an inflection point in the economy and in a policy that significantly impacts economic activity.
As the world’s largest economy, the United States is a major influence around the world. We have grown faster than other developed markets and many emerging economies over the past decade. The result is an appreciating currency (this is a good time to travel abroad). The strong dollar and rising rates both have the effect of slowing growth. We are concerned that should rates continue to increase, the economy will slow.
The reason for raising rates is to limit inflation which, as a reminder, is a mandate of the Fed. Although education, healthcare and housing have experienced an increase in costs, many other sectors have seen declines, resulting in subdued inflation. Our long-standing belief in productivity gains due to technology advancements is alive and well and will continue to support stable prices.
Our main concern today is that the Fed’s policy may become too restrictive, slowing the economy and corporate profits. It takes anywhere from six to nine months for rate changes to work their way through the system and show up in government statistics. The good news is that the economy and markets are overall in very good condition and small errors shouldn’t cause too much harm.
As we enter the fourth quarter, we are not surprised by recent volatility in markets. Historically, stocks and bonds struggle when interest rates are in transition. In the short-term, we have muted expectations and the recent pull back in stocks is not only normal, but needed for the long-term health of markets. The looming mid-term elections likely play a small role as well in recent market actions, with polls suggesting a decent chance that the House of Representatives will flip to Democratic control.
For the first time since establishing EPIQ Partners six years ago, we are more enthused on the outlook for fixed-income. Returns, which have been poor for bonds in the past few years, are poised to be more competitive with riskier assets now that Fed policy approaches the end of a tightening cycle.
We wish you a festive fall season and look forward to updating you in the New Year. Please reach out to continue the conversation.
We are pleased to partner with Charles Schwab & Co. and use their custodial services. They have been a solid service provider to our firm and clients. Below is an article from Bloomberg, detailing how the company is investing in its business to better support its clients.
Daniel Aronson, CFA Bruce Langer, CFA Ben Frey, CTP