Midyear Outlook: Fed's about-face breathes life into economic cycle | Capital Group Canada | Insights

Insights

ARTICLES  |  JULY 2019

Midyear Outlook: Fed's about-face breathes life into economic cycle

Featuring
Mike Gitlin, head of fixed income
Darrell Spence, economist

At the midpoint of 2019, Capital Group investment professionals discuss the outlook for the global economy and financial markets.


Key takeaways

  • A dramatic shift in U.S. monetary policy has extended a long-running economic expansion.
  • International stocks continue to lag, but company-specific opportunities abound overseas.
  • Fixed income investors should consider upgrading their portfolio as bond markets rally.

 

With the S&P 500 Index mere basis points away from bear-market territory, the U.S. Federal Reserve delivered a timely gift shortly after New Year's Day 2019. In a monumental policy shift, Fed officials made it abundantly clear that their plan to raise interest rates this year is on hold.

That move, coupled with mixed signals on the progress of U.S.-China trade talks, fundamentally changed the outlook for financial markets and the global economy. While the investment landscape looked dark and foreboding near the end of 2018, it brightened considerably in the first quarter of this year, and market gains since then have generally held up well.

Based on U.S. dollars.

What a difference six months makes.

On a year-to-date basis through mid-June, most markets are solidly in positive territory and appear poised to stay there for a while — thanks to low interest rates and a healthy U.S. economy. U.S. GDP growth in the first quarter came in at a surprisingly strong 3.1%, the highest first-quarter rate since 2015.

That said, there are reasons why the Fed and other major central banks around the world don’t want to raise interest rates at the moment and may even be looking to cut in the months ahead. Economic growth abroad is slowing as Europe and China struggle with a deteriorating trade environment. With punishing tariffs imposed by multiple countries and trade wars ongoing, it is difficult to confidently assess the global outlook.

"Events are changing rapidly, and that's why we are seeing higher levels of market volatility almost on a daily basis," says Darrell Spence, an economist with Capital Group. "If you could put aside the trade disputes for a moment and just look at the fundamentals, you'd see a U.S. economy that actually looks pretty well supported and generally slowing growth abroad — but nothing that suggests a sharp downturn in the months ahead."

Macro perspectives: Lower-for-longer rates extend the cycle.

As Mark Twain might have put it: Rumors about the death of low interest rates were greatly exaggerated. Even after the Fed hiked short-term rates four times last year, they remain low by historical standards. And, if anything, the Fed appears ready to cut rates as a counterbalance to late-cycle conditions in the U.S. and worsening global trade tensions. Lower rates are generally supportive of corporate earnings growth, suggesting stocks could appreciate in the second half of the year.

A low unemployment rate and rising wages should continue to support U.S. consumer spending. On the flip side, those same conditions can eventually hurt corporate profitability and trigger greater stock market volatility. Given these circumstances, it makes sense to prepare for a tougher environment in 2020 and beyond by taking a closer look at dividend-paying stocks and avoiding excessive credit risk in the bond market.

Equity opportunities: International equities deserve a place in well-diversified portfolios.

Outsized gains in U.S. equities over the past decade have left international markets relatively unloved and underexposed in many portfolios. That could prove to be a mistake down the road.

Non-U.S. stocks offer a number of potentially attractive traits, including diversification, higher dividend yields, the chance to benefit from currency tailwinds if a strong U.S. dollar starts to weaken and, perhaps the most compelling attribute, substantially lower valuations.

Beyond that, the highest returning stocks each year are often located outside the United States. Since 2009, the top 50 companies with the best annual returns overwhelmingly had a non-U.S. address. Had you decided to ignore international equities, you would have missed a shot at many of the best opportunities.

chart-top-50-stocks-916x476

Fixed income opportunities: It's time to revisit your bond allocation.

Years of ultra-low yields have pushed many investors into areas of the bond market that may not hold up particularly well during an economic downturn or a sharp decline in equity markets. Lower rated corporate bonds, in particular, have been a popular choice as investors engage in the "hunt for yield." Problem is, those types of bonds have had a higher correlation to equities, meaning they are less likely to provide protection when stocks decline.

Given lofty valuations in the high-yield bond market, investors are not being sufficiently compensated for taking on this higher risk at a time when the U.S. economy is exhibiting classic, late-cycle conditions.

"A core bond portfolio should serve four primary roles, affirms Mike Gitlin, Capital Group's head of fixed income. "It should provide diversification from equities, income, inflation protection and capital preservation. What it should not do is replicate equity risk."

Increasing exposure to high-yield bonds or emerging markets debt should be an independent decision, separate from a primary core bond strategy, Gitlin notes. When stocks come under pressure, bonds should provide stability. Investors should ensure they own enough core in their fixed income allocation to provide that stability. Fixed income strategies that are more total-return and income-seeking may not provide ballast when it’s most needed.

Based on U.S. dollars.

 

About

Mike Gitlin Head of Fixed Income

Mike is a partner at Capital Fixed Income Investors, chairs the fixed income management committee and serves on the Capital Group management committee. He has 25 years of investment experience, four with Capital. Mike was previously the head of fixed income and global head of trading for T. Rowe Price. He has also held positions with Citigroup Global Markets, Credit Suisse Asset Management and George Weiss & Associates. Mike earned a bachelor's from Colgate University.

Darrell Spence Economist

Darrell R. Spence is an economist at Capital Group. He has 26 years of investment industry experience, all with Capital Group. He holds a bachelor’s degree with honors in economics from Occidental College graduating cum laude, and is a member of Phi Beta Kappa and Omicron Delta Epsilon. He also holds the Chartered Financial Analyst® designation and is a member of the National Association for Business Economics. Darrell is based in Los Angeles.


Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the prospectus before investing. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated.

Unless otherwise indicated, the investment professionals featured do not manage Capital Group‘s Canadian mutual funds.

References to particular companies or securities, if any, are included for informational or illustrative purposes only and should not be considered as an endorsement by Capital Group. Views expressed regarding a particular company, security, industry or market sector should not be considered an indication of trading intent of any investment funds or current holdings of any investment funds. These views should not be considered as investment advice nor should they be considered a recommendation to buy or sell.

Statements attributed to an individual represent the opinions of that individual as of the date published and do not necessarily reflect the opinions of Capital Group or its affiliates. This information is intended to highlight issues and not be comprehensive or to provide advice. For informational purposes only; not intended to provide tax, legal or financial advice. We assume no liability for any inaccurate, delayed or incomplete information, nor for any actions taken in reliance thereon. The information contained herein has been supplied without verification by us and may be subject to change. Capital Group funds are available in Canada through registered dealers. For more information, please consult your financial and tax advisors for your individual situation.

Forward-looking statements are not guarantees of future performance, and actual events and results could differ materially from those expressed or implied in any forward-looking statements made herein. We encourage you to consider these and other factors carefully before making any investment decisions and we urge you to avoid placing undue reliance on forward-looking statements.

The S&P 500 Composite Index (“Index”) is a product of S&P Dow Jones Indices LLC and/or its affiliates and has been licensed for use by Capital Group. Copyright © 2019 S&P Dow Jones Indices LLC, a division of S&P Global, and/or its affiliates. All rights reserved. Redistribution or reproduction in whole or in part are prohibited without written permission of S&P Dow Jones Indices LLC.

Bloomberg® is a trademark of Bloomberg Finance L.P. (collectively with its affiliates, "Bloomberg"). Barclays® is a trademark of Barclays Bank Plc (collectively with its affiliates, "Barclays"), used under licence. Neither Bloomberg nor Barclays approves or endorses this material, guarantees the accuracy or completeness of any information herein and, to the maximum extent allowed by law, neither shall have any liability or responsibility for injury or damages arising in connection therewith.

MSCI does not approve, review or produce reports published on this site, makes no express or implied warranties or representations and is not liable whatsoever for any data represented. You may not redistribute MSCI data or use it as a basis for other indices or investment products.

Capital believes the software and information from FactSet to be reliable. However, Capital cannot be responsible for inaccuracies, incomplete information or updating of the information furnished by FactSet. The information provided in this report is meant to give you an approximate account of the fund/manager's characteristics for the specified date. This information is not indicative of future Capital investment decisions and is not used as part of our investment decision-making process.

Indices are unmanaged and cannot be invested in directly. Returns represent past performance, are not a guarantee of future performance, and are not indicative of any specific investment.

Capital Group funds and Capital International Asset Management (Canada), Inc. are part of Capital Group, a global investment management firm originating in Los Angeles, California in 1931. The Capital Group companies manage equity assets through three investment groups. These groups make investment and proxy voting decisions independently. Fixed income investment professionals provide fixed income research and investment management across the Capital organization; however, for securities with equity characteristics, they act solely on behalf of one of the three equity investment groups.

The Capital Group funds offered on this website are available only to Canadian residents.


Related Insights