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Finding Normal
The "New Normal" is a phrase investors became familiar with after PIMCO executive Mohamed El Erian coined it in 2009, at the height of the financial crisis. He used the term to d
escribe a period of time in which economies grow very slowly, corporate profits are relatively static, unemployment is high and the government plays an outsized role.
Eight years later, GDP growth has gone from -5.4% in the first quarter of 2009 to a positive 2.1% in the fourth quarter of 2016. Unemployment fell to a nine year low of 4.6% in November of 2016, and corporate earnings are experiencing double digit growth (see Economic News below). Once we eliminate the last piece of the New Normal definition---- significant government intervention in the capital markets ---- we could see a return to the "Old Normal."
Government Intervention
You will recall that the Federal Reserve used a number of tools to combat the effects of the Financial Crisis and Great Recession. It cut the Federal Funds rate to zero and pursued an expansionary monetary policy to stimulate the economy, including three separate rounds of quantitative easing (QE). At the end of their buying spree, the Fed's balance sheet was roughly five times the size it was prior to the 2008 financial crisis. (Today its total assets exceed $4 trillion, up from less than $1 billion before the crisis.)
With its third interest rate hike last month, the Fed has successfully moved interest rates off of zero without significant impact on the capital markets. Most Fed watchers are now concerning themselves with when and how the Fed might unwind its huge balance sheet.
Balance Sheet Normalization
After the release of the Federal Open Market Committee's (FOMC) meeting minutes last week, a new catch phrase will be gaining popularity with economists: "balance sheet normalization." Decreasing the size of
the Fed's balance sheet will
require more finesse than increasing it did, but it's clear from the minutes, FOMC members are already discussing their options and that normalization could begin as early as this year.
A stable
monthly reduction of the balance sheet is their most
likely course, and it probably would
involve some combination of
rolling off maturing securities and outright
sales. Although we expect the Fed will do
its best to gently decrease the size of its
balance sheet, it is likely that anticipation
and announcement of the project will cause
heightened interest rate volatility in the
coming year. The good news is that the Fed's plans are generally telegraphed well in advance of any moves.
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Stocks were mostly flat to modestly negative last week with large cap stocks out-performing their small cap counterparts. Investors seemed to take a wait-and-see approach as they digested some mixed labor market data, continued to await firm policy changes out of Washington, and anticipated first quarter earnings reports from corporate America.
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> Earnings Season Begins: The first quarter 2017 earnings season begins this week, starting in earnest tomorrow, April 13, with several big banks slated to report. Following a strong showing in the fourth quarter, consensus for first quarter earnings growth is a very solid 10.1%, according to data from Thomson Reuters. Financials, technology, and energy are expected to be the biggest contributors to overall earnings growth.
> S&P Sector Standouts: As outlined above, t
he S&P 500 appears likely to produce double digit year-over-year earnings growth in the first quarter. It will be powered by energy's rebound from the oil downturn that battered the sector early last year. But financials and technology, the sectors with the two biggest weights in the S&P 500, are expected to do more than their fair share. Financials are likely to benefit from the rise in interest rates over the past year, along with healthy capital markets and credit conditions; technology should get support from strength in semiconductors and software.
> DOL Fiduciary Rule:
Readers of the Market Digest know that we have long covered the twists and turns of the Department of Labor's (DOL) Fiduciary Rule which requires advisors on retirement plan assets to put their clients' interests ahead of their own. The latest development came this week when the DOL officially announced a 60-day delay.
The Obama-era rule, first proposed back in 2010, was intended to go into effect Monday, April 10, but now the DOL has pushed back implementation until June 9 so it can honor President Trump's executive order to assess the rule's potential impact. In its notice, the DOL left the door open to additional delays.
Sadly for investors and advisors alike, this delay only brings more uncertainty. It's possible the rule could still be implemented as intended. Or, the rule could be repealed completely. Or, the ability to qualify for an exemption to the rule could be significantly loosened, thus allowing more financial advisors to avoid compliance.
We will continue to follow the developments and bring you the latest updates. However, regardless of the ultimate outcome of the Rule, if you have an IRA (or really, any investment accounts), we highly recommend you review your portfolio to find out if your advisor is steering you toward investments that generate higher commissions and fees for him/her. Currently that is a
legal practice, but it's hard to argue it's in your best interest.
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New Market Wealth Management offers modern investment solutions backed by extensive research and experience serving the needs of wealthy families. Through our strategic partnership with
Cliffwater LLC
, we provide institutional-quality research, investment due diligence and asset allocation tools. We believe this level of experience and unique access to in-depth, sophisticated research are essential for success in today's complex world markets.
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