When I began writing this blog in January, I set out a number of "key" themes that I suggested would be significant for 2015.
The overiding theme was to "Expect The Unexpected".
Well there has been lots of surprises for 2015 thus far, as we look back over the last 3 quarters, but the forward looking prognosis remains elusive:
The US Federal Reserve wants to begin the process of normalizing interest rates (and so does the Bank of England).
The "wild card" at the moment is the direction for inflation.
Central banks (generally) want to see a 2% rate of "core" inflation (which extracts the more volatile components like food and energy).
Global economic conditions have been putting downward pressure on commodity prices and at the moment this does not look like it is about to change anytime soon.
The US Federal Reserve remains optimistic about the improvement in the US economy, however admits that there are global factors that have given them cause for concern.
A stronger $US, reduces global demand for US goods and services (exports) and simultaneously allows lower foreign import prices which in turn puts downward pressure on core US prices (in essence the US is importing deflationary pressures).
Certainly there is a corelation between commodity prices and core PCE inflation.
The real question, then, becomes whether or not the US Fed is being too optimistic about its views for the US economy.
It's track record suggests that, in the past, it has erred to the side of being overly optimistic, so there is a credibility issue at stake.
The worry amongst the economic "thinkers" is that if a recession should occur in the US over the next year or two, the Fed will have little room to act in order to lower interest rates to further stimulate economic activity (because interest rates are at 0%).
On the demand side of the equation, consumer activity in the US has picked up, a little. Todays data for August showed a little better than expected uptick in activity:
However, the trend looks to have peaked and most of the consumer spending recently has been on automobiles, rent and restaurants, financed at low interest rates.
The Fed is counting on employment growth to drive consumer spending and in turn, drive the economy. Hence, their optimism.
Next up: 3rd Quarter earnings: expectations are for further declines in S&P 500 company earnings of approximately 4%. If this is the case, it will be the first back to back, quarterly decline in earnings since 2009.
This has been driving another of our 2015 themes, that stocks were / are still, expensive. The 12 month forward price to earnings ratio at 15.2 compares to the 10 year average of 14.1. However, it is down from a level of 17 in May (when equity prices peaked).
It would not surprise us to see the S&P 500 back at the 1750 level , down from the current level of 1900 and the highs at 2135.
This, among other factors, have us calling for a "low return environment" for investment asset growth for the next while.
There will be opportunities to put money to work at better levels / prices down the road, but it will benefit those who are patient.
Scott Tomenson,CIM Managing Partner, Chief Investment Strategist