Recap of a Conference Call Featuring Guy Adami and a Senior Economist, Andrew Patterson, from Vanguard

Recap of a Conference Call Featuring Guy Adami and a Senior Economist, Andrew Patterson, from Vanguard

By: Guy Adami, Director, Advisor Advocacy
Published January 31, 2018

While 2017 was a banner year, 2018 has also gotten off to a remarkable start. The United States is experiencing trend growth around 2%, and even Europe and Japan posted reasonable strong growth, exceeding expectations. Given some of the driving factors like aging populations, demographic shifts, and technological change, which typically serve to suppress growth and potentially inflation, these are reasonably strong numbers. We are expecting much of the same in 2018, a return to pre-crisis GDP growth and inflation.

Federal Reserve Pushing Inflation

Everyone is waiting to see what will happen with inflation this year, it is certainly something the Federal Reserve is pushing for as we go from monetary policy to fiscal policy. Will we see wage growth commensurate with the job growth we’ve seen? Patterson maintains that it’s all about how you look at the metrics. The labor report every month shows average hourly earnings. The issue with examining average hourly earnings is that it is a ratio of aggregate earnings and aggregate hours worked. However, jobs are being created at a rapid pace. For the last 12-18 months, we have seen an average of 200,000 new jobs every month. The aggregate hour of the number of hours worked is increasing rapidly, but if you look at the metrics of everyone who has held a job or changed jobs, but not lost a job, we actually are getting some wage inflation now, perhaps just not as much as people expected.

Part of the discussion included the Fed’s swollen balance sheet. With a cap of 50 billion per month begun in October of 2017, Patterson sees potential difficulties in the future. Looking out into 2019 and beyond, the Federal Reserve may not have that many mortgage securities rolling off, which can create some uncertainty in the marketplace. It’s hard to see an environment where rising interest rates would not affect the stock market in some way. However, the Fed has been very transparent and provided a great deal of clarity with their expected pace of balance sheet rollovers and interest rate increases, and only time will tell the impact. The bull market at this strength won’t persist forever, but there may not have to be an immediate correction. For more details on Andrew’s thoughts regarding the Federal Reserve Balance Sheet, you can read his commentary here.

U.S. and China Relations

Although not worrying about a trade war or the dissolution of NAFTA, China poses one of the biggest perceived risks in the marketplace. We are expecting China to hit their announced growth targets. We do take a look at the underlying measures and come up with our own estimates of economic strength in China and those remain strong as well. When considering ongoing negotiations and global trade, the numbers don’t tell the whole story. You have to look at things like value-add in a production process. For example, China may be putting the finishing touches on an iPhone, but German and U.S manufacturers added value along the way. Policymakers understand that and are taking very measured steps towards trade negotiations with China.

The Approach to Portfolios for 2018

At the start of the New Year, everyone wants to know what their return expectations should be for their assets. How can investors move closer to historic returns? Patterson mentions getting back to the historical returns of the 1970s and 1980s is going to be difficult, but there are steps investors can take. The conversations regarding asset allocation are determined by a number of factors including risk tolerance and time horizon, and those are conversations that should be had on a case-by-case basis by every advisor with their clients. It is important to set realistic expectations; getting back to the days of a 60-40 balanced portfolio returning 8-10% is a thing of the past for the foreseeable future. If for no other reason than that yields are expected to remain low. Trying to juice a portfolio to get back to those balanced portfolio returns of the past is something I wouldn’t recommend. However, volatility is, while not at historic lows, it is low for the environment in which we find ourselves.

Patterson’s response to sectors he’d look to underweight or overweight in 2018? “Global diversification is key.” He does acknowledge a lower rate of return for U.S. equities, about 3-5%, non-U.S. equities somewhere in the 5.5-7.5% annualized return range. Rather than calling for underweight and overweight, these numbers exemplify the benefits of international diversification.

Keeping an eye on the Horizon

As we move deeper into the new year, there will be more discussions to be had regarding the ever-changing flow of the market. Guy Adami keeps us up to date with quarterly conference calls such as this one, so stay tuned for new updates in the coming months.