DR.CHENJIAZI ZHONG

Economic Update

Growth. Largely driven by less weakness in net exports and nonresidential fixed income, growth is expanding. Sub-trend growth and inflation are what markets will be pricing in over the next three to six months.

Jobs. Total nonfarm payroll employment increased by 287,000 in June[1], after changing little in May (+11,000), massively topping analyst expectations, and the participation rate rose to 62.7%[2]. Job growth occurred in leisure and hospitality, health care and social assistance, financial activities, as well as information. While the unemployment rate rose to 4.9 percent[3].

Profits. Most U.S. companies continued to struggle with low oil price and a strong dollar.

Inflation. The latest inflation rate for the U.S. is 1.0%[4] through the 12 months ended May 2016, which firmed further. Headline and core prices both increased 0.2% on the month.

Rates. The Federal Reserve kept policy on hold at its June 2016 meeting, leaving the Federal funds rate target range of 0.25%-0.50%. The Fed also lowered its long-term expectations for the Federal funds rate, leading market expectations for the rate hikes even lower; the market currently only expects one further rate hike this year.

Manufacturing ISM. Economic activity in the manufacturing sector expanded in June for the fourth consecutive month. The June PMI registered 53.2 percent, an increase of 1.9 percentage points from the May reading of 51.3 percent[5].

At the same time, leverage is rising. In the developed markets, it is government debt; in the emerging markets, it is corporate debt. The increased leverage, when combined with weak nominal growth, may result in a headwind, as debt affordability will eventually reach the breaking point. Additionally, U.S. durable goods orders are improving while inventory growth is not keeping up and consumers’ spending on services are weaker than expected.

Significant Currency Moves Occurred

China’s Yuan Hits Fresh 5-1/2-Year Low on Weaker PBOC Fixing, Dollar Strength

China’s yuan hit a fresh 5-1/2-year low against the dollar in early trading on July 6, 2016, after the central bank sets its official yuan/dollar midpoint rate at 6.6857[6], which was its lowest level since November 2010.

Source: Strategas Research Partners, LLC

Pound Skids to New 31-year Low as BOE Expected to Cut Rates

The British pound slumped to a new 31-year low on July 6, 2016, as expectations that the Bank of England compounded fears about the possible economic fallout from the Brexit. The Bank of England (BOE) on July 5, 2016 announced measures to stabilize the U.K. economy and warned that the outlook for the financial system has become challenging. BOE Gov. Mark Carney warned that further monetary easing is likely this summer, sparking another leg lower in the pound, which has shed 14%[7] of its value against the dollar since the June 23 vote.

Source: Strategas Research Partners, LLC

Yields Keep Declining to New Lows after Brexit

Source: Strategas Research Partners, LLC

Swiss Bond Yields Now Negative Out to 50 years

Swiss government bonds yields all the way out to 50-year maturities have now all turned negative, as the global bonds rally powers ahead amid deep economic uncertainty. The 10-year Gilt yield has dropped to 0.8 per cent, a whisker away from the record low 0.78 per cent it hit last week.

Japan’s 20-Year bond yield turns negative

The rally in government bonds broke new ground on July 6, 2016 as the yield on 20-year Japanese debt fell below zero for the first time[8]. This unease, exacerbated most recently by the Brexit, has led investors in ever-greater numbers to seek havens such as sovereign debt, driving prices up and yields down.

Investment Implications

In an environment where a slow upward trend in earnings despite the temporary drag from cheap oil and a high dollar, coupled with low interest rates, still make stocks look attractive in relative terms. In fixed income investing, to reduce volatility and increase liquidity during economic and market uncertainty, I favor “up in quality” assets. Furthermore, a diversified approach with a global exposure is appropriate given Fed tightening and the growth prospects abroad:

• High quality, long-duration government debt benefits in the near term from central bank’s response and potential easing. It provides stability during periods of risk-off.
• High quality U.S. high yield, while no longer cheap, continues to be supported by strong retail flows, and modestly weaker fundamentals should improve through the year-end.
• Leveraged loans, which is higher quality and can also provide an element of defensive positioning.
• European high yield, adjusted for sector, ratings and duration, remains cheap to U.S. high yield. Europe is experiencing above-trend growth and is earlier in its recovery, providing the opportunity for credit improvement and potential ratings upgrades. Supply remains muted.
• Cash and the perceived safe haven of gold can be sources of liquidity during periods of market correction.

[1] U.S. Bureau of Labor Statistics

[2] U.S. Bureau of Labor Statistics

[3] U.S. Bureau of Labor Statistics

[4] U.S. Government

[5] Institute for Supply Management

[6] Strategas Research Partners, LLC

[7] Bloomberg

[8] The Wall Street Journal