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Posted by on Sep 1, 2017 in Crossing Wall Street, Featured, Market Insight

Crossing Wall Street Review – September 1, 2017

Crossing Wall Street Review – September 1, 2017

You Can Forget about That Parade of Rate Hikes

By Eddy Elfenbein, editor of Crossing Wall Street and portfolio manager of the AdvisorShares Focused Equity ETF (NYSE Arca: CWS)

On Wednesday, the government updated its report on Q2 GDP growth. The initial report in July said the economy grew in real, annualized terms by 2.6%. This week, that was raised to 3.0%. That’s the best quarter for the economy for the past nine quarters.

From the 60s until the last recession, the U.S. economy tended to grow in real terms by about 3%. Since then, the economy has grown in slower terms, around 2%. While the last GDP was encouraging, I doubt it’s the beginning of a growth resurgence. The Atlanta Fed has a model that tries to predict the GDP numbers. For Q3, the model currently says 3.3%. That would be very good.

Later today, the government will release the employment report for August. The numbers recently have been pretty solid. Unemployment is currently at 4.3%, which is tied for a 16-year low. The economy has added an average or 200,000 jobs every month for the last seven years.

For our purposes, what’s been most interesting has been the lack of inflation. Traditional economics (don’t laugh) suggests that prices should rise as we get close to full employment. If anything, inflation has been going down as more people are working. The Fed likes to watch the PCE price index. That rose by just 1.4% in July.

Last December, the Fed said it sees raising interest rates three times in 2017, 2018 and 2019. I wrote, “Not to put too fine a point on it, but that’s nuts.” It looks like I was right. While the Fed has already raised rates twice this year, a third doesn’t look to be happening. In fact, the futures market doesn’t see another hike coming until June 2018.

What’s been interesting is the behavior of the bond market. Long-term yields have been trending lower, while short-term yields have been climbing higher. The three-year note is the dividing line. Anything longer than that means yields are going down. Shorter than that, they’ve been rising. This means that the yield curve is getting flatter. Traditionally, a flat yield curve is a warning sign for the stock market and the economy. While the yield curve is indeed getting flatter, we’re still a long way from the danger zone.

The 10-year inflation-protected bond still yields you a measly 0.4%. A few years ago, I ran some numbers and said that the stock market does well until TIPs yield 2.4%. That shows you how much room we have. Of course, five years ago, 10-year TIPs were yielding -0.90%.

I also wanted to touch on another interesting phenomenon, and that’s divergence between energy stocks and materials stocks. These two sectors tend to be decently correlated, but the connection is far from perfect. This year, however, they’re moving in different directions. This represents a major trend of 2017—metal prices are going higher, while energy prices, oil and natural gas, are going down. There’s no rule that extraction industries need to run in parallel, but they generally have.

Copper, for example, is now at a three-year high. Gold and silver have been coming to life recently as well. This may suggest that the global economy is getting back on its feet despite a sluggish energy patch. This may also explain the weak dollar this year. In fact, the Dow is actually down this year, if it were priced in euros. Overall, I think the financial markets are in a healthy state, and hopefully, the Houston area will be back as strong as ever.

The information, statements, views, and opinions included in this publication are based on sources (both internal and external sources) considered to be reliable, but no representation or warranty, express or implied, is made as to their accuracy, completeness or correctness. Such information, statements, views and opinions are expressed as of the date of publication, are subject to change without further notice and do not constitute a solicitation for the purchase or sale of any investment referenced in the publication.