The last week’s market highlights:
Quote of the week:
“Life is never complete without its challenges.” – Stan Lee
Each week, we present our featured topics in the context of the major themes listed below from the Nuveen Q4 Outlook:
- U.S. economy: Still running ahead of its peers.
- Global economy: Trade a bigger concern outside the U.S.
- Policy watch: Trade risks haven’t bitten the U.S. yet, but that may change.
- Fixed income: Continue to position for rising rates.
- Equities: The price is right outside the U.S.
- Asset allocation: Finding pockets of opportunity.
Commodities corner: Time to grin and bear it
For oil investors, the fourth quarter has triggered unpleasant memories of 2014. After peaking in June of that year, both the U.S. benchmark (West Texas Intermediate, or WTI) and the global proxy (Brent) descended into bear-market territory in less than four months as U.S. supply surged. (A bear market is typically defined as a pullback of 20% or more from a recent high.)
Fast forward to October 3, 2018. Oil prices were at or near multi-year highs, spurred by an accelerating U.S. economy and a looming drop in output due to supply outages in Venezuela and U.S. sanctions on Iran.
But market sentiment quickly soured, dragging down oil prices with it. In mid-October, China, the world’s second-largest economy, reported its worst pace of quarterly growth since 2009. Last week, investors fretted over news that Japan and Germany, the world’s third- and fourth- largest economies, respectively, had contracted in the third quarter. Amid concerns that a global economic slowdown could cut fuel demand, both the WTI and Brent benchmarks recently fell into bear markets, just as they had in 2014.
But the plunge in oil prices hasn’t been driven solely by fears of declining demand. In fact, the problem now is oversupply: there’s simply too much of the stuff. According to the International Energy Agency's latest report, the U.S., Russia, and Saudi Arabia are pumping out crude at record levels, causing global supply to significantly outpace demand and more than offset reductions from Iran and Venezuela.
After retreating early last week, WTI and Brent found their footing later on, closing at $56.44 and $66.97 per barrel on November 16, respectively. In our view, the worst of the selloff is probably over, although prices could dip a bit further in 2019 as global GDP softens slightly.
Some economists argue that cheaper oil is a net positive for the U.S. economy because it boosts disposable income and tames inflation. We’re not so sure. For example, rather than open their wallets as gas prices began to fall in mid-2014, consumers chose to pocket the savings. Indeed, the personal savings rate stayed high—consistently above 7.2%—from June 2014 through June 2015. Not surprisingly, as savings increased, personal consumption slid during this period, keeping a lid on consumer-driven stimulus.
The rate of inflation, meanwhile, has remained well under control. Core CPI, which strips out food and energy prices, increased just 2.1% in October compared to a year ago. This marks the slowest year-over-year gain in six months.
Crucially, falling oil prices stifle the rapidly growing U.S. energy sector, resulting in reduced investment in capital projects and weaker job growth. Profits of energy companies suffer, too. With less-healthy bottom lines, more oil companies may struggle to repay debt and see a decline in credit quality. Such developments can also hurt creditors, including banks with loans to companies in the sector.
The U.S. economy: America says, “‛Debt’s’ the way we like it”
Last week, the Treasury Department reported that the U.S. had kicked off its 2019 fiscal year by recording a $100.5 billion budget deficit in October, up from $63.2 billion a year earlier. Receipts rose 7% versus last year, to $252 billion, while outlays climbed 18%, to $353 billion. The three largest expenditures were Social Security ($84 billion), defense ($69 billion), and Medicare ($53 billion), followed closely by net interest payments ($32 billion).
Deficit hawks were likely not pleased, even though deficits tend to provide a short-term boost to the economy. (In effect, the government borrows money and plows it back into the economy.) According to Goldman Sachs, deficit spending should add a healthy 0.6% or so to U.S. GDP this year and about 0.4% next year. By 2020, though, this stimulus is projected to turn into a headwind, detracting from economic growth.
The longer-term outlook looks even less promising. The Congressional Budget Office, which issues projections of what federal spending, revenues, and deficits would be for the next 30 years if current laws do not change, forecasts:
- A jump in the federal deficit from 3.9% of U.S. GDP in 2018 to 9.5% in 2048.
- A sharp increase in the federal government’s net interest costs as interest rates rise from their currently low levels and debt accumulates. Noninterest spending is also expected to escalate, mainly due to higher spending for Social Security and major health care programs, primarily Medicare.
- An increase in revenues thanks to rising individual income tax receipts, but not enough to keep pace with the upswing in spending.
Although the U.S. is forecast to accumulate red ink for many years to come, we don’t expect the country’s greater debt load to trigger an emerging-market-style debt crisis similar to the ones experienced by Argentina and Turkey. The U.S. has several unique strengths to help overcome future obstacles to borrowing heavily. Chief among them is the dollar’s role in the global economy. Investors view the greenback as a “risk free” store of value backed by the U.S. economy’s dynamism and diversity. Moreover, because most financial transactions, including international trade, are conducted in dollars, robust demand for the currency should continue.
Another advantage is our nation’s deep, liquid bond markets. Under normal circumstances, countries often funnel their export earnings into U.S. Treasuries. And in times of crisis, investors seek shelter in U.S. sovereign debt and other dollar-based assets. The bottom line? The U.S. should always be able to borrow—and at relatively low rates, to boot.
In a report issued earlier this year, Moody’s expressed its belief that U.S. fiscal health will weaken amid higher interest rates and rising entitlement costs—unless Congress takes the highly unpopular steps to reduce those costs or raise revenue (i.e., increase taxes). At the same time, the rating agency thinks the country’s broad economic strength will “support its credit profile for the foreseeable future.”