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Weekly Market Recap

Start the week off right with this one-page snapshot of headlines and market performance, including:

The week in review:
  • Core PCE was flat M/MM
  • Mfg. PMIs increased slightly
  • Services PMIs fell
  • Unemployment rate fell to 4.9%
  • Payrolls increased by 151K
This week ahead:
  • Job openings
  • Retail sales
  • Import prices
  • Consumer sentiment
 
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A resilient economy

As written in this week's Thought of the Week, all eyes were on last week’s jobs report as the bears were looking for signs that the uncertainty gripping markets in recent months might be showing up in the hiring data. In the end, they would be disappointed. Despite a below-consensus headline payrolls number (+151K vs. +188K), trend growth remains solidly above 200K, the unemployment rate fell to 4.9%, wages rose 0.5% (up 2.5% on the year) and the participation rate climbed for a third consecutive month.

Moreover, job losses were mostly concentrated in odd-ball areas (-39K in private educational services; -14K courier/messenger jobs), both related to larger than normal seasonal layoffs. In all, this report was not bad enough to cancel rate hikes this year, nor was it strong enough to cause the Fed to rush. However, markets seem to think otherwise, with Fed futures indicating probabilities dropping for all meetings in 2016 as shown in this week's chart. Most importantly, the report bodes well for investors, indicating resilience from an economy that is being tested by a slowing China, weak energy earnings and a strong U.S. dollar.

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Weekly Strategy Report

A review of global markets and portfolio positioning in January

  • January was a grueling month. Sharp falls in equity, commodity and currency markets induced an abrupt flight to quality. Government bonds yields fell significantly and the US dollar posted sharp gains.
  • Policy uncertainty in China and the ferocity of recent oil price declines drove much of last month's market turmoil. Neither China uncertainty nor a low oil price is likely to reverse any time soon. Risks in the short term will remain elevated.
  • We keep a cautious near-term stance as markets adjust to underlying economic and financial imbalances. We are more constructive medium term as we believe concerns about global growth are exaggerated. Volatility will remain higher than normal.
  • The path of the US dollar will be pivotal to future returns. If the USD were to consolidate its recent gains, it would relieve current market stress and potentially boost risk appetites.
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Weekly Market Recap

Start the week off right with this one-page snapshot of headlines and market performance, including:

The week in review:
  • Home prices increased in Nov.
  • Pending home sales increased 0.1%
  • Durable goods orders fell 5.1% m/m
  • Flash Services PMI down to 53.7
  • Consumer confidence up to 98.1
  • Consumer sentiment down to 92.0
  • New home sales increased to 544k
  • ECI increased 0.6% in 4Q15
This week ahead:
  • Personal income
  • Mfg. and Non-Mfg. PMIs
  • Light vehicle sales
  • Dec. ADP and BLS employment
  • International trade
 
 
 
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The consumer is alive and well

As written in this week's Thought of the Week, real U.S. economic growth slowed to an annualized rate of 0.7% in 4Q15, but with consensus estimates of 0.8%, this report did not come as a surprise to markets. Expectations leading up to the report were for slower growth due to the familiar headwinds of low commodity prices, an inventory overhang and a strong dollar. Each of these came to pass, as shown in the chart. Business investment, for example, detracted 0.2% from growth this quarter, as investment in mining and oil exploration structures decreased at an annualized rate of almost 40%.

Strength in the report was similarly predictable, and although consumption slowed to an annualized pace of 2.2% last quarter, it still contributed 1.5% to growth, and residential investment proved to be a tailwind following an unusually mild start to the winter. In 2015, real GDP increased at an above-trend rate of 2.4%, matching economic growth in 2014. While there was some weakness in this quarter’s report, growth at an annual pace of 2.4% is consistent with our expectation for continued rate increases in 2016, and the details of this report highlight that the consumer is alive and well.

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Weekly Market Recap

Start the week off right with this one-page snapshot of headlines and market performance, including:

The week in review:
  • Housing market index was flat
  • CPI fell 0.1% m/m
  • Housing starts fell 2.5% in December
  • Philly Fed improved slightly
  • Flash Mfg. PMI improved to 52.7
  • Existing home sales up 14.7% in December
This week ahead:
  • Housing price index
  • Consumer sentiment
  • Employment cost index
  • GDP
  • FOMC meeting
 
 
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An oily situation: prices for early 2016

As written in this week's Thought of the Week, the first few weeks of 2016 showed renewed pessimism over oil prices. After sanctions were lifted in Iran, oil prices breached the $30 mark and recently touched $26.55 per barrel. This commodity-related negativity has spread to risk assets, with the equity market max drawdown of 9% year to date and high yield spreads widening above 700 bps.

Although the global supply glut seems to be worsening as Saudi Arabia again rejected the idea of production cuts and the lifting of Iranian sanctions will bring them back to the market, the U.S. is showing signs of supply side softening as companies scale back rig counts and production. As this continues, falling revenues from inactivity will pressure the sector in the near term, but in the longer term this could precipitate a reversal as supply and demand rebalance. While this may take time to materialize, the price movements seen in the first few weeks of 2016 seem exaggerated, especially considering many of the hardest hit sectors are typically benefactors of lower oil prices. In times of increased volatility and dislocations, it is important to focus on fundamentals and understand where risks stem from, rather than being distracted by emotions and market movements.

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Weekly Market Recap

Start the week off right with this one-page snapshot of headlines and market performance, including:

The week in review:
  • Job openings up to 5.4 M
  • Import prices down 8.2% y/y
  • PPI final demand -1.0% y/y
  • Retail sales -0.1% m/m
  • Consumer sent. up to 93.3
  • NFIB survey up to 95.2
This week ahead:
  • CPI
  • Housing starts
  • Philly Fed survey
  • Existing home sales
 
 
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Investors are now more bearish than at any time since last July

As written in this week's Thought of the Week, Investors have had a shaky start to the year as worries about China, oil and the U.S. economy prompted a global stock market selloff. In our view, these worries are no reason to abandon equities. China’s economy is slowing, but this is nothing new. Also stock market moves in China, while volatility-producing, have little to do with underlying economic or company fundamentals, and the U.S. is relatively well insulated from a slowing China. Oil prices are falling largely due to overproduction and while low oil prices are certainly dragging on investment and energy-linked employment in the U.S., low oil prices do not have the ability to knock the U.S. into recession. Negative headlines create unease amongst investors and, as can be seen in the chart of the week, investors are now more bearish than at any time since last July. However, as is also shown in the chart, bearish sentiment is a good contra-indicator for the S&P 500, with solid equity market gains usually being logged in the year following very bearish sentiment. This should serve as a reminder to investors that the U.S. market is sentiment-driven in the short run, but determined by company and economic fundamentals in the long run.
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A transition with Chinese characteristics

By Gabriela Santos
This bulletin, written by Gabriela Santos and Hannah Anderson, examines the impact of China's slowing economy on developed and emerging markets.
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Weekly Market Recap

Start the week off right with this one-page snapshot of headlines and market performance, including:

The week in review:
  • Markit and ISM Mfg PMIs lower
  • Services PMIs lower, but solidly >50
  • Light vehicle sales were 17.2m
  • ADP employment increased 257k
  • Trade deficit improved to -$42.4bn
  • Payrolls increased 292k
This week ahead:
  • NFIB survey
  • Job openings
  • Import prices & PPI
  • Retail sales
  • NY Fed survey
  • Industrial production
  • Consumer sentiment
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January hiccups

As written in this week's Thought of the Week, it has been the worst start to the year for equity markets since 2008. Risk-off sentiment swept the U.S. market despite positive signs for the economy including a solid employment print, a growing services economy, and more evidence that the Fed will remain dovish through the early stages of the rate hiking cycle. A confluence of global factors triggered the market drop of 5% in the first week of 2016, including a sell-off in Chinese equities, new lows for oil prices, and lowered estimates for global growth in 2016.

Investors wonder if the early stumble in the market this year foreshadows a difficult year for markets. The chart of the week shows that January returns do not always predict full year returns, and 60% of the time that January returns are negative, the full-year return is positive. Although blockbuster equity returns associated with earlier stages of the business cycle are likely behind us, consumer strength should continue to fuel growth in the U.S. throughout the year, possibly pushing equities higher and putting the initial market hiccup behind us.

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Weekly Market Recap

Start the week off right with this one-page snapshot of headlines and market performance, including:

The week in review:
  • Home prices increased 0.9% m/m
  • Consumer confidence jumped to 96.5
  • Pending home sales fell 0.9% m/m
This week ahead:
  • Manufacturing PMIs
  • Vehicle sales
  • Services PMIs
  • Employment report
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Major market themes of 2015: A retrospective

As written in this week's Thought of the Week, as we kick off 2016, it is worth taking a look back at 2015 to address some of the major market themes that led to considerable return dispersion across asset classes. Emerging market equities and commodities both struggled, as a seemingly unstoppable rise in the U.S. dollar and fears of a global growth slowdown that was “Made in China” weighed on returns. Turning to U.S. equities, large cap companies outperformed their small cap counterparts, but both experienced heightened levels of volatility in the second half, finishing the year essentially at the same place they began.

Outside of the U.S., the strength of the dollar weighed on returns for U.S.-based investors, with developed market equities up slightly due to decent returns out of Japan but mixed returns in Europe and the U.K. Finally, after casting a shadow over markets for the better part of 2015, the Federal Reserve raised interest rates in December for the first time in 9 years. However, with the exception of U.S. high yield, which suffered due to weakness in the broader energy complex, fixed income markets finished the year flat as investors opted for safe-haven investments due to rising volatility across risk assets. While it is easy to become frustrated in the wake of a year where performance was largely driven by macro headwinds and uncertainty, it is important for investors to remember to stay invested for the long run and that these storms are best weathered with a diversified portfolio.
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The broad truth about narrow markets

By James Liu
This bulletin, written by James Liu, addresses recent investor concerns about low market breadth.
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Making fiscal policy stimulative

As written in this week's Thought of the Week, fears of a fiscal cliff arose once again this year, as legislators repeatedly failed to pass a budget. However, a combination of willingness to compromise on taxes, removal of certain policy riders, and the resignation of Speaker Boehner seemed to bring the parties together and an omnibus spending package passed late this month. This bill contains several positive measures for the U.S. economy and puts fiscal policy in a position to ease as monetary policy tightens. Domestic spending has been lifted above the sequester caps.

A deal on corporate taxes was reached so that companies can plan their research and development activities instead of wondering if they will retroactively receive tax incentives. Most importantly for investors, the omnibus spending package suspends the debt ceiling until early 2017, sparing markets from the turmoil of a debt ceiling fight for at least a year. A multi-year transportation bill was also approved in December for the first time in years, enabling repairs to begin on America’s crumbling infrastructure. All in, these measures will provide a boost to aggregate demand, as can be seen in the Chart of the Week. Because of these measures, the budget deficit will increase to 3.0% of GDP, higher than the previously estimated 2.2%, making fiscal policy stimulative for the first time in seven years.

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Weekly Market Recap

Start the week off right with this one-page snapshot of headlines and market performance, including:

The week in review:
  • Real GDP 3rd est. rev. down to 2.0% saar
  • Personal income rose 0.3% m/m
  • Consumer spending rose 0.3% m/m
  • New home sales fell to 490 k
  • Existing home sales down to 4.8 m
  • Consumer sentiment rose to 92.6
This week ahead:
  • Final 3Q15 Real GDP
  • FHFA home price index
  • Existing & new home sales
  • Durable goods & Personal income
  • Consumer sentiment
 
 
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Weekly Market Recap

Start the week off right with this one-page snapshot of headlines and market performance, including:

The week in review:
  • Core CPI increased 2.0% y/y
  • Mfg. surveys were mixed in Dec.
  • NAHB survey weakened slightly
  • Housing starts up to 1,173k
  • Industrial production fell 0.6% m/m
  • Flash Mfg. PMI fell to 51.3
  • Flash Services PMI fell to 53.7
The week ahead:
  • Final 3Q15 Real GDP
  • FHFA home price index
  • Existing & new home sales
  • Durable goods & Personal income
  • Consumer sentiment
 
 
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Fed's forecast: four rate hikes in 2016

As written in this week's Thought of the Week, the Federal Reserve (Fed) signaled its confidence in the strength of the U.S. economic recovery by raising short-term interest rates 0.25% last week. The move was a unanimous decision by the voting members of the Committee, and it ends seven years of near-zero interest rate policy. The rate increase had been well communicated to the investing community, so the market reaction to the announcement was positive, with stocks rallying and Treasury yields remaining relatively stable.

But now that the hurdle of the first rate increase has passed, markets must refocus on the Fed’s expectation for the path of further interest rate increases. While the tone of the statement, projections and press conference was dovish, one hawkish surprise, within the Fed’s projections, was the median forecast for the federal funds rate at the end of 2016, which implies four rate increases next year. This projection is at odds with the market’s even lower expectations for the federal funds rate. While markets responded calmly to the Fed’s action last week, falling unemployment and rising inflation may cause the Fed to stick to its forecast of four rate hikes in 2016 in the end, which could entail more risk to the bond market than is implied by initial market reactions.

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A Brighter Outlook for 2016

By Dr. David Kelly
  • 2015 has been a year of waiting, worrying and sideways markets. As we enter 2016, some of the waiting is over and some of the worries should diminish, providing a clearer, brighter outlook for 2016.
  • However, in a still slow-growing U.S. and global economic environment, valuations are not looking particularly cheap across many asset classes.
  • Because of this, returns will likely be modest with the best long-term gains accruing to those who recognize mispricing at both the macro and micro levels and have the patience to wait for it to resolve.
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Asset Allocation Views 1Q 2016

By John Bilton
  • After a year of growth scares and choppy markets, we see a modestly better outlook in 2016, with the U.S. economy in mid-cycle, the recovery broadening out in Europe and some early signs of stabilization in emerging economies.
  • The trajectory of the U.S. dollar is pivotal; as U.S. rates start to rise, the dollar’s climb should slow as the gap between growth in the U.S. and the rest of the world narrows.
  • Stabilization in the U.S. dollar and oil will reassure equity and credit markets; recovering earnings plus consumer resilience in developed markets will give investors the confirmation they crave that gradually rising U.S. rates will not snuff out growth.
  • We start the year overweight stocks (notably Europe ex-UK and the U.S.) and credit, neutral duration and commodities, and underweight cash and emerging markets (EM).
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Weekly Market Recap

Start the week off right with this one-page snapshot of headlines and market performance, including:

The week in review:
  • Job openings fell to 5.4M
  • Import prices fell 0.4% in November
  • PPI increased 0.3% m/m
  • Retail sales improved 0.2% m/m
The week ahead:
  • CPI
  • HMI
  • Housing starts
  • Industrial production
  • FOMC meeting
 
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Value in energy companies with low debt levels

As written in this week's Thought of the Week, oil prices experienced a fresh wave of pessimism following the OPEC meeting on December 4th, when the cartel maintained
production at its current level of 31.5 million bbl/day. While largely expected, the move effectively removes the ceiling on OPEC production, thereby increasing production in the midst of a supply glut. OPEC’s strategy over the past 18 months has been to maintain market share at the expense of other non-OPEC producers, namely U.S. shale players, and ultimately price them out of the market. With both U.S. and OPEC production increasing, more pain should be felt in the energy sector.
 
However, given OPEC’s persistent strategy, there have been signs of future waning production in the U.S. as companies scale back on replacement capex and active rig counts continue to decline. Inevitably, these measures will lead to less output in the longer term, with agencies such as the EIA and IEA expecting U.S. production to decline by 0.5 million bbl/day and demand increasing by 1.6 million bbl/day in 2016. Energy-related securities in both equity and fixed income markets will likely experience pain in the near term, but value may be found in companies with low debt levels, efficiencies of scale and strong balance sheets who can successfully manage through the current low price environment.
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Weekly Market Recap

Start the week off right with this one-page snapshot of headlines and market performance, including:

The week in review:
  • Unemployment rate at 5.0%
  • ISM mfg. PMI down to 48.6
  • Light vehicle sales 18.1 M
  • Unit labor costs +1.8% q/q saar
The week ahead:
  • Job openings
  • Retail sales
  • Consumer sentiment
  • Producer prices
  • Import prices
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Tightening of the Fed on track

As written in this week's Thought of the Week, the European Central Bank (ECB) eased further last week, extending the timeframe of quantitative easing and pushing deposit rates even lower. Despite the aggressive easing, markets in Europe and the U.S. sold off at first and then calmed down as investors digested what was ultimately some very positive news. While the ECB has committed to easing policy through March 2017, the Federal Reserve is on the verge of tightening here at home.

The November employment report provided further evidence of U.S. labor market improvement, putting the Fed on track to tighten policy at its December meeting. This rate hike has been well telegraphed and is expected by the market, with market-based odds of a hike approaching 90%. As the Fed raises rates, the divergences in global monetary policy will grow even starker. Despite the market's initial reaction, this clear divergence in monetary policy highlights the need for investors to have a plan for addressing global monetary policy divergence; U.S. investors may want to look for investment opportunities overseas where asset prices might benefit from the easy money policies.
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Weekly Market Recap

Start the week off right with this one-page snapshot of headlines and market performance, including:

The week in review:
  • Existing home sales were 5.36m
  • 3Q15 Real GDP up to 2.1%
  • Flash Mfg. PMI down to 52.6
  • Consumer confidence sank to 90.4
  • Durable goods improved 3.0% m/m
  • New home sales up to 495k
The week ahead:
  • Pending home & vehicle sales
  • Markit & ISM Mfg. PMI
  • Markit & ISM Non-Mfg. PMI
  • ADP Employment & Payrolls
  • Trade deficit
 
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Diverging central bank policy: a theme in 2015

As written in this week's Thought of the Week, diverging central bank policy has been a well-televised theme in 2015, and in mid-December, divergence may finally begin. This week, the European Central Bank may ease monetary policy further in an effort to stimulate inflation expectations across the European economy, and two weeks later, the Federal Reserve is expected to raise the federal funds rate. Though the expectation of these policy moves is fairly consensus, the financial impact is largely unknown. For example, rising short-term rates in the U.S. and lower rates in Europe should, in theory, lead to dollar appreciation.

However, the expected difference in interest rates may already be priced in. Turning to long rates, the impact of diverging monetary policies is more apparent. This week’s chart shows the positive correlation between 10-year government bond yields in Germany and the U.S., which suggests that low rates in Europe will likely anchor long rates in the U.S. While U.S. government bonds may face some headwinds, even from a gradual increase in rates, the more credit-sensitive sectors of the bond market may not feel this same pain. In fact, slowly rising interest rates are a navigable headwind for credit, as this has historically led to tighter spreads, rather than higher yields, and is therefore less pain for investors in this space.
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Weekly Market Recap

Start the week off right with this one-page snapshot of headlines and market performance, including:

The week in review:
  • Empire State mfg. increased to -10.7
  • Core CPI 0.2% m/m, 1.9% y/y
  • Industrial production fell 0.2% m/m
  • HMI fell to 62
  • Housing starts fell to 1.06M
  • •Philly Fed increased to 1.9
The week ahead:
  • PMI flash
  • Existing/new home sales
  • GDP
  • HPI
  • PCE
 
 
 
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Retailers facing significant competition from internet sales

As written in this week's Thought of the Week, over the past few weeks, questions about the strength of the U.S. consumer have arisen from disappointing department store earnings announcements and an October retail sales number that came in below consensus expectations. Although the outlook for consumer discretionary was weakened by several retailers reporting worse than expected earnings, it is important to recognize, when gauging the current and future strength of the consumer, that the majority of consumer spending has shifted from a typical trip to the mall toward experiences and services.
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Skirting the hard landing

By George Iwanicki

While we do not believe an EM crisis is under way or inevitable, we believe emerging markets equities are still range-bound, constrained by the triumvirate of headwinds. Valuations are not sufficiently cheap to prompt a tactical "buy today" mentality. However, they are cheap enough (including consideration of the EM currency de-rating) to encourage investors to be setting valuation or fundamental "guideposts" to add to the asset class rather than run from it because of the news flow and worries that have overtaken investors.

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Weekly Market Recap

Start the week off right with this one-page snapshot of headlines and market performance, including:

The week in review:
  • Import prices -10.5% y/y
  • Export prices -6.7% y/y
  • Job openings 5.5 M
  • Retail sales +0.1% m/m
  • Producer prices final demand -1.6% y/y
  • Business inventories +0.3% m/m
  • Consumer sentiment 93.1
The week ahead:
  • CPI
  • Industrial production
  • Housing starts
  • Philly Fed survey
 
 
 
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Earnings growth to return next year

As written in this week's Thought of the Week, the 3Q15 earnings season has been a tough one for the S&P 500. At the index level, earnings per share fell by 15.2% from a year prior, but rose by 1.8% when the energy sector is excluded. However, despite the weakness observed this year, estimates for 2016 have stayed relatively constant, and currently imply a 19.3% increase year over year; that said, even if earnings surprise to the upside next year, such a strong rate of earnings growth will be difficult to achieve. Alternatively, if one uses more reasonable assumptions, it does seem possible that earnings growth could reach high single digits in 2016.

Part of the reason for this has to do with the fact that the hit to energy and materials companies from low commodity prices should roll off, consumers may begin to spend their oil savings and both economic and corporate fundamentals should remain supportive. Thus, while the 3Q numbers are disappointing and investors may want to adjust their expectations for 2016, earnings growth looks set to return next year, which supports maintaining a slight overweight to U.S. equities within the context of a balanced portfolio.
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A brave new world: the deep de-carbonization of electricity grids

By Michael Cembalest
Previously we analyzed the individual components of the electricity grid: coal, nuclear, natural gas, wind, solar and energy storage. This year, we look at how everything fits together in a stytem dominated by renewable engergy, with a focus on cost and CO2 emissions. The importance of understanding such systems is amplified by President Obama's "Clean Power Plan", a by-product of which will likely be greater use of renewable energy for electricity generation.
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Dr. Kelly's Commentary: The North Star of the Economy

By Dr. David Kelly
This commentary, written by Dr. David Kelly, discusses how the unemployment rate affects the length of economic expansions.
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Weekly Market Recap

Start the week off right with this one-page snapshot of headlines and market performance, including:

The week in review:
  • ISM & Markit Mfg. PMIs to 50.1 & 54.1
  • ISM Non-Mfg. PMI up to 59.1
  • Light vehicle sales were 18.2m
  • Trade deficit improved to -$40.8
  • ADP employment increased 185k
  • Total payrolls increased 271k
The week ahead:
  • NFIB survey
  • Import & Producer prices
  • Job openings
  • Retail sales
  • Business inventories
  • Consumer sentiment
 
 
 
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Benefits from an overweight to equity relative to fixed income

As written in this week's Thought of the Week, the Chinese devaluation of the Renminbi preceded a sharp drop in equity prices in August, and many investors questioned whether the slump was a buying opportunity or a correction justified by fundamentals. Equities bottomed in August and quickly retraced losses, suggesting the movement was not indicative of fundamental problems; October’s large cap U.S. equity return of 8.3% marked the best month for equities since 2011. However, economic and fundamental indicators paint a muddled picture of growth and challenge the underpinnings of the relief rally.

Equities rallied in October through a lackluster earnings season, weak indicators of manufacturing production and third quarter GDP growth that was sharply reduced by slower inventory growth. Additionally, slowing international growth and uncertainty over the path of interest rate increases continue to overhang the market. However, continued solid U.S. consumer spending, improvement in the European economy and stabilization in emerging markets are positive for U.S. equity fundamentals. Despite recent volatility, we maintain our view that U.S. equities can move higher, and investors may benefit from an overweight to equity relative to fixed income.
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3Q15 Earnings season recap: What will earnings do after a gap year?

This bulletin, written by James Liu, recaps the third quarter earnings season.
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Weekly Market Recap

Start the week off right with this one-page snapshot of headlines and market performance, including:

The week in review:
  • New home sales fell to 468K
  • Durable goods fell 1.2% m/m
  • HPI increased 0.1% m/m
  • Pending home sales fell 2.3% m/m
  • Core PCE 1.3% y/y
  • ECI up 2.0% y/y
  • Consumer sentiment fell to 90
The week ahead:
  • ISM/PMI manufacturing
  • Light vehicle sales
  • International trade
  • Employment situation
 
 
 
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Fundamentals in the U.S. economy

As written in this week's Thought of the Week, at first glance, the 1.5% q/q saar initial estimate of 3Q real GDP growth does not send a positive message about the health of the U.S. economy. However, this headline number is masking strength in key underlying areas, mostly notably the consumer. Final demand, growth excluding inventory changes, increased 3.0% led by a 2.2% gain in consumer spending. This follows a solid 2.4% increase in 2Q and reiterates the continued strength in the U.S. consumer. Business and residential investment added an incremental 0.3% and 0.2%, respectively, and government spending increased 0.3% primarily due to state and local governments.

Even with the stronger dollar and slowdown in China, foreign trade resulted in a minimal 0.03% drag, much less than expected. A large inventory build-up in the first half of the year is the culprit behind the lower headline number, shaving 1.4% from an otherwise steady growth rate. It is worth noting that while this inventory stockpile could impact coming quarters, most of the damage is behind us given that it would require only an additional 0.6% drag on annualized GDP to get back to the average pace of inventory accumulation. Despite the inventory correction, fundamentals in the U.S. economy remain strong and the expansion continues, albeit at a moderate pace.

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Weekly Market Recap

Start the week off right with this one-page snapshot of headlines and market performance, including:

The week in review:
  • Housing starts +1.2 M
  • Existing home sales +8.8% y/y
  • PMI mfg. flash 54.0
The week ahead:
  • 3Q GDP
  • FOMC meeting
  • Durable goods orders
  • New home sales
  • Employment cost index
  • Personal income & outlays
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Third quarter GDP and concerns from the FOMC meeting

As written in this week's Thought of the Week, this week is an important one from an economic data standpoint, with the release of the first estimate of 3Q GDP and the FOMC meeting being focal points for investors. The U.S. economy looks healthy, but record low unemployment claims, solid monthly payroll gains, and slow labor force growth indicate that spare capacity may be running out. Overall, the pace of expansions tends to slow as they age, and this one is no different. The 3Q GDP number this week should highlight the continued trend of moderate growth, as the economy works through an inventory overhang and a stronger U.S. dollar drags on trade.

Turning to the Fed, while we do not expect a rate hike at this meeting, how the Fed interprets recent economic data will be important in setting expectations for future decisions. Is the Fed making decisions based economic momentum, or are they more focused on the broad health of the economy? Recent history would suggest that the Fed is looking for stronger momentum, but such momentum may not materialize. Other noted concerns of the FOMC at their last meeting, like volatility and weak inflation expectations, seem to be dissipating, leaving the Fed with a judgement call of whether the overall state, or rate of change in the economy, is more important. If it is the later, we may be stuck with emergency measures for quite some time.

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Dr. Kelly's Commentary: Deflation delusions  

By Dr. David Kelly
This bulletin, written by Dr. David Kelly, addresses the impact that deflationary fears have had on the Fed's decision to postpone rate hikes.
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Weekly Market Recap

Start the week off right with this one-page snapshot of headlines and market performance, including:

The week in review:
  • Retail sales fell -0.1%
  • Empire state survey improved to -11.4
  • Philadelphia Fed survey was -4.5
  • Core PPI increased 0.8% y/y
  • Core CPI firmed 1.9% y/y
The week ahead:
  • NAHB survey & FHFA HPI
  • Housing starts & Existing home sales
  • Flash Manufacturing PMI
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Volatility an opportunity for high yield spreads

As written in this week's Thought of the Week, recently high yield spreads have widened from their June 2014 tights to levels not seen since 2012. While some investors may view this as a warning signal, we believe that this volatility has created opportunity. Spread widening began with a widespread sell-off in high yield after Janet Yellen pointed out the very tight level of spreads, and was exacerbated through the end of last year by falling oil prices, which, as shown in the chart of the week, led to both energy and broad sector spreads increasing.

Furthermore, 75% of the domestic high yield index is made up of cyclical sectors (including energy), and given that the asset class tends to move with U.S. large cap equity, recent volatility and the risk-off sentiment in markets may have accentuated the energy-led spread widening. Generally when spreads widen it is a result of investors ratcheting up their expectations of default; however, current spreads imply a 6.0% default rate compared to the actual default rate of 2.3% in the last twelve months and an average of 3.9% since 1988. Thus, given our expectations for continued economic expansion in the U.S. accompanied by a rebound in earnings in 2016, coupled with stable high yield fundamentals outside of the energy sector, it appears that investors in the high yield space could benefit from spread compression from current elevated levels.

Download full Weekly Market Recap

Avoiding the stagnation equilibrium

By Dr. David Kelly
At their September meeting, the Federal Reserve decided, for the 54th consecutive time, to leave short-term interest rates unchanged at a near-zero level. While only one voting member of the Federal Open Market Committee (FOMC) dissented, the Fed’s action, or rather inaction, was hotly debated.

Those advocating an immediate hike argued that the economy had progressed far beyond the emergency conditions that had led to the imposition of a zero interest rate policy in the first place and that the Fed was already dangerously “behind the curve.” Those lobbying for further delay pointed to a lack of wage inflation and signs of weakness in the global economy.

However, frustratingly, we believe this argument, like all monetary policy debates in recent years, has been waged on a false premise, namely that increasing short-term interest rates, even from these extraordinarily low levels, would hurt aggregate demand. We believe that the opposite is true. The real-world relationship between interest rates and aggregate demand is non-linear and an examination of the transmission mechanisms suggest that the first few rate hikes, far from depressing aggregate demand, would actually boost it.
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Weekly Market Recap

Start the week off right with this one-page snapshot of headlines and market performance, including:

The week in review:
  • ISM non-Mfg. PMI lower to 56.9
  • Markit services PMI lower to 55.1
  • Trade deficit expanded to -$48.3bn
  • Jobless claims were 277k
  • Import prices were -0.1% lower m/m
The week ahead:
  • NFIB survey
  • Retail sales
  • PPI & CPI
  • NY & Philly Fed surveys
  • Consumer sentiment
  • Job openings
Continue Reading PDF

Trend reversal for foreign central banks

As written in this week's Thought of the Week, foreign central banks spent most of the 2000s buying U.S. Treasury securities to build international reserves as a means of backing their currencies, financing imports, and otherwise maintaining the ability to absorb unforeseen external shocks. Recently, the trend reversed and foreign central banks became net sellers of U.S. Treasuries. Low commodity prices caused some commodity exporters to dump Treasuries while China, the largest foreign owner of Treasury securities, sold U.S. dollar reserves to manage yuan valuation against the dollar.

Central bank buying helped to keep a lid on rates through 2014, but selling pressure this year has yet to cause a meaningful increase in Treasury yields. The 10-year Treasury yield has been range bound for most of the year, and while risk-off market movements create a bid for risk-free U.S. government securities, central bank selling is an opposing upward force on yields that may be causing the 10-year to hover just around 2.0%. Without central bank buying pushing Treasury yields lower, rates on the long end of the curve may begin to rise ahead of the first federal funds rate increase. The uncertain path of interest rate increases and yield curve movement underlines the need for a diversified fixed income portfolio.

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Weekly Market Recap

Start the week off right with this one-page snapshot of headlines and market performance, including:

The week in review:
  • Core PCE increased to 1.3% y/y
  • Pending home sales fell 1.4% m/m
  • HPI decreased 0.2% m/m
  • Consumer confidence increased to 103
  • Light vehicle sales increased to 18.1M
  • PMI/ISM manufacturing 53.1/50.2
  • Factory orders fell 1.7%
The week ahead:
  • ISM non-mfg. index
  • International trade
  • FOMC minutes
  • Import prices
Continue Reading PDF

Continued Volatility

As written in this week's Thought of the Week, almost all asset classes declined in Q3 2015 as uncertainty related to China’s economy and the timing of a Fed rate hike resulted in increased volatility in global risk assets. The S&P 500 was down 6% for the three months ending September 30, but was the best performing equity market with the MSCI EAFE and EM returning -10% and -18%, respectively. Small cap U.S. equities struggled more than the broader market, falling 12%. Commodities faced continued downward pressure falling 14% in the wake of weaker than expected Chinese data.

Within the fixed income space, high yield fell 4% as spreads continued to widen in response to lower energy prices and slowing global growth. The two standouts for the quarter were the Barclays Agg., which rose after the Fed failed to raise rates in September, and REITs which benefitted from resilient domestic economic data. Investors can expect continued volatility through the end of the year as uncertainty continues to loom over monetary policy and weakness in emerging markets. These challenging market environments are when investors most need to maintain composure and stay invested with a diversified portfolio.

Download full Weekly Market Recap

Weekly Market Recap

Start the week off right with this one-page snapshot of headlines and market performance, including:

The week in review:
  • Existing home sales 5.3 M
  • Flash mfg. PMI 53.0
  • Durable goods orders -2.3% y/y
  • 2Q GDP 3.9% q/q saar
The week ahead:
  • Personal income & outlays
  • Employment report
  • ISM mfg. index
  • Dallas Fed mfg. survey
  • Construction spending
  • Factory orders
Continue Reading PDF

Services Drive Growth

As written in this week's Thought of the Week, recent concerns about weakness in emerging markets have sparked conversations about the potential for any economic weakness to infect developed economies via trade. However, it is helpful for investors to remember that developed market growth tends to be driven by services, rather than manufacturing, making it less exposed to the export cycle. Furthermore, outperformance in the service-oriented areas of the economy is a strong signal for overall growth. We have noticed that the service-related industries in developed markets, particularly in Europe, have grown much faster than their manufacturing counterparts in recent months.

As shown in this week’s chart, the Purchasing Managers Indices (PMI), which are broken down into services, manufacturing, and composite indices, offer us a useful way to examine these sectors on both an absolute and relative basis. Furthermore, while the official figures are published monthly, flash readings are released mid-month, which can give investors an idea of where growth may be headed. The flash estimates released last week suggest that services have continued to drive growth across the developed world, a trend that looks set to continue into the end of the year.

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The Millennials - Executive Summary

By Michael Cembalest, Katherine Roy

The millennial generation (individuals born between 1982 and 2000) is the subject of intense scrutiny: their likes and dislikes, social media inclinations and digital footprints, fashion sense, dining habits, reproductive trends, political and religious views, workplace objectives, etc. This year, millennials will overtake the baby boomers as the largest living generation in the United States, so there are plenty of reasons to study them. This is the abbreviated version of the study.

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The Millennials

By Michael Cembalest, Katherine Roy
The millennial generation (individuals born between 1982 and 2000) is the subject of intense scrutiny: their likes and dislikes, social media inclinations and digital footprints, fashion sense, dining habits, reproductive trends, political and religious views, workplace objectives, etc. This year, millennials will overtake the baby boomers as the largest living generation in the United States, so there are plenty of reasons to study them.
 
Our focus here is not on smartphone usage or cultural preferences, but on how millennials will manage their finances and maintain their financial independence throughout their working years and through retirement. Our analysis is presented in the form of a proposal for a web-based show (The Millennials) available for live streaming, complete with backstory, a list of episodes and detailed production notes. Millennials that binge-watch the series in its entirety, as well as their financial advisors, employers and parents, will gain a greater understanding of the drivers of financial security in a rapidly changing world, one that the millennials will now inherit.
Continue Reading PDF

Weekly Market Recap

Start the week off right with this one-page snapshot of headlines and market performance, including:

The week in review:
  • Retail sales increased 0.2% m/m
  • Industrial production fell -0.4% m/m
  • Empire State survey weak at -14.7
  • Core CPI maintained 1.8% y/y growth
  • Housing starts fell to 1.126m saar
  • Philadelphia Fed survey fell to -6.0

 
The week ahead:
  • Existing & new home sales
  • FHFA HPI
  • Flash Markit Mfg. and Non-Mfg. PMIs
  • Durable Goods
  • Consumer sentiment
  • Final statement of 2Q15 Real GDP

 
Continue Reading PDF

No Raising Rates by the FOMC

As written in this week's Thought of the Week, the FOMC decided to maintain its policy rate during last week’s meeting. Many economists guessed that the Committee would raise rates for the first time in almost ten years after months of rhetoric from the Fed indicated that its dual mandate of maximum employment and stable prices had been sufficiently met. In fact, instead of raising rates the FOMC decided to hold off. In the past, moderate inflation and a tightening labor market would be grounds for raising interest rates. However, as shown in the chart of the week, the FOMC’s projections for the federal funds rate at the end of 2016 are sinking with the unemployment rate.

The counterintuitive relationship between the two exists because the Fed is increasingly considering international developments including the strong U.S. dollar exchange rate and global market and economic turbulence in its assessment of U.S. economic strength. The FOMC’s inaction despite falling unemployment and stable prices adds an additional element of uncertainty to the market, which may be negative for equities and positive for treasuries in the near-term. However, on a relative value basis we still believe in an overweight to equity versus fixed income relative to a normal portfolio.
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Dr. Kelly's Commentary: Waiting on the world to change

This bulletin, written by Dr. David Kelly, addresses the Federal Open Market Committee meeting announcement on September 17.
Download full Commentary

Weekly Market Recap

Start the week off right with this one-page snapshot of headlines and market performance, including:

The week in review:
  • Job openings increased 5.8M
  • Import prices fell 1.8% m/m
  • PPI was flat m/m
  • Consumer sentiment fell to 85.7

 
The week ahead:
  • Retail sales
  • Industrial production
  • CPI
  • HMI & housing starts
  • Philly Fed
  • FOMC meeting

 
Continue Reading PDF

Proceeding with Caution

As written in this week's Thought of the Week, with uncertainty from China and the Fed rattling markets over the past few weeks, emerging market weaknesses have reemerged. Similarities from both the late 1990s EM crisis and the taper tantrum in 2013 have increasingly been referenced, but it’s important to note some of the marked differences in the current environment. Since the late 90s, many EM countries have increased their FX reserves and improved their current account balances, leaving them more capable ofdealing with impending Fed rate hikes. Other new exposures, such as the increase in corporate debt issuance since 2009, are a bit more worrisome, but how the credit wind-down is handled remains to be seen.

Importantly, when we look at systemic risks to other countries and regions from a slowdown in China, we find that the U.S. and developed markets overall remain largely isolated from the impact. Exports from the U.S. to EM make up just 4% of GDP and U.S. banks have just 3% exposure to China. According to an analysis by JPMorgan Securities, these exposures and others only translate to a -0.03% impact on real GDP growth in the U.S. given a 1% drop in Chinese GDP. While investors should remain cautious given the situation in emerging markets, they should not let recent volatility steer them away from sound, fundamental investments in developed markets.
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Emerging markets and the Fed: A game changer?

By Gabriela Santos, Ben Luk
As developed economies continue to heal, the liquidity tide will no longer lift all EM boats equally. This paper focuses on the impact of previous rate hikes on emerging markets, the lessons learned during the "taper tantrum" period and how investors should differentiate within EM in today's environment.
Continue reading Market Bulletin

The long and short of baby boomer balance sheets

Baby boomers are entering retirement, bringing with them a median level of household assets considerably higher than that of their parents’ generation and, in all likelihood, far exceeding that of the next generation as well. We refer to this massive accumulation of assets—and the impact it is likely to have on the economy, markets and the retirement prospects of multiple generations—as baby boomers' "financial exceptionalism." This research examines the evolution of baby boomer balance sheets and attempts to assess and quantify its implications for markets and investors.
Continue reading Investment Insights

Weekly Market Recap

Start the week off right with this one-page snapshot of headlines and market performance, including:

The week in review:
  • Mfg. PMI 53.0
  • ISM mfg. index 51.1
  • Unit labor costs +1.7% y/y
  • Payrolls +173,000
  • Unemployment rate 5.1%
The week ahead:
  • Job openings
  • Import & export prices
  • Producer prices
  • Consumer sentiment

 
Continue Reading PDF

Resilient Economic Picture in the Developed World

As written in this week's Thought of the Week, in light of recent market volatility, it is important for investors to remember that while emerging markets may have a tough road ahead, the underlying economic picture in the developed world has proven resilient. The G3 economies, Europe (the 28 European Union countries), the U.S., and Japan account for approximately 52% of global GDP, and as such are major drivers of global demand.

Unemployment rates in these economies have continued to decline gradually and the improvement in economic growth across the developed world should support further job creation, improving consumer confidence, and stronger consumption. These are all positive developments for corporations, as falling unemployment is indicative of an expanding business sector. As such, it is important for investors to look through the volatility of the past few weeks, and instead focus on thoughtful asset allocation which tilts them toward those areas which have proven relatively insulated from the contraction in emerging markets.
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Emerging markets breakdown? A view from within

By George Iwanicki, Richard Titherington, Pierre-Yves Bareau
From George Iwanicki, Richard Titherington, and Pierre-Yves Bareau, the latest Investment Insights:
  • The broad emerging market (EM) asset class continues to suffer from three related headwinds that date back to 2011.
  • While income statement fundamentals have been challenged, balance sheet fundamentals in most of the emerging markets remain reasonably healthy, particularly in those countries that are not heavily dependent on commodity exports.
  • Concerns about China's cycle have intensified fears of either an intra-Asian currency war or a further breakdown in Chinese growth that exacerbates the three headwinds that the emerging markets have already been navigating.
Continue reading Investment Insights

Rethinking the "core": Finding the middle ground in equities

In an environment of lower returns and higher volatility, equity approaches that straddle both actively and passively managed strategies can help investors generate higher returns or minimize volatility.

In a lower-return environment, the contribution from any excess return is a more meaningful contributor to overall return. But because finding consistently outperforming active managers can be difficult, many investors have gravitated toward benchmark-oriented solutions.

Investors who have adopted a core-and-satellite approach for their core equity allocation should consider substituting some or all of their passively managed equity allocations for incremental return-enhancing or risk-reducing strategies. Doing so should result in better risk-adjusted returns.

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Spending in retirement: Effective investment strategies and successful outcomes depend on realistic spending projections

By Katherine Roy, Sharon Carson
Where does the money go? A question that Katherine Roy and Sharon Carson present in an analysis of spending in retirement:
  • Understanding how people spend as they age can help financial advisors and their clients build better retirement plans, craft more effective investment strategies and attain more successful retirement outcomes.
  • On average, spending is highest for households led by 45-year-olds; households led by older individuals spend less. While this pattern holds for the majority of households, spending patterns do vary.
  • Research shows that most retirees fall into one of four spending profiles: foodie, homebody, globetrotter, or health care spender.
  • Financial advisors need to ask the right questions to create accurate profiles of their clients and adjust their retirement plans accordingly. Inquiring about housing, desire to travel and concerns about health care expenses are good places to start.
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In the context of our macro views and a multi-asset portfolio

Global Multi-Strategy Team comments on recent market moves, the most current being driven by a combination of genuine fears over emerging markets and Chinese growth and exacerbated by a thin summer market and uncertainty over the Federal Reserve’s (the Fed) next move.

  1. Global growth — There will be some drag on global growth, but this does not look like 2008 and the prospect of emerging markets derailing the (admittedly sluggish) domestic growth in US and Europe is low.
  2. Fed policy — September hike now unlikely, but we expect the Fed to match a delay with a modestly hawkish rhetoric.
  3. Other Central Bank policy — It is the PBoC not the Fed that hold the keys to stabilising this recent move, watch for RRR and outright rate cuts in the near future.
  4. Inflation — Our low inflation macro theme remains in play, breakeven inflation has fallen sharply recently, but a repeat of the deflation scare of early 2015 does not seem to be on the table.
  5. Stocks — An ugly run in stocks would probably present a buying opportunity but the pace of the recent washout has caught many by surprise. We expect to now need policymaker reassurance before buyers step up.
  6. Bonds — Duration is not giving much protection to weak stocks as term risk premia are already very compressed. The risk-reward in long duration looks stretched now.
Continue reading PDF

Global economic growth headwinds uncovered

By David Lebovitz
In this video, Global Market Stategist David Lebovitz discusses the global opportunity set in a changing investment environment and how to understand what global headwinds mean for long-term growth.
Watch video

Weekly Market Recap

Start the week off right with this one-page snapshot of headlines and market performance, including:

The week in review:
  • S&P Case-Shiller & FHFA HPIs were soft
  • New home sales increased to 507k
  • Consumer confidence surged to 101.5
  • Durable goods orders grew 2.0% m/m
  • 2Q15 GDP revised up to 3.7% q/q saar
  • Pending home sales grew 0.5% m/m
  • Consumer sentiment fell to 91.9
The week ahead:
  • Markit & ISM mfg. PMIs
  • Markit & ISM non-mfg. PMIs
  • Light vehicle sales
  • ADP employment & Employment report


 
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The Power of Diversification

As written in this week's Thought of the Week, after years of relative calm, equity markets have finally suffered their first correction since 2011, falling -12.4% from the May 21st highs (through August 25th) and snapping the third longest streak without such a correction in fifty years. Fears over slower growth in China, uncertainty around the timing of rate hikes and technical factors related to market positioning all played a role. But how unusual is this correction?

As it turns out, not very; in 19 of the last 35 years, markets suffered a decline of 10% or more, and in all but two of those 35 years markets saw 5% declines or more. Importantly, we don't see this correction as morphing into a full blown bear market; the U.S. economic data remains solid, commodity prices and inflation are low, and monetary policy will remain extremely accomodative, even if the Fed hikes rates. For investors, it is times like these that the power of diversification is on full display. During the 12.4% correction, a portfolio of 60% stocks, 40% bonds would have only suffered a drop of 7.8%.
Download full Weekly Market Recap

Take stock: Equity investing for P&C insurers

By Mark Snyder

Mark Snyder, Head of Institutional Strategy & Analytics, explains how SMAs have led to a wide dispersion in results, large deviations from standard benchmark returns, and in many cases underperformance.

For U.S. property and casualty (P&C) insurers, public equity investments diversify risk in income-oriented portfolios, typically offer higher expected returns than fixed income securities and provide a ready source of liquidity. They have regularly made up the second-largest allocation in P&C portfolios after fixed income and currently account for nearly 10% of total non-affiliated investments.* P&C insurers hold most of their equity investments in separately managed accounts (SMAs). The low-turnover, buy-and-hold strategies of many SMAs, while allowing for precise control of the timing of realized gains and losses for tax purposes, have led to a wide dispersion in results and large deviations from standard benchmark returns—with substantial under performance in many cases, as our analysis shows.

P&C companies have allocated a much smaller portion of equity investments to funds and exchange-traded funds (ETFs). These allocations trade the ability to manage tax outcomes for the SMA’s ability to track a benchmark at low cost or gain access to skilled managers who can potentially outperform a benchmark. We believe insurers should give this trade-off serious consideration, weighing the advantages of a buy-and-hold strategy against the drag it can impose on returns that chronically lag an established benchmark.

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Recent Market Events: Regarding the Chinese Renminbi and recent market corrections

By Richard Titherington
Comments from Richard Titherington, CIO Emerging Markets and Asia Pacific Equities, regarding the Chinese Renminbi and recent market corrections.
 
Panic selling can create opportunities for long-term managers with discipline and stock selection expertise to buy stocks that they previously thought were too expensive. Our Emerging Markets Equity team is revisiting their portfolios and looking to add to high conviction ideas whose share prices have corrected to attractive levels.
 
Historical analysis suggests that investors can potentially enjoy significant upside when entering the markets at low Price to Book levels.
Continue reading

Weekly Market Recap

Start the week off right with this one-page snapshot of headlines and market performance, including:

The week in review:
  • Headline & Core CPI 0.2% & 1.8% y/y
  • Empire State mfg. -14.9
  • Housing starts up to 1.2 m
  • Housing permits down to 1.1 m
  • Existing home sales 10.3% y/y
The week ahead:
  • New home sales
  • Durable goods
  • 2Q GDP 2nd est.
  • Personal income and outlays

 
Continue Reading PDF

The July Inflation Report for Housing and Energy

As written in this week's Thought of the Week, the July inflation report highlighted the two opposing forces that have kept the consumer price index within a small range over the past few months: energy and housing. Energy has dragged on headline CPI for the past year given the sharp decline and subsequent volatility in oil prices; despite pushing the headline reading modestly higher last month, energy prices should return as headwinds in the August report. Moving away from energy, core CPI (inflation excluding food and energy) has been supported by a strong uptrend in housing, with shelter costs the largest contributor to growth in July.

As housing demand continues to absorb the available supply, home prices should continue to rise and the broader housingmarket should continue to improve, putting upward pressure on core inflation. This lift from housing and drag from energy are the key reasons why the two measures have diverged so sharply, and furthermore, why headline CPI is far more volatile from month-to-month than the core measure. As shown in this week’s Chart of the Week, the stability in core CPI, which has remained between 1.6% and 1.8% y/y for the past year, stands in sharp contrast to the headline CPI number. Stable core inflation near 2.0% should keep the Fed on track for a September rate hike, but continuing volatility in other prices and lack of wage growth undoubtedly adds some uncertainty.

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The Wage Puzzle - Long version

By Dr. David Kelly

This bulletin, written by Dr. David Kelly, discusses factors affecting the lack of wage growth in the U.S.:

  • Structural, not cyclical, factors are largely responsible for the lack of wage growth in recent years. These factors—such as the retirement of baby boomers, the continued fall in union membership, growth in part-time workers and a slowdown in productivity—cannot easily be fixed by monetary or fiscal stimulus.
  • U.S. wage growth has also failed to respond to falling unemployment due to temporary forces, such as the plunge in inflation and pessimistic attitudes on the economy, which should fade in the months ahead. As these influences wane and as the unemployment rate continues to decline, wages should move higher.
  • The lack of wage growth does not appear to justify the Federal Reserve’s (Fed) near-zero interest rate policy. We expect the Fed will, in the absence of further shocks, initiate the first rate hike in more than nine years in September.
Continue reading Market Bulletin

Chinese yuan devalued — Reform not stimulus

By Tai Hui
This bulletin, written by Tai Hui, Chief Market Strategist — Asia, discusses the PBoC’s move to devalue the Chinese currency and how this decision will impact economic growth in region.
Continue reading Market Bulletin

Weekly Market Recap

The week in review:
  • Job openings decreased to 5.25M
  • Retail sales increased 0.6% m/m
  • Import prices were down 0.9% m/m
  • PPI increased 0.2% m/m
  • Industrial production jumped 0.6% m/m
The week ahead:
  • HMI
  • Housing starts
  • CPI
  • Existing home sales
  • Philly Fed
  • Flash PMI

 
Continue Reading PDF

Not Out of the Woods Yet

As written in this week's Thought of the Week, with over 90% of S&P 500 market cap having reported Q2 profits, it appears that earnings are not yet out of the woods. Much of the story was consistent with the previous two quarters, as lower oil prices weighed on energy sector earnings and Dollar strength continued to be a headwind for large multi-national corporations. As a result, headline earnings fell by -10.1% from a year earlier, but posted positive year-over-year growth of 2.6% ex-energy.

Margins came in at 9.5%, below their previous peak of 10.1% in 3Q14, but excluding energy margins spiked to 10.7%, indicating that companies may have adjusted to the stronger currency, putting them in a better position to offset lower revenues with cost cuts than was had been case in previous quarters. However, downward pressure on margins will likely accelerate as wage growth picks up, and companies will be forced to grow revenues in order to maintain their current levels of profitability. With full year 2015 EPS growth projected to be a meager 1%, we anticipate single digit returns for the S&P 500 this year, but anticipate a rebound in 2016 EPS growth as many of the macro headwinds which have been dampening corporate profitability subside.

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Dr. David's August 2015 Commentary: The wage puzzle (short version)

By Dr. David Kelly

Dr. Kelly's Commentary for August 2015:

The July U.S. jobs report was solid and mostly in line with expectations. However, it is notable that, in a steadily improving job market, both labor force growth and wage growth remained weak. We have argued in the past that most of the labor force problem is structural rather than cyclical. That is to say, it is largely due to the retirement of babyboomers, a surge in disability benefits and a growing number of Americans who are essentially excluded from the job market due to prior felony convictions, educational deficiencies and issues with addiction. All of these are important issues and deserve the urgent attention of the government.

However, unlike a general lack of economic demand, they cannot be fixed by monetary or fiscal stimulus. Wage growth also remains very weak with wages of production and nonsupervisory workers up just 0.1% in July compared to June and up just 1.8% year-over-year. This is remarkably different from the last three economic expansions. The July jobs report showed only a marginal drop in the unemployment rate from 5.28% to 5.26%. However, the last three times the unemployment rate hit 5.3% on the way down, wage growth was much stronger, achieving year-over-year gains of 3.3% in November of 1988, 3.4% in June 1996 and 2.6% in January 2005.

So why are wages so weak, this time around? A full explanation is elusive. However, statistical analysis suggests that, as is in the case of labor force participation, the problems are largely structural or else due to factors that are mostly independent of demand in the economy.

Continue reading Monthly Commentary

Weekly Market Recap

The week in review:
  • ISM & Markit Mfg. PMIs were 52.7 & 53.8
  • ISM & Markit Svcs. PMIs were 60.3 & 55.7
  • Light vehicle sales increased to 17.5m
  • ADP payrolls increased by 185k
  • Trade deficit fell to -$43.8bn
  • Nonfarm payrolls increased by 215k
The week ahead:
  • NFIB survey
  • Job openings
  • Retail sales & Industrial production
  • Import prices & PPI
  • Construction spending & Consumer credit

 
Download full Weekly Market Recap

Rising Inequality for the Service Sector PMIs

As written in this week's Thought of the Week, both globally and in the U.S., the service sector PMIs did better than the manufacturing PMIs in July. One of the reasons for this may have to do with rising inequality. Various indicators suggest that this expansion has been better for higher income families, causing higher wealth disparity in recent years. This divide may be important for the performance of the services sector because, as shown in the chart of the week, higher earners spend a larger portion of their incomes on services like personal care, education and travel compared to lower earners.

Expenditures of low income families are dominated by spending on essential goods like food, shelter and energy. Because of this changing expenditure mix, weakness in consumer spending may be overstated by soft retail sales and building inventories. However, a full blown recovery will require not just better growth in income for wealthy families but also income growth for lower earners.
Download full Weekly Market Recap

2Q15 Earnings season recap: High hopes, low expectations

We estimate that 2Q 2015 earnings-per-share (EPS) for S&P 500 companies declined by 6.9% on a year-over-year (y/y) basis. Lower oil prices and the stronger U.S. dollar have dragged down earnings growth since 4Q 2014.
 
Fortunately, because these factors are transitory in nature, downward revisions to earnings estimates have stabilized and there are high hopes for EPS to rebound by 4Q and in 2016.
 
Excluding the energy sector, S&P 500 EPS grew by 4.1%, below historical trends. This is because the stronger dollar resulted in an average EPS decline of 5% for the most dollar-sensitive companies.
 
While share buybacks have boosted EPS over this market cycle, they have been of secondary importance at best. The primary drivers of earnings have been sales and margin growth.
 
We continue to favor U.S. equities despite the recent slowdown in EPS growth. Our base case for 2015 still calls for a single-digit return for the S&P 500, which we believe is attractive for most portfolios in this market environment.
Continue reading Market Bulletin

2015 outlook: The graduates

By Michael Cembalest
Michael Cembalest, Chairman of Market and Investment Strategy, discusses the global monetary experiment.
Watch video

Weekly Market Recap

The week in review:
  • Durable goods orders up 3.4% m/m
  • S&P/Case-Shiller HPI fell -0.2% m/m
  • Consumer confidence fell to 90.9
  • Pending home sales fell 1.8% m/m
  • 2Q15 Real GDP increased 2.3% q/q SAAR
  • ECI fell to 2.0% y/y
  • Consumer sentiment fell to 93.1
The week ahead:
  • Markit & ISM manufacturing PMI
  • Light vehicle sales
  • ADP employment
  • Employment report
  • International trade
  • ISM non-manufacturing PMI

 
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Clear Headwinds to Growth

As written in this week's Thought of the Week, last week’s GDP report showed that the real economy grew at an annual rate of 2.3% in the second quarter. Although this was below the consensus estimate of 2.9%, the report contained revisions to the data back to 2012, and on a positive note, growth for Q1 was revised from -0.2% to +0.6%. If the economy expands at an annual rate of 2.5% in the second half of 2015, the economy will have expanded by 2.1% for the year, slightly above the Fed’s forecast of 1.9%.

However, there are some clear headwinds to growth, as real inventory accumulation was $110 billion in 2Q15, compared to average growth of $29 billion per quarter over the past 10 years. If inventories were to return to this average in a single quarter, that would represent a 2% hit to real GDP growth, making it difficult to achieve 2.5% real growth for the balance of the year. On balance, the U.S. expansion in continuing at a slow but steady pace, and the latest GDP print reinforces our view that the Fed will begin to normalize interest rates in September.
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India and Mr. Modi: A progress report

By Tai Hui

Market reaction to the Modi government’s reform program has cooled. After a strong 2014, India’s equities market have grown only moderately this year, with the MSCI India gaining 4.5% in dollar terms (USD) and 5.6% in local currency.

  • Nevertheless, the government has made much progress in the past 12 months, implementing measures to encourage foreign direct investment (FDI) and a more friendly business environment for foreign companies and promoting energy, coal and mining reforms, as well as implementing enhanced social welfare programs.
  • Some reforms are still works in progress, however, and have not yet met market expectations. Manufacturing growth has been disappointing and the tax system is still unfavorable for foreign companies. Both the Goods and Services Tax (GST) and land reforms have been delayed, casting doubt on the government’s ability to push ahead with reform.

While we believe India’s reform agenda is progressing at a steady pace, clearly more remains to be done—and to judge from the market’s reaction, more will be expected in 2H 2015.

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Dr. Kelly's July 2015 Commentary: Annual checkup

By Dr. David Kelly

Dr. David Kelly's commentary for July 2015:

He warns that it is only prudent to consider both careful monitoring and a prescriptiont to make exact predictions of long-term outcomes for U.S. stock and bond investors. The most effective monitors are market prices and the monthly employment report. If stock prices continue to rise and longterm yields remain low, even as the employment report shows a tightening job market and anemic labor supply, then the eventual risks to both bond and stock markets will rise.

As for a prescription, it is relatively simple at this stage. Given the super-low yields on cash, it still makes sense for long-term investors to be in long-term assets. However, this should also be a time to be a little underweight fixed income overall, while looking at global opportunities in both equities and fixed income. It also makes sense to have a broad and active approach in asset allocation across stocks, bonds and alternative assets and in hiring managers who can focus on what is still good value in markets that, after a very long run, are no longer so cheap.

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Seeking direction in a volatile market: Trends in endowments & foundations

Endowments and foundations generated low-double-digit returns in fiscal year 2014 as a result of strong U.S. public equity markets and a shift to alternatives and longer-lived investments. However, as volatility and interest rates increase and global macroeconomic and financial cycles start to normalize, institutional investors will need to adapt to the changing market environment.

In this article, Monica Issar, Global Head, J.P. Morgan Endowments & Foundations Group, and Anthony Werler, Chief Strategist, J.P. Morgan Endowments & Foundations Group, highlight the key trends in nonprofit investment management, as well as areas of opportunity for investors.

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Europe's recovery: From caterpillar to butterfly?

Last year, we laid out our view that structural reforms, much looser monetary policy and a weaker euro had finally set the European economy on the road to recovery. We felt that markets had largely underestimated this improvement, opening up opportunities for investors wishing to increase their exposure to the European equity and bond markets.

This optimism has been borne out by the turnaround in market sentiment towards Europe since the start of 2015. As we approach the second half of the year, it seems a good opportunity to take stock of progress over the past 12 months, gauge whether this improvement is sustainable and assess further opportunities for investors in European assets.
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M&A Market Recovery

As written in this week's Thought of the Week, although the M&A market took longer to recover than many other areas following the financial crisis; activity picked up in 2014 and is set to outpace the level seen during the 2007 peak. While some investors may read this activity as reminiscent of 2007, there are a number of fundamental differences this time around. U.S. earnings growth met some headwinds last year, which have persisted into the first two quarters, and with global growth projected to be only 2.5% this year, corporations need to find alternate ways to generate top line growth in the absence of more robust economic growth.

As a result, companies are accessing product innovation and more nuanced markets by acquiring firms that currently produce or exist in these arenas; in other words, they are buying revenue growth rather than creating it.  Furthermore, the combination of healthy balance sheets with large cash balances and easier capital market access due to historically low interest rates stands in stark contrast to the main objective in the 2007 boom, when companies employed leverage and financial engineering in an effort to generate excess returns. Thus, given the strength in corporate capital structures and the desire for companies to grow in a challenging, slow growth economy, the current M&A cycle does not seem to be suggesting that the market has peaked, but rather, represents an effort by companies to generate stronger revenue and earnings growth, which should ultimately benefit investors.
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Balancing Investment Objectives for Colleges and Universities

We use a real world example for a comprehensive volatility and liquidity assessment to understand the implications of asset allocation shifts in a university's portfolio. Working closely with our Institutional Solutions & Advisory group, an internal team focuses on providing objective analysis and solutions for institutions.
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Iranian Oil and the World Market

As written in this week's Thought of the Week, after the P5+1 group (China, Germany, France, Russia, U.S. , and the U.K.) and Iran announced a historic accord earlier this week, attention promptly turned to Iran's oil supply. With the fourth largest proven reserves in the world, Iran has the potential to drastically increase the world's supply of oil. However, Iranian oil will likely be slow to come online, which should limit any impact on world oil markets. Furthermore, despite the comprehensive sanctions the U.S. has had in place since 2010, Iranian oil has continued to trade on the world market. The U.S stopped purchasing Iranian oil and has prevented domestic companies from investing in the sector since 2010, but E.U. prohibitions on such activities only began in 2012.

Additionally, China and India have been continuous consumers of Iranian oil products, and it is this demand from emerging markets that has kept Iran on the list of top oil exporters. Once all sanctions are removed (a big if, as measures to lift sanctions still must be passed by the U.S. Congress and Iranian parliament), the additional supply will likely only be a drop in the bucket of the global oil trade, as production is estimated to only increase by 500,000 barrels per day; this would represent 0.5% of global production, and much of this additional oil will be consumed within Iran as their economy recovers from the sanctions that have been in place and gradually returns to growth.
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Stephanie Flanders speaks to Bloomberg about Greece

By Stephanie Flanders

Get Stephanie Flanders' reaction to the unfolding events in Greece. In this interview on Bloomberg Business, she discusses impact of the referendum, the weakened government, political change in Greece and the IMF memo leak.

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Creating Opportunities through Risk Management and Diversification

Real world liquidity, volatility, risk/return scenarios to drive enhanced returns for a non-profit healthcare client. Discover which three trends are found in this case study and how the client achieved their investment goals across a broad range of asset pools by employing our robust analytic and risk-management capabilities.
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The Greek Saga with Contained Volatility

As written in this week's Thought of the Week, last week's referendum results showed a Greek population that is fatigued with austerity and seemingly willing to take a big leap into the unknown with this important step toward a possible exit from the Euro currency. There is no precedent for a country leaving the single currency area, so the markets' reaction to this unexpected twist in the Greek saga could well have been violent - but so far, markets have been relatively well-behaved, with equity markets only dipping slightly and bond yields across Europe only marginally higher.

This time around, European and global financial markets seem practically immunized from the Greek disease. While the lives of the Greek people will be interminably changed, the chart of the week shows that the risk of direct contagion from a "Grexit" is low because Greece is now a much smaller (and shrinking) portion of the global economy and markets. For long-term investors, any short-term volatility that may be caused by the deteriorating situation in Greece seems to be well contained.

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Global Changing of the Guard

As written in this week's Thought of the Week, with the first half of 2015 now in the books, there has clearly been a changing of the guard in global markets. After several years of double-digit returns, the S&P 500 is lagging other equity markets as the effect of lower oil prices and a stronger U.S. dollar have been too much for an improving economy to offset. On the other hand, U.S. small caps have benefitted from their domestic orientation, returning 4.8%.

Outside the U.S., both emerging and developed equity markets have regained some ground this year, rising 3.1% and 5.9%, respectively, with Europe and Japan benefitting from quantitative easing and emerging markets seeing signs of stabilization.

That being said, interest rate sensitive asset classes such as fixed income and REITs have suffered at the hand of higher and more volatile interest rates, but high yield has returned almost 2% as spreads tightened against a backdrop of rising rates. Finally, commodities continue to struggle, falling 1.6% in 1H 2015. The stark difference in returns so far this year should not only remind investors of the importance of time horizon, but also of the need for balance and diversification.

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A Focus on Partnership

By Monica Issar
In this case study, we emable clients through our global insights and investment platform. Using a real world example, we provide the foundation with access to our robust analytics platform, capital markets knowledge, and local on-the-ground investment expertise across asset classes to help address the challenge of seeking increased sources of return while managing an appropriate spending policy.
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Health care costs in retirement

A sound retirement strategy must plan for increasing health care expenses. While managing and investing for current income, an effective retirement strategy must also include sufficient growth investments to cope with the added health care costs.
 
This paper will:
  • Analyze the forces driving health care spending growth
  • Assess the pressure points and sustainability of the current Medicare system
  • Consider options for future retiree health care coverage
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Recovering European Economy

As written in this week's Thought of the Week, the first read on activity in both manufacturing and services sectors across Europe suggests that the recovery there continues to take hold. The June flash reading for the composite Purchasing Managers' Index (PMI) came in at a level of 54.1, above the key index level of 50, which separates acceleration from deceleration.

In addition to showing improvement from the May reading, this is the strongest reading for the composite PMI since May 2011. The composite indicator gives a good reading for the Euro Area as a whole, particularly given that most European economies tend to be largely services based, and the June number suggests that the euro area economy is on track to expand at about a 2% rate this year, in line with our expectations for a gradually recovering European economy.

Although last week's reading is preliminary, improvement in the PMI, along with stronger retail sales, rising prices, and improving consumer confidence should form an attractive backdrop for European earnings to rise, providing fundamental support for equity markets across Europe to continue pushing higher.

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Reducing constraints to maximize potential

By Peter Kirkman
From November 2014: Peter Kirkman, portfolio manager for the Global Thematic and Sector Funds, discusses how an unconstrained approach enables him to build a concentrated portfolio of his highest conviction ideas.
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Neutral Directions

As written in this week's Thought of the Week, for the better part of this year, the equity market has been moving sideways, as a decline in corporate profits, mixed messages on U.S. economic growth and uncertainty surrounding when the Federal Reserve will hike interest rates all weigh on investors. In fact, the S&P 500 has only risen +3.0% in 2015, a disappointing performance particularly when compared to the double-digit returns observed during the past two years.

Investors have been struggling to find conviction in whether the next big move for the market will be higher or lower, and as shown in the chart of the week, 40% of investors report feeling "neutral" about the direction of the stock market over the next six months. This unusually high level of uncertainty amongst investors may be one reason behind the lack of direction that we have observed in the market this year. However, economic growth seems to be emerging from its winter slumber, and earnings appear to have picked up in the second quarter.

Furthermore, while the first interest rate hike remains a short-term hurdle for the market, it is unlikely it will evolve into a long-term headwind. While volatility may increase further as the Fed prepares to hike interest rates, improvement in both U.S. economic growth and corporate profits should offer investors some relief, while simultaneously providing a fundamental reason for equity markets to push higher.

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Dr. Kelly's June 2015 Commentary: The advice surplus

By Dr. David Kelly

Historians generally agree that Napoleon’s fatal mistake on June 18, 1815 was that he thought the ground was too soft and he thus waited too long before launching an attack on the forces of the Duke of Wellington. This allowed the Prussian army the opportunity to regroup and attack him from the side.

Dr. David Kelly illustrates the dire conclusions from delaying any rate hike until 2016. The Fed appears to be gradually getting more comfortable with the pace of demand growth and, barring some macroeconomic shock, we believe that they will finally raise interest rates by September. As was the case two centuries ago, waiting for firmer ground would be a mistake.

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Taper Tantrum

As written in this week's Thought of the Week, the past couple of months have seen global bond yields rise sharply. While some investors have likened the recent sell-off to 2013’s taper tantrum, there are some clear differences between the two events.

The taper tantrum was led by a rise in U.S. rates as investors became anxious about the end of quantitative easing in the U.S. However, recent action in bond yields has been led by European rates, and decomposing this move shows that it has been a rise in real yields, which are reflective of an improving growth outlook, that has led global yields higher.

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European assets: Volatility strikes back

What has happened? Rather than abating, as many had expected, the sell-off in European markets that began in late April has continued into June.

What has been driving this? There are a number of factors being touted as the primary driver of recent market movements, including:
  • Changing inflation expectations relative to the start of 2015
  • Unwinding of speculative positioning
  • Liquidity concerns in key markets
  • A mild softening of economic data
  • Worries over Greece
  • Worries over a rising euro
Do we think this will last? It is good news to see bond yields rising, if that increase comes as a result of reduced fears of deflation and/or increased hopes of economic recovery.
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Living in a less liquid world: The do's and don'ts for bond investors

The bond liquidity issue is one of the hottest topics in finance today. But what exactly is it? Is liquidity lower today and, if so, why? Most importantly, what does it mean to investors? In this bulletin we explore these timely subjects, focusing primarily on liquidity in the corporate bond market. We conclude with a list of do’s and don’ts for bond investors to consider.
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Rise in Bond Yields

As written in this week's Thought of the Week, the past few weeks have seen a notable rise in bond yields, in many cases bringing them to year-to-date highs. German Bunds have seemingly led this move, but despite the belief by some investors that the ECB would try to “talk down” this volatility, Mario Draghi stated that he was not concerned and that investors should “get used to it” at the press conference following its June meeting.

Additionally, a stream of better news from developed economies, including improving construction, better vehicle sales, and strong jobs numbers in the U.S., coupled with signs that inflation may be picking up in Europe, has led to an increase in investors’ nominal growth expectations, placing upward pressure on yields. However, some areas of the bond market saw more muted moves, as sectors like high yield saw spreads decline but absolute yields remain unchanged, highlighting the benefits of diversification within the asset class.

While the recent move seems a bit aggressive given the ECB’s commitment to QE, more volatility likely lies ahead. However, it is important to remember these moves appear particularly extreme because yields are moving around historically low levels. As such, investors could be well served by maintaining a balanced and diversified approach within fixed income.
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Quantitative Easing Behind Us

As written in this week's Thought of the Week, with quantitative easing behind us, and the FOMC now considering when to raise short term rates, very easy monetary policy in the U.S. is winding down. Investors are concerned about the impact that the higher short-term interest rates could have on long-term rates, and some are also worried that a Fed decision to stop reinvestments of coupon and principal from its Treasury holdings could be an additional headwind to the bond market.

As shown in the chart of the week, $300 billion in Treasuries mature within the next two years, which could put upward pressure on long-term rates if not reinvested. However, the Fed has made it clear that it intends to initially tighten monetary policy by raising rates, while measures to reduce its balance sheet are levers that may be pulled at some stage in the future.

So far, the Fed has been keenly interested in not impacting the bond market too severely as it scales back accommodative policy. While tightening policy should eventually include a decrease in the size of the balance sheet, the Fed will execute this step carefully and investors should probably not be overly concerned about upcoming maturities.
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CIO Perspectives: Innovative asset class solutions

By Jeff Geller
Investors are challenged with constructing portfolios for today's risks. Listen to Jeffrey Geller, CIO of Multi-Asset Solutions Group, discuss key findings in this episode of our Insights audio program from October 2014.
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1Q 2015 GDP

As written in this week's Thought of the Week, now that it is becoming increasingly likely that the second estimate of 1Q 2015 GDP will be revised into negative territory this week, it is important to examine what may have been responsible for this contraction. The weakness observed in the first quarter was a function of a number of factors: lower than expected consumer spending due to a very cold winter, subdued exports and a spike in imports due to the West Coast port strikes, and declining investment in structures resulting from the sharp decline in oil prices at the end of 2014 and into the beginning of this year.

However, these factors all seem relatively transitory in our view; two months into the second quarter, the economy seems to be turning around. As shown in this week's chart, the index of Leading Economic Indicators improved at its fastest pace in the past nine months, with this improvement likely driven by a stabilization in oil prices, consumers feeling better about their finances, and strength in the housing and labor markets.

While it is important not to extrapolate a single data point into a broader trend, the turnaround we have begun to see in parts of the U.S. economy points to a bounce-back in 2Q growth, and highlights that despite a hiccup in the first quarter, the story for the U.S. economy remains one of gradual expansion.

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Corporate pension plan update

By Rafael Silveira
From November 2014: Rafael Silveira, Asset Management Portfolio Strategist and part of the Institutional Solutions and Advisory team, reviews key issues for corporate pension plans and the implications for investors.
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What's in store for emerging markets in 2015

By Pierre-Yves Bareau
In January 2015, Pierre-Yves Bareau wrote about how the growth picture remained challenging for emerging market economies, with momentum fading and the growth differential over developed markets continuing to narrow. Some of what we said:
 
Against this backdrop, our investment focus will continue to center on differentiation, while we will remain defensively positioned with a focus on technicals and liquidity. We currently favour higher quality issuers, monitoring fundamentals for signs of a catalyst to time entry into higher yielding "turnaround" stories.
 
We are more defensively positioned with respect to EM currencies, maintaining a U.S. dollar bias. While we acknowledge that value has been created in EM FX, both fundamentals and timing need to be right. We favour oil importing currencies that are not threatened by deflation concerns—the Turkish lira and Indian rupee being two such currencies. On the corporate side, liquidity remains the chief concern. Valuations have recovered to attractive levels, while fundamentals have declined on the margin and solvency is not an issue.
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Lowered Earnings Growth Estimate

As written in this week's Thought of the Week: going into the Q1 2015 earnings season, analysts substantially lowered earnings growth estimates due to two dominating macro headwinds: the strength of the USD and falling oil prices. Ultimately, these forecasts proved to be accurate, as earnings for the overall S&P 500 fell 5.0% year-over-year despite a strengthening global economy. However, excluding energy companies, the index witnessed year-over-year earnings growth of 9.1%, in line with historical averages.

Furthermore, strength in the bottom line was maintained with 70% beating earnings expectations, despite only 36% of companies beating their revenue estimates. Top line numbers suffered from both economic and translation effects from a stronger USD and the steep decline in income from energy companies. However, the fact that companies were able to maintain margins despite challenges faced this quarter bodes well for earnings growth for the remainder of 2015.

We anticipate S&P 500 EPS to grow by 2.9% in 2015, with the index reassuming positive earnings growth in the third and fourth quarters. While we expect only mid-single digit returns for the S&P 500 this year, we still maintain an overweight to U.S. equities, with the caveat that both sector and security selection will remain paramount going forward.

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Accessing Asia: Investing in the infrastructure imperative

By Pulkit Sharma
Our Global Real Assets expert Pulkit Sharma, with Real Asset Strategist Michael Hudgins, discusses the infrastructure opportunity in Developing Asiaone of the world’s fastest growing regional economies, in this video from September 2014.
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Impact of Increase in the Fed Funds Rate

As written in this week's Thought of the Week, the FOMC has maintained it will keep monetary policy accommodative until its objectives of full employment and price stability are reached, which has led many to watch wage inflation closely in an effort to determine how close the Fed may be to meeting its dual mandate. The unemployment rate has fallen 4.6 percentage points from its Oct. 2010 high of 10.0% to 5.4% in April, but despite this improvement, wage growth has floundered.

Although wages for production and non-supervisory workers increased a meager 0.1% in April, another measure of wage inflation, the Employment Cost Index, showed the underpinnings of strengthening wages in the first quarter. Despite these somewhat conflicting signals, the bottom line is that stronger wage growth is a signal that the Fed can seriously consider raising rates, as a pick-up in wages should help push inflation toward the FOMC’s long-term target of 2.0%. However, higher labor costs can squeeze margins, potentially dragging on corporate earnings growth.

As such, while an increase in the Fed Funds Rate should be viewed as a vote of confidence in the U.S. economy, equity investors will need to be increasingly selective in the later stages of the expansion as corporations face increasing headwinds to earnings, including a stronger U.S. dollar and wage inflation.

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Absolute return bond investing: multiple approaches to mitigate risk

By William Eigen
In this video from August 2014, Bill Eigen, head of Absolute Return and Opportunistic Fixed Income, describes his philosophy toward absolute return fixed income investing.
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Managing risk, delivering results

By Raffaele Zingone
Catch Raffaele Zingone, Portfolio Manager for the U.S. Research Enhanced Index Strategies, discuss his three-pronged investment approach and how he mitigates risk while delivering returns in this video from October 2014:
  • Stock prices follow long-term earnings
  • The market often misprices stocks based on those long term projections
  • If you can capture those mispricings consistently over time you can generate excess return
He also discusses managing risk in the portfolio through a set of simple rules, quanititative risk modeling, and proactive risk control.
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Chinese A- and H-Share Equity Markets

As written in this week's Thought of the Week, with the Chinese A- and H-share equity markets up over 84% and 33%, respectively, since the PBoC announced a surprise rate cut last November, many investors may feel they are missing out on a sustained rally. However, a deeper dive into what is supporting the major upward move may indicate this is much more of a tactical, short-term play that is best approached with active management expertise. The outperformance is largely driven by easing moves pursued by the PBoC, as well as the expectation that these moves will persist given ongoing disappointing macroeconomic data.

Additionally, Chinese investors have limited investment options due to multiple restrictions, so with the recent downturn in the property market, many of them are rushing into the domestic stock market. The "euphoric" sentiment created by these developments can be seen in the chart of the week, which shows the number of new weekly investment accounts jumping to 3,284K through April 17, alongside a similar jump in the A-share market.

However, without strength in fundamentals in the form of positive economic data, investors should view the current liquidity-driven surge as more or less temporary and should focus on the longer-term "new China" plays that center on themes such as the Chinese consumer, health care and SOE reform.

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Missing Link: Economic exposure and pension plan risk

By Alex Christie
This October 2014 paper by Alex Christie, provides a framework for managing extreme economic risks such as those that could affect a plan sponsor during periods of high market volatility. The problem can be compounded when poor investment performance affects the pension plan at the same time as a downturn in the sponsor's business.
 
Pension plan trustees are increasingly aware of the range of risks present in defined benefit pension plans. Volatile markets have led to volatile funding ratios, compounding the impact of falling interest rates and increasing longevity. This heightened awareness has led many plans to look at ways of managing these risks.
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Are tailwinds the new headwinds for bonds?

By William Eigen
Bill Eigen, CIO of Absolute Return and Opportunistic Fixed Income Investing, explains today's fixed income markets in this video from August 2014.
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Federal Funds Rate

As written in this week's Thought of the Week, now that the Fed moves closer to raising short-term interest rates, many are asking what this could mean for long-term rates. However, since the federal funds rate has been unchanged since December 2008, recent history provides little evidence on this sensitivity. Additionally, estimates based on previous history should be treated with caution, particularly given the high degree of distortion in today’s bond market and the recent dampening influence of aggressive QE in Europe and Japan on international bond yields.

That being said, statistical analysis of quarterly data from 1985 to 2010 shows that a 1% move in the federal funds rate has been associated, on average, with a 0.22% move in 10-year Treasury yields, after controlling for movements in inflation, economic growth, foreign yields, exchange rates and equity market volatility. As shown in this week’s chart, this sensitivity has ranged from 12 basis points in the early 2000s to 43 basis points in the early 1990s.

Thus, it seems likely that Fed tightening will boost long-term yields to some extent and, therefore, investors may want to consider diversifying fixed income holdings to include less rate-sensitive areas within the asset class.

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Hedge funds: Back to normal?

By John Anderson
As quantitative easing unwinds in the U.S. and markets begin to normalize after five years of recovery, will hedge funds reassert the long-term risk-return profile investors have come to value and expect? John Anderson's analysis from November 2014 suggests:
  • While hedge funds have underperformed conventional assets on an absolute basis over the last five years, they continue to provide alpha and portfolio diversification.
  • Long-term investors who focus on performance over an investment cycle have benefited from allocating to hedge funds.
  • Managers with more flexible investment toolboxes may benefit from recent structural changes in markets, such as the decline in market liquidity.
  • Historically, low growth, low inflation and rising rate environments have been attractive for hedge funds, while volatile markets have provided a relative advantage.
  • The greater dispersion of hedge fund returns vs. long-only strategy returns highlights the importance of manager selection.
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Lower Energy Prices and Windfall

As written in this week's Thought of the Week, despite this week’s 8% jump in oil prices, J.P. Morgan’s Investment Bank estimates that lower energy prices have left an extra $33 billion in the pockets of consumers since October, with more on the way. Most data suggest consumers have been a bit stingy with this windfall thus far, but last week's retail sales report from the Census Bureau offered some encouragement; despite a 22% decline in gasoline station sales, overall sales were up modestly year-on-year.

In fact, with the exception of electronics and gasoline, all of the underlying components of the report saw gains. Leading the way was a strong 7.7% year-over-year increase restaurant spending, an indication that consumers are starting to put their newfound energy savings to use.

For investors, elevated consumer confidence, a tightening labor market, lower oil prices and warmer weather could lead to healthier spending headed into the summer - good news for markets.

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Case for concentration: Greater focus, greater insights

By Gregory Luttrell
In this video from July 2014, Gregory Luttrell discusses his views on the current environment and how a concentrated approach helps him capitalize on today's opportunities.
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Housing market seems to be catching some steam

As written in this week's Thought of the Week, after having patiently waited for an uptick in the housing sector through this seven year recovery, we are finally starting to see signs of life in recent data. Notably, weekly mortgage applications for purchase increased for the third consecutive week, up 7% the first week in April, after having been mostly flat to start 2015. This renewed appetite for home purchases has yet to be consistently seen since 2008.

A large reason the housing sector has lagged the economic recovery until recently is due to the lack of household formation, which led to decreased inventories and increased home prices. These factors, combined with stricter lending standards for banks, priced out lower income buyers.

However, with increased strength in the labor force and solid household formation numbers through the end of 2014, the housing market seems to be catching some steam. Recent positive economic data continues to reaffirm that the U.S. is still poised to grow through 2015, and makes the case for domestic growth assets even stronger.

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The great re-alignment

By Richard Oswald
This paper from April 2014 discusses three key challenges with traditional fixed income benchmark strategies:
  • Duration: Significant sensitivity to changes in interest rates
  • Concentration: Highest allocation to the most stressed and frequent borrowers
  • Constraints: Limited flexibility to capture returns outside the confines of the index
Employing an unconstrained approach to fixed income investing can address each of these issues. In this Strategy Insights we look at one approach to unconstrained investing and examine the potential effects on risk and return when benchmark-agnostic strategies with more flexibility to change duration and sector exposures are blended with traditional core fixed income allocations.
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The hedging edge: How much beta do you want?

By Hamilton Reiner

Have a refresher course on how investors have learned that unexpected threats and volatility can quickly erase their hard-won equity gains in the market.

This paper from February 2014 provides a broad overview of these equity hedging strategies and insight on what to consider when evaluating different types of equity hedges, as well as an examination of the roles these strategies can play in asset allocation and investor portfolios. Successful equity hedging strategies start with an effective stock valuation and investment process. In addition, the complexities of managing options and short positions also require a set of unique and robust operational capabilities, as well as a portfolio team with the skills and experience in shorting and managing derivatives- and options-based strategies.

Equity hedging strategies, which can include hedged equity or long/short strategies, help investors stay in the market during bouts of volatility. They do this, in part, by capturing gains when the markets are rallying and cushioning the falls when the markets are dropping. Given the variety of approaches to hedging equities, investors need to consider their objectives, risk profile and desired beta exposure when selecting an appropriate strategy.

Continue reading Investment Insights

Balance and Diversification for Driving Returns This Year

As written in this week's Thought of the Week, with the first quarter of 2015 now behind us, it has become increasingly clear what could drive returns over the course of this year. Investors have seen the effects of easy monetary policy, a rising dollar, and low oil prices play out in their portfolios, with some of the results more positive than others. An increase in global liquidity, particularly in Europe and Japan due to aggressive quantitative easing programs, has contributed to the strong performance of developed market equities so far this year.

However, U.S. large caps with a large international footprint have suffered at the hand of a stronger U.S. dollar, while more domestically-oriented U.S. small caps have outperformed their large cap brethren. Commodities broadly suffered from the drop in oil and weaker demand from emerging markets, and within emerging markets we have seen a divergence between the commodity importers and the commodity exporters.

Meanwhile, high quality U.S. fixed income ended the quarter in positive territory, but fixed income broadly will be at the mercy of the Federal Reserve going forward. While some of these headwinds, such as oil and a rising dollar, will likely continue over the coming quarters, there are also unforeseen risks that could disrupt markets. As a result, the best approach for investors remains one of balance and diversification.

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Downward Revisions to Estimates for S&P 500 Earnings

As written in this week's Thought of the Week, downward revisions to estimates for S&P 500 earnings have been especially negative over the last three months, reflecting both the drag on energy companies from lower oil prices and the stronger dollar's negative impact on exporter-oriented earnings.

However, the impact of these headwinds should have a diminishing impact on estimates later in 2015 as both energy prices and the U.S. Dollar are likely to be more stable going forward than they have been in the last year.

Fortunately for equity investors, the second half of the year should also feature a boost to consumers stemming from the lagged effect of windfall energy savings, while the economic drags from an unusually harsh winter melt away with yesterday’s snow banks. Now if only someone could fix some of these darn pot holes…

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Positive Changes in the Unemployment/Wage Growth Relationship

As written in this week's Thought of the Week, historically, the unemployment rate and wage inflation have displayed an inverse relationship; when the unemployment rate falls, wage growth increases. This has been the case in the U.S. for the past 30 years, but has, so far, failed to materialize in the current market cycle.

While the unemployment rate fell to 5.5% in February, (the lowest rate which many on the Fed had previously regarded as consistent with stable inflation), average hourly earnings for production workers were only up a meager 1.6% year-over-year, far below their expected growth. This apparent change in the unemployment/wage growth relationship was recognized in the Fed meeting last week as the FOMC lowered its longer term unemployment rate projection to 5.1%.

By adjusting this estimate, the Fed has essentially granted itself more room to maneuver in delaying a rate hike, and in doing so has reduced near-term risks to U.S. fixed income markets while also relieving some of the upward pressure on the U.S. dollar.

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The Rise of the U.S. Dollar in Recent Months

As written in this week's Thought of the Week, the rise of the U.S. dollar in recent months should slow U.S. economic growth by boosting imports and reducing exports. While the U.S. is a consumption-led economy and greater buying power feels good to the consumer, as a nation we still import over 16% of what we consume and export more than 13% of what we produce.

According to an IMF study (WEO, April 2007), in the long-run, a 10% rise in the real effective exchange rate reduces exports by 4.9% while boosting imports by 3.7%. As shown in the chart below, we estimate that the real exchange rate has risen by 13.6% just since August 2014.

Over time, this could add 5.0% to imports and cut 6.7% from exports, reducing real GDP by a cumulative 1.5% - certainly something for the Fed to consider as they contemplate tightening policy.

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Diversification in Insuring a Portfolio's Value

As written in this week's Thought of the Week, seeing the outstanding absolute performance of U.S. equities over the past few years, it is natural that clients are questioning the merits of diversification. Although an asset allocation portfolio has delivered lower returns than the S&P 500 by this stage of the market cycle, it is important to remember the role that diversification plays in insuring a portfolio's value.

By definition, asset allocation returns should be less volatile on the upside and on the downside. For example, in 2008, a portfolio of 100% U.S. equities lost nearly 50% of its value, compared to the 33% lost from an asset allocation portfolio (see disclosure for definition).

The asset allocation portfolio recovered its pre-financial crisis value in just less than two years, while the equity portfolio didn’t recover its value for nearly three years. Especially in the later stages of a bull market, investors should remember that diversification is an investment tool meant to balance risk and return.

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What are P/E ratios implying for the markets - Chart of the week

Stocks are likely to get more expensive, but not because investors are bidding them up. This chart juxtaposes the forward P/E ratios with the implied earnings trend from that forward P/E, and shows that forward P/Es are rising—not because prices are rising, but because earnings are falling. This is due, in part, to the impact of falling oil prices and the rising U.S. dollar.
 
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Is the ECB’s QE too late? - Chart of the week

In the game of quantitative easing (QE), there are costs to being late. With eurozone inflation and yields at extremely low levels, this chart from the Market Insights team shows that the European Central Bank’s (ECB) latest QE move is coming late in the QE game.

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When will the Fed raise rates? Look at wages and job gains - Chart of the week

Despite a strong employment report, wage growth, which tends to have an inverse relationship with the unemployment rate, declined in December. This chart shows that investors should pay close attention to both job gains and wage growth for any developments that might change the Fed’s timeframe for raising rates.
 
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Investing for the long-term: Consider a barbell approach - Chart of the week

By Michael Cembalest
Investors should consider a “barbell” approach when thinking about rebalancing in 2015 and beyond.
 
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Tracking the business cycle

By Michael Hood

This paper examines past and current business cycles, outlines the current stages of the U.S., UK and the euro area cycles, and looks at the relationship between business cycles and financial market performance:

  • Economic cycles play a key role in driving capital market outcomes and why a tilt toward growth-sensitive assets is still warranted
  • Five main conclusions emerge from the preceding examination of business cycle history, theory, and market relationships
  • Assets that will perform relatively well during a recession, such as government bonds and high-quality corporate credit, represent an integral component of investing for the long run, given the difficulty in predicting the timing of such downturns
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Deeper dive on infrastructure investing

By Michael Cembalest
This video from May 2014 takes the infrastructure conversation deeper with Michael Cembalest, and discusses what surprised him about this research and where he sees opportunities going forward.
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Sovereign Client experience

By Patrick Thomson
From May 2014: in this video, Patrick Thomson discusses what sovereign clients can expect from their partnership with JPMAM.
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