While it seems like the World Series just ended, baseball’s spring training will be here before you know it. With that in mind, we’ve spent a considerable amount of time analyzing U.S. economic conditions within the context of America’s pastime.
What we’ve been asking ourselves most is, exactly what inning of the current economic cycle are we in, and what will be driving performance going forward, specifically for the dollar?
Last year our firm targeted the cycle in the seventh inning, noting the later stages of a baseball game often last the longest with continuous pitching changes and longer at-bats. To assume we are now in the eighth inning, however, would be too simple.
With the Fed apparently stepping up to the plate and ready to tighten monetary policy, it’s time to resume play after the central-banking equivalent of a long, drawn out rain delay.
And in line with higher interest rates, investors need to be mindful of where the dollar is headed in 2016, the pace of future rate hikes, and how the U.S. economy will be affected.
In fact, we expect the dollar to oscillate in value shortly after the Fed raises rates – perhaps sending the current economic cycle into extra innings, with the greenback appearing to have priced in a substantial amount of rate hikes that may never occur. Currency speculators and investors aren’t likely going to wait around a few years to fully realize the rate hikes needed to justify the dollar’s gain and as such could send the dollar down in value by year end.
The increase in the dollar, in light of the Fed’s delayed rate hike moves, looks very similar to the timeframe of 1992-1995. Even then, the dollar gave back almost its entire gain it garnered leading up to the rate hikes.
And while the labor market continues to show strength, many indicators, particularly in manufacturing, are signaling the economy is still somewhat fragile. If the Fed does proceed with rate hikes, it will likely be done “quarter by quarter,” a third of the pace in 1994-1995.
So with that in mind, what are some potential opportunities for investors to consider?
- Corporate sales and earnings are poised for growth after being suppressed by the dollar, which has risen 8.25 percent year to date and 22.94% percent from its lows set in May 2014.
- Small and mid-cap look to outperform in the first half of the year, but we expect to see favorable year-over-year comparisons in the second half of 2016 for large cap earnings. This will be driven by our expectation for a lower dollar which would assist larger companies who generate a large amount of revenue from international sources.
- Financials could be a good focal point for investors because historically the initial increase in rates has allowed a bit more spread margin for traditional financial based lending. With the regulatory environment as such, the traditional profits generated from lending should become a more important drive of revenue, especially considering the large amount of pent up liquidity held by banks.
The pivot point for 2016 appears to be the U.S. dollar. There appears to be a logical narrative that has been quite a bit ahead of itself in pricing in a substantial amount of rate hikes that may never occur, or occur at a turtle-like pace; or at best will require more time than the average dollar bull will wish to hold. 2016 will be a very interesting year as the Fed’s historic regime of zero interest rate policy comes to an end. Fed and dollar watchers will have plenty to discuss as they attempt to chart the direction of the economy.
This commentary is for informational purposes only. All investments are subject to risk and past performance is no guarantee of future results. Please see AAM’s disclosures webpage for additional risk information at https://www.aamlive.com/legal/commentary-disclosures.
Advisors Asset Management, Inc. (AAM) is a SEC registered investment advisor and member FINRA/SIPC. | 18925 Base Camp Road | Monument, CO 80132 | www.aamlive.com
Matt Lloyd is Chief Investment Strategist for Advisors Asset Management