Emma Wall: Hello and welcome to the Morningstar series Market Reaction. I'm Emma Wall and here with me today is James Dowey, Neptune Investment Management's Chief Economist.
Hi, James.
James Dowey: Hi.
Wall: So bullish or bearish on the U.S.?
Dowey: Well, bullish on the U.S. I mean, the pushback that we would get from that, and that we do from clients, is that valuations are very high. We actually think that valuations probably do speak to low returns on the 10-year basis, but I think on a one-year basis, I think you can do fine in the U.S. still.
Particularly, if you're focused on domestically-facing stocks that are not so hit by the stronger dollar, which is where we're positioned at present.
Wall: So domestic stocks are predominantly reliant on the U.S. consumer going out and spending their cash. But there have been some figures to show that U.S. households are only spending 25% of the benefit they are feeling from the oil price coming down, which is effectively a tax cut for the U.S. consumer. So is that 25% enough to continue for the US – both stock market and economy – to grow?
Dowey: Yeah, well, this doesn't really surprise me. Actually, I think that as a consumer you treat a windfall like this quite cautiously. You wait and see if this is going to have an effect on your finances over the longer term and if it proves to do so, then you start spending. We think that the oil price fall is going to have quite a degree of permanence to it.
We think we are at a lower level equilibrium price for oil today. And we think that as we move forward over the next year or so, the U.S. consumers are going start spending in that windfall, so we're pretty confident.
Wall: Let's talk quickly about weather. We had a minor weather event this year in the first quarter, which affected GDP. We had a major one last year. Is this something we can expect Q1 U.S. every year now or does it really make that much difference?
Dowey: Well, certainly it's a case of deja vu, all over again in terms of weather Q1. It's been much more localised this year actually. It's a smaller weather effect. It's just the East Coast, it's snow related as opposed to temperature related that has a much smaller effect on the economy. But it still is going to have an effect.
In addition, what you've got over on the West Coast is, you've had port strikes, that chopped a bit of GDP as well. And then, of course, with the oil price fall, you've seen a reduction in oil and gas related CapEx.
So you've got problems in the East Coast, problems in the West Coast, programs in Texas, it's all added up to quite a meaningful hit to GDP. And we think that it's probably going to be – going to come in at about 1% for Q1. Now that's a different story to last year where it was a recession essentially in Q1 last year.
But in terms of the dynamics and implications for the market, it's actually quite similar. We think that we see an acceleration over the summer and that's going to be supportive of asset prices, supportive of the dollar. And I think it's going to change the market's perception slightly of where the Fed is going from here.
Wall: And talking about the Fed, of course, what everyone wants to know is, when will interest rates rise? The Fed has that dual agenda of getting wage growth and controlling prices. Wage growth is starting to come through, unemployment is low, people are finally getting pay rises. Does that mean, we're going to get interest rate rise now soon?
Dowey: We think so. So on the unemployment side, the labour market is within the bounds of normality now, so that part of the mandate is basically has a green light flashing, it's saying hike rates.
On the inflation side, the Fed is basically waiting to see if this oil price deflation feeds through into inflation more broadly, pushing it down.
The way to gauge this is to look at core inflation; core inflation is doing fine actually and most recently has started to pick up again. So we think on the inflation side, as well as, telling the Fed to go pretty soon.
There is one really big extra factor that the Fed needs to be cognisant of. And that is, the Fed has to be careful that it doesn't spook the market; that it doesn't create another taper tantrum and they're terrified of doing so. They're absolutely terrified by it.
So I think that what you need to look for is an equilibrium where the Fed knows what the market is thinking, the market knows what the Fed is thinking and that's kind of when they're going to go. So at present, that's kind of converging on a September hike at present, it could come in a bit to June if we do get this acceleration that I had mentioned over the next two or three months.
But essentially, I think, at the end of the day it is not going to make that much difference. Where we are picking a fight with the consensus as it were at present, is on the pace of hikes thereafter.
We think that the path for the Fed over the next two or three years is going to be much steeper than the market currently expects. We see no reason whatsoever in the U.S. at present for an abnormal rate cycle. And yet the market at present has very, very shallow expectations.
If we're right about that, there will be big implications for asset prices. Bonds will fall in price, equities will be a mixed picture. I think you'll need to asset allocate well within U.S. stocks. But I think that probably the biggest implication is that this will be supportive of the dollar over the next couple of years.
Wall: James, thank you very much.
Dowey: Thanks, Emma.
Wall: This is Emma Wall for Morningstar. Thank you for watching.
