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AAM Viewpoints - Lower for Longer - B&G’s Economic and Market Outlook for 2015


Lower growth. Lower inflation. Lower interest rates. We continue to expect all three to persist; both here in the United States and other developed economies, for longer periods of time than many expect.

“Lower for Longer.” This key theme, expressed in Bahl & Gaynor’s third quarter 2014 review, addressed our economic outlook not only for the upcoming quarter, but for the next several years. For the most part, our prognostications have become reality. Interest rates remain stubbornly low. Trends in observed inflation and inflation expectations continue their downward trajectory, with both reaching troubling levels in the Eurozone. Finally, growth has been very mixed globally. The United States is displaying characteristics of an economy moving beyond the recovery phase and into an expansionary period. But outside U.S. borders, major developed economies appear to be decelerating (China), stagnating (Europe and Japan), or contracting (Russia).

The first six years following the financial crisis featured relatively homogeneous central bank policies and actions. All stimulus. All the time. However, with the Fed’s conclusion of quantitative easing (QE) and positioning to begin raising rates, the United States will stand alone globally in its tightening policy versus accommodative stances in Europe, Japan, China and sundry other nations. With the United States “breaking rank,” the interaction between economies will become much more dynamic on a global scale.

Global economic growth and stability is predicated on the delicate concept of yin and yang, whereby expanding economies offset those that are struggling. As we look at the global picture, there is only one economy truly doing well, the United States. The aggregate demand drag from international economies is likely to be significant and places a lot of importance on the domestic economy to “subsidize” austerity and weakness abroad. Should the United States even appear to be losing momentum, as occurred in early October, Bahl & Gaynor sees no other safe haven for investors to stash equity assets. In such a scenario, the potential increase in volatility would be significant and a flight to quality could ensue.

Bahl & Gaynor views the combination of relative economic strength in the United States and diverging global central bank policies as fertile ground for a bull market in the U.S. dollar versus other currencies. Chart 1 (below) contains what Bahl & Gaynor considers to be, “The Only Chart That Matters” in the case for a strengthening U.S. dollar. The chart overlays the yield of various countries’ 10-year government bonds with their corresponding long-term credit rating. Without even adjusting for credit quality, the United States clearly offers the greatest yield. Adjusting for credit quality would only intensify the disparity between the United States and the risk/reward profile of every other country listed.

Chart 1:

10-Year U.S. Government Bond Yields

As of December 31, 2014

 

Massive amounts of foreign capital have been funneling into long-term Treasuries as foreign governments take measures to weaken their currencies. With no indications of a shift in the prevailing fact pattern, this intense foreign investment should keep long-term U.S. Treasury yields lower than may otherwise be warranted in a vacuum.

While the dollar has strengthened materially in 2014, its appreciation is relatively small in scale when viewed through an historical lens. When the recent uptick is considered in conjunction with our economic outlook, the argument for long-term U.S. dollar strength is compelling.

Given this expectation, it bears to mention the S&P 500’s increasingly foreign sensitivity. Even though foreign markets represent 33% of S&P 500 constituent sales, we do not believe the effect of a strengthening U.S. dollar is fully incorporated into top-down earnings estimates or bottom-up constituent projections. The drag on revenues and – ultimately – earnings, presented by a strengthening U.S. dollar could become very evident in the second half of 2015. First quarter results in 2015 will likely benefit from favorable comparisons given an abnormally cold 2014 winter, but the gravity of a strengthening U.S. dollar and weakening foreign aggregate demand may be on full display by mid-2015.

We are extending our “lower for longer” view to oil and other growth-related commodities. Prices have maintained a downward trajectory for over a year as decelerating economic growth in China, Japan and Europe has become more pronounced. Hindsight being 20/20, the combination of 1) a sharp increase in U.S. oil production, 2) fewer production disruptions in OPEC-member countries (Organization of Petroleum-Exporting Countries), and 3) tepid demand growth hampered by decelerating developed economies, created significant global excess supply. This excess supply is expected to increase further in 2015, primarily driven by U.S. production maintaining its torrid growth rate. These extreme supply-and-demand imbalances, complicated by political motives that encourage production, have created a landscape in which Bahl & Gaynor believes it will be difficult for the price of crude oil and growth-related commodities to rise materially in the foreseeable future.

BOTTOM LINE:

In summary, our forward view remains “Lower for Longer.” Lower growth. Lower inflation. Lower interest rates. All for longer periods of time than many expect. Additionally, the combination of the Fed “breaking rank” with foreign central bank policies and diverging U.S. growth, inflation and interest rate expectations versus other major developed economies is extremely supportive of a massive and long-running bull market in the U.S. dollar. Finally, the presence of supply-and-demand imbalances and political motivations for over-production will depress crude oil and other growth-related commodity prices in the foreseeable future.

We continue to expect heightened volatility across global markets as the long-term implications of a materially stronger U.S. dollar and lower oil prices become evident. We believe the path will not be uniform, direct or without peril - there will be blood. Thinly capitalized companies face long odds of survival in a volatile environment; making shareholder returns a dubious prospect, at best. We expect well-capitalized entities with strong free-cash flow will emerge winners.

The execution of Bahl & Gaynor’s investment strategies focuses on the ability of well-capitalized companies to pay and grow dividends. These enterprises view dividends as part of their capital budgeting process, which instills discipline in both the commitment to capital expenditures and use of leverage. In light of our outlook, we believe high-quality, dividend growth stocks to be the best-positioned avenue through which to capture favorable, long-term risk-adjusted return

 

CRN: 2015-0127-4577R 

This commentary is for informational purposes only. All investments are subject to risk and past performance is no guarantee of future results. Please see the Disclosures webpage for additional risk information at www.aamlive.com/blog/about/disclosures. For additional commentary or financial resources, please visit www.aamlive.com

The views expressed in this commentary are not necessarily that of AAM.

This commentary is from Bahl & Gaynor (B&G), a strategic partner of AAM.


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Effective, June 10, 2016, please note that Gene Peroni left Advisors Asset Management (AAM) to become President of Peroni Portfolio Advisors, Inc. Peroni Portfolio Advisors, Inc. ("PPA") is an investment advisor independent of AAM.

 

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