Three Developments to Watch in the Second Half
The Investment Conversation
Three Developments to Watch in the Second Half
A Roundtable Discussion
Lord Abbett’s midyear roundtable continues as our experts tackle inflation, the housing market, and consumer debt levels—and their potential market impact in the second half of 2019.
Joseph Graham, CFA
Joseph Graham: Welcome to the 2019 Midyear Outlook. My name is Joe Graham. I'm an investment strategist at Lord Abbett. Today, I'm surrounded by a number of our leading investment professionals. We'll be talking about markets, what's happened over the last few quarters, where the opportunities are today. So now I'll turn it over to these individuals to introduce themselves.
Leah Traub, Ph.D.
Partner & Portfolio Manager
Leah Traub: Hi, I'm Leah Traub, partner and portfolio manager in taxable fixed income.
Partner & Portfolio Manager
Kewjin Yuoh: Hi, this is Kewjin Yuoh, partner and portfolio manager of taxable fixed income.
Dan Solender, CFA
Partner & Director of Tax-Free Fixed income
Daniel Solender: Hello, I'm Dan Solender, partner and director of the tax-free fixed income group.
ID: Thomas O’Halloran, J.D., CFA
Partner & Portfolio Manager
Tom O’Halloran: This is Tom O'Halloran. I'm a partner of Lord Abbett and a portfolio manager of the growth strategies.
Partner, Director of Strategic Asset Allocation
Giulio Martini: I'm Giulio Martini, partner and director of strategic asset allocation.
1. Inflation Implications
Graham: Tom, do you see-- domestically, do-- do your companies see inflationary pressures? Are they seeing wages kind of creep into their cost structures?
O’Halloran: Well, we're at tight labor markets right now, and there are wage increases happening-- so that is beginning to happen. But when you look at inflation overall, you can see that the trend in inflation at this low level and nonvolatile level has been going on for a good while. Twenty years, Giulio, or--
Martini: Since the mid-1990s, really.
O’Halloran: So we don't see a problem with our companies. As a growth investor, that's something that means a great deal to me, because if inflation flares up, the future is worth a lot less today. I watch that very carefully, and I believe that inflation will stay under control, and that's why I think growth will keep doing well.
Martini: Well, what Tom's touching on also, and so many of the companies he looks at are really involved with, [is] one of the major reasons why inflation is staying low. Because what we're starting to see is signs of a productivity acceleration which is an element of the U.S. economic expansion that's been kind of missing in action so far.
VISUAL: Hear more of Giulio Martini’s insights on accelerating U.S. productivity in this video. ]
We've had very, very weak productivity growth, and that's resulted in very slow wage increases and, frankly, a lot of dissatisfaction as people just didn't really feel the benefits of the economic expansion, which we've been going through for the past ten years. But what we started to see a couple years ago is wage increases starting to accelerate.
And whereas that could pose an inflationary threat, it's not doing so, because simultaneously productivity's picking up at the same time, and so production costs aren't going up, even though wages are. And in many ways, that kind of acceleration in productivity creates the potential to have the best of all possible worlds, because it means that households can have an improving standard of living, we can continue to have low inflation, businesses can maintain profit margins to the benefit of shareholders, and all of that coming together is something that we saw for extended periods of time in the 1960s, in the 1980s, in the mid-1990s, but we haven't seen for a while.
Yuoh: I think that one thing that could cause some surprise, I'm not sure if you have an opinion on this, Giulio and-- and Leah, is-- if the Fed does something about inflation targeting, [VISUAL: Inflation targeting: When a central bank attempts to steer actual inflation toward a publicized target rate.] or it introduces some new policy regarding inflation targeting or GDP targeting, whatever it might be. If that happens in the second half of this year, I think that would be a significant volatility driver or curve-steepener in everything that we've been talking about.
Traub: Well, that would be a big driver of volatility. I think it's a very low probability that they do anything. They're having a conference in June where they're talking about research around potentially changing or modifying a little bit their language or how they're thinking about inflation targeting and whether they-- you know, if you noted in the [May 1] FOMC press conference, Chairman Powell was very, very adamant about the symmetric inflation target. [VISUAL: Symmetric inflation targeting: Adjustments to central bank policy when inflation overshoots or undershoots a stated target.] I mean, the fact that they're very symmetric around that. Now how do they institutionalize that? I'm not certain they really can institutionalize that.
2. U.S. Housing Sector
Graham: Let’s talk about risk where we all see risk in the market this year. Housing is one [subject] that occasionally gets brought up.
Martini: Well, there's one part of housing that's weak, and that's single-family home construction. But it's weak in part because there's been kind of a shift in consumer preferences towards multi-family units and towards renting rather than owning.
And so what we've seen is a full recovery in multi-family construction at the same time that single-family housing has only recovered about 60% of the average level of housing starts from the 1990s into the early 2000s. So that's a huge change in the housing sector and in construction. Now more recently, single-family housing has started to pick up.
And that's another thing that's unusual for a late-cycle environment. Typically, housing is weakening in the latter phases of a business expansion. And if it's starting to strengthen now, it's another factor that could sustain growth.
Solender: One thing on the municipal bond side—everyone keeps comparing this time period to the pre-credit crisis time period. And one thing we have on the municipal bond side that gets to what Giulio is talking about, in 2006–07, we had a tremendous amount of speculative real estate deals.
But we're not seeing a lot of speculative deals right now, which gets to that. And then on the other side, we're seeing—and we get concerned about— some pressure on real estate, single-family homes particularly, in some of the states where the mortgage [deductibility] cap was lowered [by the 2017 U.S. tax legislation], and prices are coming down a little bit. So we need revenues from real estate taxes to support some of our bonds. And that's not been an issue, because [municipalities] can slowly raise tax rates in a lot of places, and it takes several years for those decreases in values to really hit revenue. So we're not seeing the impact locally from the problems right now.
Yuoh: I think if we're going to have a significant recovery in housing, lending standards do have to ease up somewhat. But that's something that will be very slow-moving. I don't see housing as a threat right now.
3. Debt Levels
Graham: What about nonresidential debt on the consumer? We occasionally hear stories about auto [loans] and different kinds of delinquency rates going up. Kew, how do you see the consumers' health right now?
Yuoh: The consumer is deleveraging. Mortgage debt is significantly down. And if you look at debt-to-income [ratios] of households, that's declined to very low levels. They do have to service debt, and they have the means to do so, if you look at some of those debt servicing ratios. [VISUAL: Debt service ratio: The ratio of total required household debt payments to total disposable income.] So if you look at where the debt distribution has gone, mortgage debt has decreased, student loans have increased. Your auto and credit card debt outstanding has increased, but certainly not at the pace that student loans have. But if you look at all of that and you look the consumer balance sheet, we're in a favorable place and we've been moving in the right direction.
Martini: The public sector is where debt is increasing. Right now, clearly though, investors are not worried about it. If they were, we would be seeing much higher financing costs and we're just not. You know, the governments around the world are really able to finance themselves at very low rates. So despite this kind of general global acceleration in public debt, from the standpoint of the present moment, investors aren't concerned about it.
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