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Market View

While we believe the overall backdrop for investments remains constructive, our experts will be keeping an eye on these economic and geopolitical uncertainties.

 

In Brief

  • The confluence of a stronger U.S. dollar, higher U.S. interest rates, and trade wars could dampen the global economic expansion.
  • Following the longest U.S. bull market in equities ever, investors will have to factor in the potential impact of political upheaval in Washington as well as increasing geopolitical tensions—both of which could increase market volatility. 
  • While we remain sanguine about many of these risks, there is no doubt that such an environment underscores the need for active risk management of investor portfolios.

 

September historically has been a challenging month for investors. But no matter what happens to stocks in the longest bull market in U.S. history (with the Nasdaq Composite Index recently topping the 8,000 level for the first time), this month could be “a September to remember,” in the words of Giulio Martini, Lord Abbett partner and director of strategic asset allocation.

Indeed, with a laundry list of global developments that could weigh on financial markets worldwide in the coming month, we thought it would be useful to review some of the most important items and offer some needed context.

Higher Interest Rates and a Stronger Dollar 
While inflation is well under control and employment is strong, the U.S Federal Reserve (Fed) is likely to raise interest rates again during its meeting on September 26 (for the third time this year). Many market observers are concerned that this could lead to recession, further dampening an already slowing housing market and consumer spending. The effects also may be felt elsewhere, as a strengthening U.S. dollar (see Chart 1) makes it harder for debtors in Turkey and other emerging markets to repay loans denominated in greenbacks. So, investors should not get complacent, cautions Robert Lee, Lord Abbett partner and chief investment officer.

 

Chart 1.  The U.S. Dollar Rally Has Accelerated This Year
  

Source: Federal Reserve. For illustrative purposes only and does not represent any specific portfolio managed by Lord Abbett or any particular investment.

 

U.S. Fiscal and Political Developments
Meantime, the Congressional Budget Office reports that gross federal debt has risen to a whopping $21.2 trillion. As a percentage of GDP, that debt burden amounts to 105.4% (according to Trading Economics), the third highest in the world, behind only Japan and Italy, and is expected to grow significantly. (See Chart 2.) Of course, some economists have pointed out that, while the debt level is high, the U.S. economy is improving, and further economic growth may lessen the debt burden as a percentage of GDP. But others ask whether the U.S. government will address the debt now while the economy is on solid footing and before the economy hits a downturn.

 

Chart 2.  U.S. Debt as a Percentage of GDP Now Rivals Italy
U.S. gross federal debt to GDP versus Japan and Italy, 2013-18E


Source: TradingEconomics.com and U.S. Bureau of Public Debt   For illustrative purposes only and does not represent any specific portfolio managed by Lord Abbett or any particular investment.

 

“Congress will eventually have to increase the debt ceiling,” Martini opined at a recent wide-ranging roundtable with investment professionals. “There could be another government shutdown or a very tough negotiation around that. That doesn’t necessarily mean there would be a default on U.S. debt,” but congressional negotiations on addressing the issue could be difficult in the run-up to what are shaping up to be contentious U.S. midterm elections.

Meanwhile, the Fed reports that total U.S. corporate debt was 45.2% of GDP at the end of the first quarter, matching the highest level it hit during the financial crisis of 2008–09, and, according to Bloomberg, the share of risky debt is rising. It should be noted, however, that default rates are low—a reflection of stronger U.S. economic growth.   

Brexit and the European Union
Another potential stress on the markets could be Brexit negotiations, which are now in their final stages. According to a recent study by the International Monetary Fund, the United Kingdom’s departure from the European Union (EU)—a so-called “hard Brexit”—will hurt income and employment in the EU.

“If the U.K. and the EU settle on a standard free trade agreement whereby tariffs on goods traded are low, but with higher non-tariff barriers, we estimate that EU [excluding the United Kingdom] real output will be lower by 0.8%, and employment by 0.3%, in the long run than in a no-Brexit [“soft Brexit”] scenario,” the IMF report said.  

“A ‘hard Brexit’ scenario is not our base case,” said Lee. The 28-nation European Union not only hopes to strengthen its role in the world but also to cooperate with the United Kingdom as a close partner. Once negotiations are completed, a 21-month transition period would give businesses and administrations time to adapt, as the U.K. would stay in the EU’s Single Market and Customs Union until December 31, 2020.

But the EU has other issues to contend with, including considerable friction between Italy and the rest of the bloc over budgetary rules and procedures concerning the processing of refugees. Following the deadly collapse of a bridge in Genoa, Italian officials urged some easing of EU budget limits in order to upgrade the country’s aging infrastructure, seemingly assigning blame to fiscal austerity measures resulting from EU strictures for the tragedy. Meanwhile, the refusal of the government to allow migrants to disembark in Italy without a burden-sharing agreement with the rest of the EU opened another front for conflicts.

Geopolitical Risks
At any given time, Lee can enumerate a number of geopolitical risks that may be difficult to assess, but require constant due diligence. For instance:

  • North Korea—One big question on Lee’s mind is whether current diplomatic efforts will be able to defuse tensions on the Korean peninsula. Will North Korean leader Kim Jong Un live up to his pledge to abandon his nuclear arsenal? Unlikely—as a recent report by the International Atomic Energy Agency (IAEA) raised considerable doubts to that issue. All of which helps to explain why President Trump recently decided to delay talks, given a lack of “sufficient progress.” Trump suggested talks could resume in the near future once the United States’ trading relationship with China is resolved.
  • Iran—While the U.S.-China trade dispute helped control  international oil prices, increased diplomatic and economic pressure against Iran, including economic sanctions imposed by the United States, have hampered the global oil supply outlook. For its part, the EU appears committed to maintaining economic ties to Iran (especially in regard to oil supplies), despite President Trump’s threats of “severe consequences” of retribution. Iran has asked a U.N. court to lift the crippling U.S. sanctions. Meanwhile, escalating clashes between Israeli and Iranian forces in Syria have led observers to believe that the risks of a new, large-scale regional conflict have increased.
  • Russia—The Trump administration recently imposed new sanctions on Russia, as U.S. lawmakers weighed tougher measures, despite the need for cooperation on North Korea, Iran, and Syria, among other hotspots. One U.S. State Department official told a Senate committee that the Russian economy is under considerable strain. Foreign direct investment in Russia has fallen by 80% since 2013 and, its major exports, oil and natural gas, are facing increasing competition from the United States.

No one can say with certainty how any of these risks will evolve. But, in summing up the geopolitical outlook, Lee remains sanguine. “I don't think the picture is particularly dire on any one of these situations,” he says, “but some of the risks have increased, which underscores the important role that Lord Abbett’s risk management team plays in evaluating the impact on our portfolios.”

Suffice it to say, Lord Abbett investment professionals will be constantly monitoring key trends and developments that could affect portfolios, and while the overall outlook on the state of the global economy remains constructive, our highly collaborative approach to active management will allow us to adapt to changing market conditions as warranted.

“We expect risk markets to go up,” said Martini. “These concerns on the part of investors show they have more to overcome than usual.”  

 

IMPORTANT INFORMATION

This article is being provided for informational purposes only and is intended to illustrate certain information analyzed during the research process. It does not constitute a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy, nor investment advice, and should not be used as the basis for any investment decision. This is not a representation of any securities Lord Abbett purchased or would have purchased or that an investment in any securities of such issuers would be profitable.

Keep in mind that all investments carry a certain amount of risk including possible loss of the principal amount invested. No investment strategy, including diversification and asset allocation, guarantees a profit or protects against a loss. Stock markets and investments in individual stocks are volatile and can decline significantly in response to issuer, market, economic, industry, political, regulatory, geopolitical, and other conditions. There is no assurance that past trends will continue into the future. The value of investments in equity securities will fluctuate in response to general economic conditions and to changes in the prospects of particular companies and/or sectors in the economy. Investments in either growth or value stocks may shift in and out of favor for long periods of time, depending on market and economic conditions. While growth stocks are subject to the daily ups and downs of the stock market, their long-term potential as well as their volatility can be substantial. Value investing involves the risk that the market may not recognize that securities are undervalued, and they may not appreciate as anticipated. Small and mid-cap company stocks tend to be more volatile and may be less liquid than large cap company stocks. Mid cap companies typically experience a higher risk of failure than large cap companies. Small cap companies may also have more limited product lines, markets, or financial resources and typically experience a higher risk of failure than large cap companies. Non-U.S. equity securities generally pose greater risks than domestic securities, including greater price fluctuations and higher transaction costs. Investments outside the United States also may be affected by changes in currency rates or currency controls. With respect to certain countries outside the United States, there is a possibility of nationalization, expropriation or confiscatory taxation, imposition of withholding or other taxes, and political or social instability that could affect investments in those countries. These risks can be greater in the case of emerging country securities. Statements concerning financial market trends are based on current market conditions, which will fluctuate. There is no guarantee that markets will perform in a similar manner under similar conditions in the future.

This Market View may contain assumptions that are “forward-looking statements,” which are based on certain assumptions of future events. Actual events are difficult to predict and may differ from those assumed. There can be no assurance that forward-looking statements will materialize or that actual returns or results will not be materially different from those described here.

The information provided is not directed at any investor or category of investors and is provided solely as general information about Lord Abbett’s products and services and to otherwise provide general investment education. None of the information provided should be regarded as a suggestion to engage in or refrain from any investment-related course of action as neither Lord Abbett nor its affiliates are undertaking to provide impartial investment advice, act as an impartial adviser, or give advice in a fiduciary capacity. If you are an individual retirement investor, contact your financial advisor or other fiduciary about whether any given investment idea, strategy, product or service may be appropriate for your circumstances.

The opinions in Market View are as of the date of publication and subject to change based on subsequent developments and may not reflect the views of the firm as a whole. This material is not intended to be legal or tax advice and is not to be relied upon as a forecast, or research or investment advice regarding a particular investment or the markets in general, nor is it intended to predict or depict performance of any investment. Investors should not assume that investments in the securities and/or sectors described were or will be profitable. This document is prepared based on information Lord Abbett deems reliable; however, Lord Abbett does not warrant the accuracy or completeness of the information. Investors should consult with a financial advisor prior to making an investment decision.

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