Fed expected to gradually raise interest rates
FREDERICK Schaefer is head of US equity product at Schroders, which involves overseeing product teams for US equities.
For his second half outlook of the US economy, Schaefer sees the economy continuing to grow at a moderate pace. He says valuations are workable while the Fed is gradually raising rates in a controlled fashion. Inflation is under control while earnings are good.
Meanwhile, the consumer mood is positive, and consumer debt levels are low.
The political situation, however, is mixed. While lower regulations and taxes are positive, the US trade stance is worrisome.
Schaefer’s recommendation is that for those underweight the US, he would recommend averaging it to normal position. Meanwhile for those at full weight, he would recommend holding their position.
Schaefer spends significant time on client interface. He joined Schroders in 2007 and is based in New York.
Previously, Schaefer was a senior consultant at Evaluation Associates from 1987 to 2007, which involved managing a book of business, consulting clients about pension plans, endowments, foundations and financial organisations.
His key services ranged from asset allocation to manager evaluation and selection as well as quarterly monitoring. He has a Bachelor of Arts in Sociology from the University of Notre Dame.
Below are excerpts from the questions and anwers:
What is your outlook for the US market, now that the Federal Reserve is looking to reduce the size of its balance sheet and resume raising rates?
By all indications, the Federal Reserve will pursue a measured and well-signalled programme of raising rates. Our expectation is for one more rate rise of 25 basis points (bps), probably late in the fourth quarter.
Our focus now is on valuations and earnings. Valuations are stretched in large part due to the unusually low level of interest rates. We anticipate rates will gradually rise over the next several years which should begin to bring valuations down.
The other key is earnings. According to Morgan Stanley, sell-side analysts are projecting earnings growth of 9.3% for 2017 for our space (smaller companies) and 20.9% for 2018. For large cap companies the estimates are 10% (2017) and 11.5% (2018). This leads us to the conclusion that as long as earnings come through, the US equity market will be fine.
Do you think the impact of the rising rates has already been factored into the market?
Yes. The Federal Reserve has done a good job clearly signalling their intentions – both the amount of the expected increase as well as the timing.
US equities have expanded for almost eight years. Is this a bull at the matured stage? What is your call on the market now?
We don’t generally make market calls. As others have noted, bull markets don’t die of old age – they end due to an unexpected shock – Lehman Brothers being a prime example. We remain cautiously positive on the US market.
Hence, would you still recommend buying equities at this juncture? Why?
We are telling clients that if they are at their “normal” allocation to US equities to maintain that exposure. If they are underweight, we suggest they average in until they reach their “normal” allocation.
Based on your experience and dealings with investors, how are the sentiments like now – is it euphoria, caution or urgency to look for yield?
We are not sensing euphoria. If anything we are sensing caution and this is comforting to us.
What indicators do you look at when making investment decisions? What do these indicators tell you now?
We are focused on bottom-up company analysis so our indicators tend to be company specific. One of our favourite company metrics is ROIC (return on invested capital) as this helps us assess if a company is growing shareholder wealth over time.
Do you expect the US dollar to further strengthen?
We are not currency experts so we do not make this kind of prediction. Current developments suggest that the period of dollar strengthening has come to at least a temporary pause.
Like the equity markets, the US dollar probably got ahead of itself after the Trump election last November. Expectations for tax reform and infrastructure stimulus in particular were too high.
What sectors pique your interest at the moment?
We are interested in consumer discretionary, in part because there is a lot of negative sentiment due to the online threat. This has led to low expectations and better valuations than the broader market.
What risks should investors be aware of?
Investors should be aware of inflated expectations. This historically has led to disappointments.
Typically, what do you think is the indicator of the start of a bear market?
Typically, rising interest rates and particularly an inverted yield curve are indicators of the start of a bear market.
What are some of the technological changes that are presently happening, which will change the way the sector operates? (Example: Ride-sharing technology disrupts traditional car-hailing.)
Automation over the longer-term has the ability to disrupt so many industries from manufacturing, transportation, retail to food services. Many jobs now performed by people will disappear due to automation. This will lead to a need to re-train existing workers who have been displaced. An additional change on the horizon is the Internet of Things which has the potential to significantly change our daily lives.
What is a trend or disruption that you foresee happening in the market over the next two years?
Once the build-out of the fibre optic network is substantially in place (right now we are in the process of building “the last mile” – the connection from the home and business to the network) we are likely to see widespread adoption of a variety of changes.
A simple example will be the ability to adjust the temperature in your home remotely, as well as things such as turning on and off lights inside or outside of the home.