Politics and Economics: Linked—or Not?

A U.S. presidential outcome, one way or the other, likely will lead to some extrapolation of how economic policies might change—for example, higher/lower taxes or changes/continuation of trade policies—and, therefore, the impact on the stock market. But such policy changes take time; consider the agonizing on Capitol Hill over passage of major legislation, such as health care reform. Additionally, this involves a series of predictions: who will win, what policy changes may be made, and the outcome of such polices. So many places to get it wrong—I wouldn’t touch it.

According to conventional political and economic wisdom (there must be an oxymoron in there somewhere), the stock market presumably does better under Republicans than Democrats. Yet some studies suggest the inverse.

And because there is no shortage of opinion in politics or economics, there are some who say the economic benefits of one administration may not surface until a change in the Oval Office. Consider the theory touted in some circles that the expansion in the economy during the tenure of President Bill Clinton (1993-1997, 1997-2001) was due, at least in some degree, to the Reaganomic theories of the 1980s still trickling down through the economy. Whatever one’s view, there are plenty of data to back up either side.

More important, and the basis of our portfolio decisions at Astor, is the current state and the direction of the overall economy. “Now-casting” the current state of the economy, using our proprietary Astor Economic Index®, we feel, is more telling of the likely short-term direction of stocks than most data, including election results. While the index could be stronger, and has been stronger earlier this year, it is still decidedly positive.

Interesting to note is that the prevailing economic trend might have some role in who gets elected (versus who gets elected impacting shorter-term movements in stock prices), as indicated by election prediction models that consider some measure of how the economy is doing. The thought is that if the economy is going strong in the six months or so before the election, history suggests the party currently in the White House will win. If the economy is acting poorly, then the opposing party has a better shot. But it doesn’t work that way all the time, in the case of the Bush-Gore contest in 2000 when, according to one observer, “the economy favored Al Gore—but Bush won.”

What all of this leads us to believe is that while there may be some links, at least psychologically, between politics and the economy, the bigger and more impactful thing to watch is the $18 trillion U.S. economy.

As economists, we at Astor keep our finger on the economic pulse. Based on our study of the stock market over nearly 100 years, we believe the prevailing economic trend to be the best gauge of how and where to invest. Based on our research, we believe that periods of economic expansion tend to favor exposure to equities (beta), while periods when the economy is contracting or in recession do not favor equities and may be more appropriate periods for holding fixed income and/or even inverse equity positions. After determining the prevailing U.S. economic trend, we allocate assets accordingly, using exchange traded funds (ETFs) to take advantage of the transparency, liquidity, and variety of these investment instruments.

Any ebb and flow in the polls from now until Election Day (and even beyond, depending upon reaction to the outcome) could impact the stock market with its time-honored tradition of “climbing the wall of worry.” Worry pushes down asset prices, while euphoria sends them upward.

At Astor Investment Management, we are not in the business of forecasting presidential elections—nor do we focus on the worries/euphoria du jour. We keep our eye on the economic fundamentals, which we believe have far more impact on the market than who wins the election or any short-term fluctuation in opinions and emotions. And as of this writing, it still appears in our view that having exposure to stocks has a positive expected return.

All information contained herein is for informational purposes only. This is not a solicitation to offer investment advice or services in any state where to do so would be unlawful. Analysis and research are provided for informational purposes only, not for trading or investing purposes. All opinions expressed are as of the date of publication and subject to change. Astor and its affiliates are not liable for the accuracy, usefulness or availability of any such information or liable for any trading or investing based on such information.

 The Astor Economic Index® is a proprietary index created by Astor Investment Management LLC. It represents an aggregation of various economic data points: including output and employment indicators. The Astor Economic Index® is designed to track the varying levels of growth within the U.S. economy by analyzing current trends against historical data. The Astor Economic Index® is not an investable product.

An ETF is a type of Investment Company which attempts to achieve a return similar to a set benchmark or index. The value of an ETF is dependent on the value of the underlying assets held. ETFs are subject to investment advisory and other expenses which results in a layering of fees. ETFs may trade for less than their net asset value. Although ETFs are exchanged traded, a lack of demand can prevent daily pricing and liquidity from being available.

311161-532

Q3 GDP Beats Estimates

Q3 GDP Beats Estimates

Real GDP for Q3 2016 came in at a better-than-expected rate of 2.9%. This “advance estimate,” released by the Bureau of Economic Analysis, was above consensus/economists’ estimates of around 2.5-2.6%. In Q2, real GDP increased by an annualized rate of 1.4%.

As Astor previously observed, a Q3 GDP report that at least met expectations, along with follow-through in the ISM Manufacturing and Non-Manufacturing gauges, could be a good springboard for continued growth in Q4. This outlook also adds to the widely-held expectation, as previously noted, that the Federal Reserve will raise interest rates by the end of the year.

gdp-q3

Highlights from the report include:

  • Personal consumption expenditures rose 2.1% in Q3 vs 4.3% in Q2
  • Exports rose 10% in Q3 vs 1.8% in Q2
  • Other positive contributions were from private inventory investment, federal government spending, and nonresidential fixed investment. These increases were partly offset by negative contributions from residential fixed investment and state and local government spending. Imports, which are a subtraction in the calculation of GDP, increased.

This advance estimate for Q3 GDP is subject to two more revisions. In Astor’s view, these revisions make the backward-looking GDP “headline” number less useful for making investment decisions than economic analysis using output indicators for the current quarter, as well as near-term trends in the economy.

The Q3 second estimate report is scheduled to be released on Nov. 29.

 

All information contained herein is for informational purposes only. This is not a solicitation to offer investment advice or services in any state where to do so would be unlawful. Analysis and research are provided for informational purposes only, not for trading or investing purposes. All opinions expressed are as of the date of publication and subject to change. Astor and its affiliates are not liable for the accuracy, usefulness or availability of any such information or liable for any trading or investing based on such information.

309161-524

 

 

Passive Investing Grows in Popularity—But No Panacea

As the investing public, from institutions to individuals, moves away from stock picking and other traditionally active strategies, the beneficiary is passive investing.

As the Wall Street Journal reported recently, pension funds, endowments, 401(k) retirement plans, and retail investors are opting increasingly for passive investing that tracks an index. For the three years ended Aug. 31, investors added nearly $1.3 trillion to passive mutual funds and passive exchange traded funds (ETFs), while taking more than $250 billion from active funds, according to Morningstar.

Passive investment products can be powerful tools. But so is a chainsaw. In both cases, you need to know how to use them.

Passive investing may be appealing to some investors compared to traditional active investing such as stock picking, which is inherently difficult.

Investors who want to track market performance often prefer passive funds as a way to capture “beta” at a lower cost than active funds. In addition, traditional active funds often underperform their benchmarks.

Being too passive in one’s investing, however, is no panacea. For example, in a market downturn, a passive approach that “stays the course” through a correction in the broad market or a particular index can lead to significant drawdowns.

Another consideration, in our opinion, is that many passive index funds are market cap-weighted, with the biggest allocations going to the largest stocks in the index. That might lead investors to have greater exposure to a few stocks than they anticipated or desired.

A much better approach, we believe, is to focus on asset allocation. As a classic 1986 study published in the Financial Analysts Journal found, the potential return from “investment policy”—meaning, the selection of asset classes and how they are weighted—is the dominant determinant of portfolio performance. Investment strategy, such as picking particular stocks, was found to be much less of a determinant of performance.

At Astor, our fundamentally driven, macroeconomics-based approach focuses on asset classes—such as core equity holdings, fixed income, commodity, currencies, or real estate. We believe ETFs, which are low cost, transparent, and efficient, are the best instruments to provide this exposure. Moreover, we take a dynamic approach to asset allocation, as determined by the current trend in the U.S. economy, using our proprietary Astor Economic Index®.

We believe that when investors take a dynamic approach with a strategic holding (for example 20 percent of their overall portfolio) they can potentially gain the benefit of being more agile and responsive to economic conditions.) This is our approach to a ‘best of both worlds” strategy for being both passive and active, as advocated by some investment professions in the Wall Street Journal. 

At Astor, by putting our focus on asset allocation and with a finger on the pulse of the economy, our goal is to generate solid returns and mitigate risk, across the economic cycle.

 

 

 

All information contained herein is for informational purposes only. This is not a solicitation to offer investment advice or services in any state where to do so would be unlawful. Analysis and research are provided for informational purposes only, not for trading or investing purposes. All opinions expressed are as of the date of publication and subject to change. Astor and its affiliates are not liable for the accuracy, usefulness or availability of any such information or liable for any trading or investing based on such information.

 The Astor Economic Index® is a proprietary index created by Astor Investment Management LLC. It represents an aggregation of various economic data points: including output and employment indicators. The Astor Economic Index® is designed to track the varying levels of growth within the U.S. economy by analyzing current trends against historical data. The Astor Economic Index® is not an investable product. When investing, there are multiple factors to consider. The Astor Economic Index® should not be used as the sole determining factor for your investment decisions. The Index is based on retroactive data points and may be subject to hindsight bias. There is no guarantee the Index will produce the same results in the future. The Astor Economic Index® is a tool created and used by Astor. All conclusions are those of Astor and are subject to change.

310161-511

 

The Tension between Reacting and Overreacting: One Number Does Not Make a Trend

In asset allocation and investing, there is a natural tension between reacting and overreacting. The goal is to ensure you are skilled at the former, while avoiding the latter.

At Astor Investment Management, we believe our macroeconomics-based approach to asset allocation helps us react to what we determine to be real change in the economic trend. We reduce equity exposure (beta) when the economic trend weakens, and increase equity exposure as the economic trend strengthens.

What we don’t do is react to every little wiggle in a particular number. We often try to make this point in discussions with clients who may want to know what a particular “headline number”—be it GDP or the unemployment rate—means for investing. Our answer is that one number doesn’t make a trend. Rather, we use our proprietary Astor Economic Index® (AEI) to guide our asset allocation decisions.

To learn more about how the AEI guides our asset allocation decisions, watch this.

The AEI is designed to take a series of employment and output data and aggregate them into a single number. We think of this approach as taking a snapshot, in real time, of the economy; it is a “now-cast”—not a forecast—because we believe it is not possible to forecast recessions. The often-quote joke in finance (attributed to Nobel laureate and economist Paul Samuelson) is that the stock market has predicted something like nine out of the last five recessions.

Instead, we use AEI to gauge the strength or weakness of the current economic trend and then invest accordingly. We predicate this approach on a central insight drawn from our research into nearly 100 years of stock market returns, dividing those years into months when the economy was in expansion on the first day of the month and months when the economy was in recession on the first day of the month. On average, during periods when the economy was expanding, the stock market gained an average of 90 basis points (0.9%) per month. Conversely, when the economy was in recession, the stock market lost an average of 75 basis points (0.75%) per month.

These research findings underscore the importance of gauging and reacting appropriately to the economic trend. For example, when we are confident that the economy is in recession, as indicated by the AEI, we steadily and quickly reduce equity exposure and add more fixed income. During times when the economic trend is positive, we typically add equity exposure.

But we don’t make such moves arbitrarily or in reaction to one or two numbers. We use the AEI as a powerful tool for asset allocation and to help us stay the course even when the stock market appears to be overreacting to some number—for example, during stock market drops that are likely to be transitory during economic expansions. The stock market might sell off sharply for a short time, but if we see no change in the economic fundamentals, we will stay the course. In those instances, when the stock market comes back a short while later, we’ll give ourselves a little pat on the back for protecting our clients by avoiding overreaction. We don’t take credit for being “right”; rather, we credit the AEI and the discipline it infuses.

The most important investment decision, of course, is determining the ratio of stocks and bonds. At Astor, our rationale is driven by economic fundamentals. By using the AEI, we can discern the economic trend through the noise the data.

 

All information contained herein is for informational purposes only. This is not a solicitation to offer investment advice or services in any state where to do so would be unlawful. Analysis and research are provided for informational purposes only, not for trading or investing purposes. All opinions expressed are as of the date of publication and subject to change. Astor and its affiliates are not liable for the accuracy, usefulness or availability of any such information or liable for any trading or investing based on such information.

The Astor Economic Index® is a proprietary index created by Astor Investment Management LLC. It represents an aggregation of various economic data points: including output and employment indicators. The Astor Economic Index® is designed to track the varying levels of growth within the U.S. economy by analyzing current trends against historical data. The Astor Economic Index® is not an investable product. When investing, there are multiple factors to consider. The Astor Economic Index® should not be used as the sole determining factor for your investment decisions. The Index is based on retroactive data points and may be subject to hindsight bias. There is no guarantee the Index will produce the same results in the future. The Astor Economic Index® is a tool created and used by Astor. All conclusions are those of Astor and are subject to change.

310161-506

 

What Are You Looking At?

Fed-watching. Oil prices. The latest geopolitical headline. All sources of anxiety, some of them manufactured. The real question is, what should you be focusing on?

Even as markets persist near all-time highs, volatility not indicating too much concern, the subconscious anxiety appears to be growing. As we’ve seen in recent years (and, more recently, during Brexit) any number of things can create uncertainty in the market and cause investors to make a kneejerk reaction. The key is avoiding that.

Such event-driven market gyrations raise the questions about how investment professionals and their clients should make portfolio decisions. How you construct your portfolio goes a long way in how you view market activity. While there is no shortage of so-called rationale for buying and selling (as the cable TV pundits will attest), solid portfolio allocation decisions require equally solid rationale.

In other words — What are you looking at?

Investors who don’t make investment decisions based on specific rationale are more apt to put their money on the line based on what they think/hear or, worse yet, on attempts to time the market. The New York Times recently highlighted the potential danger of such an approach: “By buying and selling too frequently and at the wrong times and not benefiting fully from compounding, people typically do even worse than they would have done if they simply held on to their investments.” Investors get penalized for being reactionary. The less fundamental and the more ad hoc their reasoning for making asset allocation decisions, the more susceptible investors will be to react to market noise.

We believe a macroeconomic-driven asset allocation, at least for a portion of portfolios (i.e., the strategic or dynamic holdings—typically 20%), make the most sense for investors to construct portfolios that are adaptable to the current environment, while also maintaining their focus on long-term results. After all, corporations focus on economic trends. The Fed focuses on economic trends. Why wouldn’t investors?As a fundamentally driven asset allocation firm, we’ve made our careers determining why economic data matter—what data points mean and where the economy is going. Our macroeconomics-based approach is all the more important in today’s evolving capital market landscape, with potentially changing risk and return dynamics, from fixed income and more assumed risk in traditionally allocated portfolios. As we observe, in these conditions, investors are taking on more risk to pursue the same return.

For example, in today’s investment environment, realistic fixed-income return targets are becoming harder to achieve without taking on more risk. The choice for many investors has been to take on more risk for the same yield‘(1):

  • In 1995, a 100% portfolio allocation to Treasury Bonds would have an approximate 7.5% target return, with a 6.5% standard deviation.
  • In 2015, to have a 7.5% target return:
    • Treasury bonds were reduced to 12% of the portfolio
    • Equities were almost two-thirds of the portfolio
    • The standard deviation for the target 7.5% return portfolio rose to more than 17%

‘(1) Source:  Wall Street Journal/Callan Associates: http://on.wsj.com/1XN7VyS

 Without a rationale grounded in the fundamentals, investors potentially could make risky decisions without having a good reason—or worse, decisions that are not in line with their risk tolerance, which will put more emphasis on managing risk for the foreseeable future. This adds more weight to have a good answer to the question: What are you looking at?

At Astor, we believe the only acceptable answer is the economic fundamentals. That’s what matters when you’re focusing on what matters to you.

 

All information contained herein is for informational purposes only. This is not a solicitation to offer investment advice or services in any state where to do so would be unlawful. Analysis and research are provided for informational purposes only, not for trading or investing purposes. All opinions expressed are as of the date of publication and subject to change. Astor and its affiliates are not liable for the accuracy, usefulness or availability of any such information or liable for any trading or investing based on such information.

309161-484

A Mixed Picture – Economic Snapshots

The U.S. economic picture is mixed, with some signs of slowing, along with areas of strength. Let’s take a look at the current snapshots to gain a more comprehensive view.

To learn more about The Economic Picture, watch this video

ISM Manufacturing

In our opinion, the most worrying data have been ISM Manufacturing Index readings. ISM Manufacturing declined to 49.4 in August from 52.6 in July, which points to continued weakness in a sector that has been a major drag on economic growth. However, the manufacturing survey has shown improvement since February 2016. Therefore, we’ll need to see more than one month’s reading in order to detect a change in trend.

us-chart1Consumer Spending

A more positive story is consumer spending, which remains robust and is the strongest contributor to GDP. Much of the rise in the preliminary Q2 2016 GDP came from 4.2% growth in consumption.

us-chart2Wage Growth and the Employment Picture

Sustaining that strength in consumer spending depends largely on wage growth, which remains sluggish. However, the Atlanta Fed’s Wage Growth survey shows the pace of wage growth is close to 3.6% year-on-year and accelerating rapidly, which is not far from the previous cyclical peak of 4%.

us-chart3

 

Another slowing, but still robust indicator has been Non-Farm Payrolls, as labor market data show continued strength. Jobless claims remain relatively low and have been consistent with a still-strong trend in employment growth. Payrolls for August were below consensus, but our indicators, we believe, still point to strengths.

The unemployment rate has been holding at 4.9%, and the U-6 underemployment rate remained at 9.7%.  Within August’s private payrolls, manufacturing, construction and mining lagged whereas retail and financials showed the most growth.

Productivity

Weak productivity growth, at near 0, remains the factor that is holding down GDP growth, despite labor market strength. With disappointing productivity growth for several years, we believe a rise in investment as a share of GDP would be necessary in order to see any future productivity gains.

us-chart7

 

Fed Q3 “Now-Casts”

As the third quarter comes to a close, it’s important to note that the “now-casts” produced by the Federal Reserve Banks of Atlanta and New York continue to show stronger growth for Q3 than the first half of the year. The Atlanta Fed is current forecasting a 3.7% seasonally adjusted annual rate of return (SAAR) for the third quarter. The New York Fed forecast for Q3 is 2.6%. These forecasts are significantly higher than their own respective final estimates for Q2, and also higher than the Bureau of Economic Analysis’ preliminary estimate for Q2 of 1.2%. (The third estimate for Q2 GDP will be released on Thursday).

Overall, the consensus of economists’ estimates for U.S. economic growth looks stable, but have decreased to 1.54% for 2016 and 2.25% for 2017.

 

The Astor Economic Index

Meanwhile, the Astor Economic Index® (AEI), the cornerstone of our fundamentally-driven, macroeconomic-based approach to asset allocation, shows the economy is growing—but at a comparatively slow pace. As always, we continue to keep our finger on the pulse of the economy to determine the current trend as we invest accordingly.

 

 

 

All information contained herein is for informational purposes only. This is not a solicitation to offer investment advice or services in any state where to do so would be unlawful. Analysis and research are provided for informational purposes only, not for trading or investing purposes. All opinions expressed are as of the date of publication and subject to change. Astor and its affiliates are not liable for the accuracy, usefulness or availability of any such information or liable for any trading or investing based on such information.

 

 The Astor Economic Index® is a proprietary index created by Astor Investment Management LLC. It represents an aggregation of various economic data points: including output and employment indicators. The Astor Economic Index® is designed to track the varying levels of growth within the U.S. economy by analyzing current trends against historical data. The Astor Economic Index® is not an investable product. When investing, there are multiple factors to consider. The Astor Economic Index® should not be used as the sole determining factor for your investment decisions. The Index is based on retroactive data points and may be subject to hindsight bias. There is no guarantee the Index will produce the same results in the future. The Astor Economic Index® is a tool created and used by Astor. All conclusions are those of Astor and are subject to change.

309161-492

 

 

Eyes on the Fed: No Urgency for a Rate Rise

All eyes are on the Federal Reserve this week and the often-discussed question: Will they or won’t they raise rates? Here at Astor, our prediction of what we believe the Fed will do (spoiler alert: we don’t expect a rate rise in September) comes down to two important data points: employment and inflation.

To learn more about The Fed, watch this video

These data points relate directly to the mandate of the Federal Open Market Committee (FOMC) as stated in The Federal Reserve Act, particularly to promote the goals of maximum employment and stable prices. In the chart below, the blue horizontal band represents the inflation target (roughly 2%) as set by the FOMC, while the pink vertical band shows the unemployment rate (roughly 5%).

fed

 

We can see that as of August 2016 (far left), the Fed has made progress in fulfilling its mandates. The unemployment rate has been cut in half, from the high of 10% in October 2009 (in January 2010 it was still a lofty 9.8%) to 4.9% in August 2016. Inflation, meanwhile, has been not been above the Fed’s target for more than a month or two.

Looking ahead, the question that we believe is on the collective mind of the Fed is what will happen a year or two out, particularly with unemployment being so low. Will a relatively tight labor market lead to higher wages and, in turn, force inflation higher, above the Fed’s target? Recent speeches and comments made by central bankers seems to us an FOMC that is divided on this issue.

The “hawks” have been making their case for raising interest rates; in their view, with unemployment being so low, inflation looks certain to increase. For instance, earlier this month, Federal Reserve Bank of Boston President Eric Rosengren said “a reasonable case can be made” for tightening interest rates to avoid overheating the economy.

On the other hand, the “doves,” who favor keeping interest rates steady, see additional slack in the labor market; with economic growth slowing, they don’t believe higher rates are necessary. Fed Governor Lael Brainard, for example, said in a recent speech that leaving rates unchanged since December 2015 “has served us well in recent months, helping to support continued gains in employment and progress on inflation.”

Here at Astor, our analysis of the Fed’s comments is that the FOMC will refrain from raising rates in September. (We’re not alone in that view: As the Wall Street Journal reported, the widespread expectation in the market is for rates to stay steady.) Come December, though—a full year after the last rate hike, and with another quarter of economic data to digest—we believe the Fed will take the next step and raise rates.

All information contained herein is for informational purposes only. This is not a solicitation to offer investment advice or services in any state where to do so would be unlawful. Analysis and research are provided for informational purposes only, not for trading or investing purposes. All opinions expressed are as of the date of publication and subject to change. Astor and its affiliates are not liable for the accuracy, usefulness or availability of any such information or liable for any trading or investing based on such information.

309161-485