Jeffrey Kleintop of Schwab surveys economic and market trends across the world, and in an interview on Tuesday, he covered the globe. Among the thoughts of Schwab’s chief global investment strategist that he shared are:
- The Fed will “probably” raise rates in September, though it may not happen until the December Federal Open Market Committee meeting or even early next year (a contention that the FOMC’s newly released minutes support).
- Like the Swiss central bank devaluing the franc earlier this year—“which everyone has forgotten”—“six months from now we’ll forget about” China’s currency devaluation last week.
- Climate change is still a relatively small issue for most investable companies now, but climate change regulation and legislation will produce investing winners and losers.
- While the U.S. presidential election next year is interesting, the election he’ll be watching in 2016 is December’s Spanish national election.
- The “key theme next year will be central bank divergence”
- The recent money flows made by investors from U.S. equities to international funds “tactically makes sense” but also he hopes it’s a longer-term trend.
- There’s “far too much concern about Greece,” and the European Community is in better shape than many observers think.
Here, in more detail, is what Kleintop sees ahead.
1. The Fed
Speaking the day before the Federal Reserve released the minutes of its July FOMC meeting, Kleintop said he thought the Fed would raise the federal funds rate by 25 basis points, “probably” in September, though possibly in December or early in 2016. However, he said “it’s not how often but when” the Fed raises that will be important to the markets.
Responding to a charge raised in The Wall Street Journal on Monday (and by many others previously), he denied that the Fed may wait to raise rates because it fears losing “ammunition” to fight the next economic downturn. “We talked to three Fed governors who said” such a notion “was the most ridiculous” thing they’d heard. That’s because, Kleintop says, “the longer you wait” to raise rates, “the worse it is.”
In the minutes of the July 28-29 meeting released Wednesday, the FOMC “concluded that, although it had seen further progress, the economic conditions warranting an increase in the target range for the federal funds rate had not yet been met. Members generally agreed that additional information on the outlook would be necessary before deciding to implement an increase in the target range.”
The minutes also show that while inflation had yet to reach the Fed’s targeted 2% rate, FOMC members expressed general satisfaction that its other datapoints necessary for raising rates — a growing economy and an improving labor market — appear to be moving in the right direction.
While many market observers see the Chinese sky falling, Kleintop believes that China’s currency devaluation is simply “policy fine tuning” by the government, and an acknowledgement that China is moving from a manufacturing and exporting-focused economy to a more domestic-consumer-focused economy. The devaluation came because Chinese leaders saw that “consumers were benefiting, maybe too much” from the big rise in the value of the yuan, which makes imports cheaper, using as an example the big rise in sales of Mercedes-Benz cars in China.
He says that most China watchers “haven’t paid enough attention” to data like non-manufacturing PMI in China, which he trusts more than some other Chinese government economic data — “there’s no doubt they’re lying to us” about some other data — because it comes from a survey of private companies. He says we “have to change what statistics we look at,” citing as an example electricity use in China which, while it increased only 1% over all, has risen by 8% in the service sector and 5% to 6% in the residential sector.
“If consumer spending falls” in China, then Kleintop would be worried, but he sees no evidence of that happening. “Six months from now we’ll forget about” the currency move, he predicted, just as the market has done with the Swiss central bank unpegged the franc from the euro in January.
3. Climate Change
Which companies will benefit and which will lose as climate change affects business and the economy?
Kleintop said that larger-cap companies rather than small caps would benefit in the reaction to climate change legislation and regulation, such as the methane limits announced by the Environmental Protection Agency on Tuesday, President Barack Obama’s environmental initiatives and the U.N. climate change meeting this fall in Paris.
In addition, technology companies that “build solutions” for climate change are likely to do well, as will battery makers, he said in the interview. Legislation and regulation may well result in “higher prices for inputs” into many industries, with the effects felt in the consumer staples industry, Kleintop said.
So far, however, businesses’ climate change actions constitute “very small parts of big companies,” he said and noted that while surveys have indicated that millennials are more interested in combating climate change with their investing money, “we haven’t seen that actually” reflected in investing flows.
4. Election Watch
When asked how the markets and economy might react to the 2016 U.S. presidential elections, Kleintop mentioned it’s very early in the process to make any predictions. However, he noted that past presidential elections showed that a good percentage of the electorate make up their mind quite late in the process, in the prior month and even weeks before Election Day.
Rather than the U.S. elections, Kleintop said he would be closely watching the general elections that likely will be called in December by Spanish Prime Minister Mariano Rajoy: “No election could have a bigger impact.” That’s because it appears that in Europe at least, the more conservative parties seem to be in the ascendancy, and while Rajoy’s party is conservative, Spain remains mired in an economic trough, marked by stubbornly high unemployment, while Spanish splinter parties gained ground in May elections.
For investors, the concern has to do with Spanish debt. Greece’s debt “has been ring-fenced” since 2011, with most holders being institutions like the International Monetary Fund, but “that’s not true in Spain.”
5. Central Bank Divergence
Looking ahead, Kleintop said “the key theme next year will be central bank divergence.” While the governors of the Bank of England just decided not to raise the U.K.’s interest rates, he expects the BofE will do so after the U.S. Fed raises rates. In fact, the British economy is doing quite well, with unemployment below 5% and wages increasing.
Many investors have been “following QE” across the globe—investing in nations where the central banks are buying securities—and have moved some funds from the U.S. to nations with looser monetary policy, such as the European Central Bank and Japan. That trend may strengthen as the Fed raises rates.
6. Where the Money Is Going
When asked to comment on Morningstar’s recent report on money flowing from U.S. equity funds to international funds, Kleintop said that movement “tactically makes sense,” though lamenting the U.S. (and worldwide) investors’ tendency toward home market bias, “I hope it’s a longer term trend,” he said. “Most U.S. investors are not exposed” to international investing “as they should,” noting that when it comes to recent corporate earnings, both Japanese and European companies are far outstripping American firm’s earnings growth. “We have models recommending 35% to 50% exposure” to international, he said, though he admitted hardly anyone is that diversified globally.
7. Greece and the EU
Kleintop argues that there’s “far too much concern about Greece,” and that the European Union is in far better shape than many observers think, noting that there are “countries waiting to get in.” In addition to the strong corporate earnings mentioned above, “lending growth is picking up” in Europe and the ECB’s version of quantitative easing provides a “cushion under stock prices.”
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