David Lafferty

David Lafferty, Chief Market Strategist at Natixis Investment Managers, shares his thoughts on the potential outcome of the October FOMC meeting: 

90% chance the Fed will cut

“Based on futures pricing, there is a 90% chance the Fed will cut at this week’s FOMC meeting. With a probability that high, the Fed is unlikely to disappoint the market and investors by merely holding still. To be sure, there is more debate internally than the market is pricing. The problem is that the market is too far out in front of the Fed, and that effectively forces Jay Powell’s hand.

“With unemployment at a 50 year low and few cracks in the consumption component of GDP, Rosengren and George have an argument to hold the line, but the market surprise would probably create too much pain for the FOMC.”

December outlook

“Focus will quickly turn to the outlook for the December meeting which is far more in doubt. Currently, markets are pricing less than a 25% chance of a cut in December. In essence, the market is now forecasting the very “mid-cycle correction” – 3 cuts and a pause – that created so much angst this summer.

The Fed remains in a near impossible situation. Do nothing and look unresponsive to softening global growth, undertake a few insurance cuts as a mid-cycle course correction and underwhelm equity bulls, or aggressively cut thereby justifying a more bearish market narrative. They are damned if they don’t, damned if they do, and damned if they do too much.

“ Our view since the September FOMC had been that the Fed would cut once more in 2019, but that it would be more likely in December, not October.  However, continued weakness in global manufacturing, capex, and trade since September meeting has changed our view. The Fed can move this week and still retain some optionality for the December meeting.”

APEC summit

“The December meeting may turn on the possibility of a trade deal at November’s APEC summit. A phase 1 deal could certainly bolster the argument for a pause. However, if the deal fall through, expect more calls for another cut in December. This may not win over all the critics as monetary policy is a poor tool for dealing with the trade slowdown.

“In the near term, there is an easy win here and Trump and Xi will probably take it. We think there is a 65% chance of an agreement at the APEC summit, but it is a band-aid covering up the larger, more intractable issues. We remain highly skeptical of a phase 2 grand bargain in 2020.

Most of the action will come in Powell’s press conference

“Powell will certainly be asked about the repo crunch. He will likely remind investors for the umpteenth time that the new T-bill purchases to add liquidity are “not QE.” For now, the Fed doesn’t want to entertain the notion of an open-ended standing repo facility. However, the T-bill purchases in conjunction with the overnight and term repos offered aren’t completely closing the funding gap. Expect more asset purchases that are ‘not QE’.  Powell will have to address it, but he may be hesitant to break any new ground on the repo/funding issue because he wants it to be seen as separate from monetary policy.

“Having most likely gotten his two cuts – although not at once – Bullard will probably not dissent. More interestingly, we’ll see if global weakness during the inter-meeting period has put any fear into Rosengren & George or if they remain unconvinced with the US economy humming along at 3.5% unemployment.”

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David Lafferty

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David Lafferty

Trade and tariffs

Volatility has returned and the red hot stock market that began the year has now downshifted closer to neutral. While the macro data continues to be lackluster – consistent with our view that the global economy is decelerating towards potential – much of the recent malaise has been driven by the on-again, now off-again US/China trade negotiations. This month, we offer a wider, not necessarily deeper, review of the issue. While our thoughts have changed over time, our conclusions have not. Trade and tariffs lead the headlines, but the real issues are more complex and this will likely have negative implications for investors going forward.

Phase one: Underlying skepticism

While President Trump’s initial focus was on replacing NAFTA, there was never any doubt the $400 billion bilateral US trade deficit with China would eventually become a lightning rod for conflict. Through mid-2018, we remained skeptical that the US could pressure China into a significant trade deal. We never bought into the idea that because China exports more to the US than the other way around, China had “more to lose” if a trade war erupted.

Since day one, we have argued that behind the scenes, the US/China trade conflict is really about industrial policy. More specifically, the “Made in China 2025” program. The objective of MIC2025 is to make China a dominant global player in more than 30 leading industries and emerging technologies – everything from AI to robotics to green energy to semiconductors. President Xi views the program as an economic imperative with the goal of making China the economic superpower of tomorrow.

On top of this brazen threat to America’s economic might, China has played fast and loose with the rules to notch significant economic gains. These include well-documented intellectual property theft, forced technology transfer, barring foreign competition and/or mandating joint ventures, providing government subsidies to protected industries, and erecting other non-tariff barriers. It’s easy to see why US Trade Representative Lighthizer has been a long-term hawk on China. We often cite Vice President Mike Pence’s October speech to the Hudson Institute cataloging the litany of Chinese transgressions. The list was hardly limited to trade and economic offenses and noted that China was employing a “whole-of-government approach to advance its influence…” Pence noted that the US would respond in kind. Neither the New York Times nor the Wall Street Journal minced words in saying the speech effectively outlined a new “economic cold war” between the countries. We’ll unpack this in more detail later, but for now, let that sink in… an economic cold war.

As for the minor issue of the trade deficit, it is hardly any more negotiable than MIC2025 to the Chinese. The trade deficit is simply a mathematical identity: China produces more than it consumes and the US consumes more than it produces. Chinese promises to buy more US goods will only affect this at the margin. Changing the consumption and spending habits of the two largest economies in the world is a more intractable problem. Thus, our original skepticism was rooted in the idea that there was little common ground for a grand trade deal – the classic paradox of an immovable object and an irresistible force.

Phase two: Cynical optimism

he fourth quarter of 2018 challenged our original narrative. Global growth appeared to be slowing significantly, and unlike previous bouts of economic weakness, it wasn’t focused on Europe. US GDP stumbled in Q4 and activity metrics were flagging. In China, both exports and industrial production were tanking. As if to underscore the weakness, US stocks almost fell into a bear market, with a 19.8% selloff in the S&P 500® while China’s Shenzhen CSI 300 Index lost nearly 14%. As the macro gods became angrier, Trump and Xi realized they would need to find areas of compromise. This sea change was further amplified by officials (including Trump) who insisted a deal was just around the corner. While the immovable object/irresistible force problem hadn’t been addressed, investors concluded that the parties would somehow work it out, because they had to.

In phase two, we half-heartedly joined in. The rationale that market pressures would compel a deal seemed plausible, even likely. During this period in late ’18 – early ’19, before the recent stall in talks, we put the odds of a US/China trade deal at around 70% – a guess to be sure, but one that indicated an agreement was likely, but far from certain. However, we maintained a rather cynical view: While the deal might get done, we didn’t think it would be worth much. Why? See phase one. Essentially, the US could always threaten more tariffs if China didn’t play by the rules, as defined by President Trump. Our suspicion was that China either wouldn’t or couldn’t comply with the requirements of a deal and the US would be forced to act again – sending us back to square one.

Phase three: Déjà vu all over again

It turns out the trip back to square one was faster than we expected. In the same way that low tide trapped Xi and Trump at the negotiating table, the rising tide of better economic data and a skyrocketing stock market in 2019 freed the leaders from making hard choices. We suspect the US ask for extensive enforcement and compliance mechanisms was simply too much for Chinese hardliners to accept. In this respect, our thinking on US/China trade tensions has come full circle. Unlike Mexico and the new USMCA, China doesn’t have to take a bad deal. Moreover, observers have long suspected that one of China’s key tactics would be to simply wait out Trump, whose attention span for a deal is far shorter than Xi’s.

With nothing officially scheduled in the interim, markets are awaiting the next meeting of Trump and Xi at the G20 Summit in late June. We have now downgraded our likelihood of a deal this year to 50/50 – at best. If that sounds like a copout, it is. Call it the immovable problem vs. the irresistible hope.

Collateral damage?

As we noted at the beginning, our views have evolved over time. Specifics aside, what hasn’t changed is our assessment that this standoff is about more than just trade, and investors aren’t seeing the full picture if they’re focused solely on tariffs or the trade deficit. Again, we return to that phrase… economic cold war.

So where might we see collateral damage? In our view, probably not openly in the capital or currency markets. A retaliatory devaluation of the renminbi – and the capital flight that might ensue – undermines China’s larger goal of being an economic superpower. Selling its $1 trillion+ stockpile of US Treasuries also seems unlikely, as it could trigger both markto-market losses and currency appreciation. We do not, however, rule out a stealthier, longer-term plan. This strategy might include a gradual and managed depreciation of the currency or passively rolling foreign currency reserves out of US Treasuries and into other assets.

Other areas of concern between the countries? Commercial or regulatory gamesmanship, including product bans and boycotts, price wars, supply chain disruption, detained employees, and corporate espionage – think ZTE and Huawei. State- or non-state-sponsored cyberattacks? Military confrontation in the South China Sea? Coercive action toward Taiwan?

Then you have the more passive, longer-term implications: An inability to counteract North Korea’s aggression without China’s help? China doubling down on MIC2025 to offset the loss of export power? Expanded Belt & Road initiative and/or ramped-up foreign direct investment to spread China’s economic influence?

Finally, we cannot forget the potential for self-inflicted injuries. Paramount in this area would be any inflationary pressures created by the tariffs or supply chain disruption. If these pressures were to build, it could effectively end the halcyon days of the “Powell Put” at the US Fed.

We don’t claim to understand all the potential economic and geopolitical implications of the US/China standoff. The issues are complex, interconnected, and perpetual. But we do believe the following:

1. US/China tensions run far deeper than just trade. Tariffs could be just the tip of the iceberg.
2. The US has enjoyed a long reign as the world’s only economic superpower while China is fighting to gain that same status. With or without a trade deal, there is limited common ground for compromise, so the two most powerful countries aren’t going to see eye to eye for a while.
3. While not any of these consequences are assured, they would all lead to greater market volatility and none would be good for global equity values.

By David F. Lafferty, CFA® Senior Vice President – Chief Market Strategist

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David Lafferty

This month, instead of a market rehash, we’ll turn to the ever-popular active vs. passive debate. Our objective is not to argue that one is better than the other – they both have merit within a diversified portfolio of strategies.

Instead, we’ll explore how the growth in indexing is (paradoxically) forcing active managers to up their game – a positive development for investors of all stripes.

While active managers have always competed against each other, they have never had to confront a threat of this magnitude. But in a strange irony, the pressures emanating from cheap passive strategies may ultimately save the active management industry.

As Darwin demonstrated, the most adaptable species are the ones that ultimately survive.

In this case, passive investing is forcing changes to active management that are long overdue. We see five trends that should bode well for active managers who are best able to adapt in the coming years.

#1: Lower Fees, Better Performance

First, and most obvious, indexing is forcing active managers to reassess the competitiveness of their fees. Going forward, active managers will have to better align their fees with their ability to generate excess return. These downward adjustments will, by definition, improve net performance (ceteris paribus). Regulatory changes also play a role. Directives like RDR in the UK and proposed fiduciary rules in the US are forcing fund buyers to purchase lower-cost share classes with many of the extraneous expenses eliminated.

#2: Lean and Mean

On top of improved performance, a closer eye on costs could bring additional benefits. We believe lower fee revenue will result in an era of increased discipline and efficiency for active managers. Over the years, high profit margins across the industry have allowed the focus of active managers to wander. Many overinvested in areas of the business unrelated to generating alpha, but as margins shrink, the days of industry giveaways and boondoggles are likely numbered.

#3: Death of the Closet Indexers

A greater focus on generating excess return will naturally drive managers to create more differentiated portfolios. As early as the 1980s, institutions began to recognize that portfolios could be made more efficient by separating cheap beta from expensive alpha. Today, even retail investors understand the perils of benchmark hugging and overpaying for beta, and are gradually forcing the closet indexers out of business.

#4: Is Anyone Paying Attention to Fundamentals?

A fourth consequence of the growth in passive investing is an increasing misallocation of capital. Counterintuitively, indexing may be creating greater opportunities for active managers as more capital is put on autopilot without regard to asset quality. Today, the majority of indexed assets are simply allocated based on market capitalization (for stocks) or issuance size (for bonds). No distinction is made regarding companies’ fundamentals, valuation, risk, or governance practices. While investors can expect markets to remain reasonably efficient,
the surge in indexed assets can create larger pockets of mispriced securities.

#5: The Perils of Autopilot

Finally, some active strategies stand to gain from one of indexing’s inherent weaknesses: the inability to manage risk. The major market-cap and issuance weighted indexes are fully invested at all times and provide pure beta, delivering all of what the market provides, good and bad. Since 2009 this has been a boon for passive strategies, as global stocks have risen while declining interest rates bolstered bonds.

Wake-Up Call

None of these factors, individually or in aggregate, insures that the average active manager will beat the index or outperform net of fees. However, the pressures exerted by passive indexing are forcing active managers to tackle longstanding sources of inefficiency and underperformance. By setting more appropriate fees and weeding out closet indexers, active strategies should rise in the competitive rankings. Moreover, the wake-up call of the next bear market will force investors to be more discerning about the quality of the assets they own, pushing many of them towards strategies that can better manage risk. Instead of complaining, active managers should embrace the changes occurring in the asset management industry. In the long run, the competitive pressures of passive indexing may save active management.

By David Lafferty, Chief Market Strategist

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David Lafferty

Since the election of President Trump in November last year, markets have had an on-again off-again love affair with the prospects for comprehensive tax reform.

With both houses of Congress and the executive branch in Republican hands, the stock market, US interest rates, and the US dollar rose dramatically from election day through February. However, as dysfunction emerged within the GOP on everything from healthcare to immigration policy, interest rates fell back and the US dollar weakened.

Through it all, global equity markets have managed to grind higher on stronger economic data. Then, in late September, Republicans released their much-awaited “framework” for tax reform, collapsing individual tax brackets and dramatically reducing corporate rates – much of it paid for by reducing or eliminating specific tax deductions. This gave markets yet another shot in the arm, reminiscent of those first post-election days in November.

$1 trillion deficit hurdle

We believe markets are somewhat naive about what can be accomplished on the tax front. Global investors have largely misunderstood the “Republican Sweep” in Washington to mean that legislative gridlock has been vanquished.

Deep divisions within the GOP call into question what can be accomplished as multiple factions within the party squabble over the details. While core Republicans within the leadership push for lower tax rates, they will be met with intense opposition from a growing caucus of fiscal hawks who are unlikely to sign off on the resulting larger deficits – currently forecast at an additional $1 trillion over 10 years. Even this math is optimistic, given it assumes another trillion in revenue from eliminating the “SALT” deduction for state and local taxes paid.

This is likely to be a non-starter for the 20+ Republican legislators from high-tax states like CA, NY, and NJ. With only a slim margin in the Senate – and zero help from Democrats – any meaningful tax reform must have almost unanimous appeal across these GOP factions.

The current framework, while just a starting point for negotiations, hardly meets this standard. For now, the tax math is devoid of political reality: You cannot simultaneously lower rates, hold the line on deficits, and preserve cherished tax breaks.

Three scenarios for tax reform

At this point, we handicap three possible scenarios: One, a complete breakdown of tax reform resulting in no meaningful change in legislation – à la “repeal & replace” (45%). Two, minimal tax reform in 2018 with only modest reductions in rates (both individual and corporate) and few revenue offsets (45%). And three, a damn-the-torpedoes deficit-swelling tax cut where fiscal hawks acquiesce for fear of being seen as obstructionist going into the mid-term elections (10%).

Given my estimate on the likelihood of these scenarios, equity investors would be wise to base their optimism on the slowly strengthening global economy, rather than the hope of meaningful Keynesian tax stimulus.

By David Lafferty, CFA, Chief Market Strategist, Natixis Global Asset Management

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David Lafferty

“The most likely scenario for U.S./North Korea relations remains an uneasy status quo. First, outright military conflict seems unlikely. North Korea will continue to irritate the US and Asian allies with missile tests, but Pyongyang surely recognizes that any strike would bring an overwhelming response.

“Likewise, the US has few good options for effectively reining in Kim. Military action risks putting Seoul and Tokyo in Pyongyang’s sights – along with forcing China’s hand – a price too high to pay. Second, diplomacy and further sanctions can only be effective if China exerts more influence. This too however would yield only marginal results as China remains reluctant to fully embrace sanctions against its neighbor and because Kim is unlikely to fully comply with Beijing’s demands. President Trump’s recent threats to withdraw from the nuclear deal with Iran will only boost Pyongyang’s resolve to maintain and grow their nuclear capabilities.

“Caught between the mutual downside of war and the limited effectiveness of sanctions, North Korea will continue to play out in the background of markets. While August’s tensions created a mini-spike in VIX to 16 – still a fairly low reading of fear – more recent launches in September have seen no significant flight-to-quality reaction. Markets appear to be developing Kim fatigue.

“Moreover, Trump’s recent deal with democrats to delay the debt-ceiling deadline and the revival of his tax reform plans have bolstered stocks and put North Korea on the back-burner.   As long as markets continue to believe that armed conflict is unlikely, North Korean news will continue to little impact on markets.”

By David Lafferty, Senior Vice President and Chief Market Strategist

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Clinton v Trump: what’s the likely impact on markets?

When we speak to investors both in and outside of the U.S., the presidential election is almost always the number one question on their minds.

Our first caveat is to remind investors that proposal differences pre-election are always bigger than implementation differences post-election; divided government ensures that presidents get only a small portion of what they want. In general, this means that investors tend to put too much weight on election outcomes vis-à-vis portfolio expectations. Guessing whether Mrs. Clinton will be bad for healthcare stocks or Mr. Trump will be good for defense/military stocks is a poor way to build a durable portfolio.

Second, there is still a lot of time left. Due to the Electoral College math and superior fundraising and organization, Mrs. Clinton seems the odds-on favorite to win. But we still have a few weeks left. We’ve got one more debate to go, and with these two candidates, the final weeks offer a higher-than-usual chance for more bombshells (perhaps something in Donald’s tax returns or Hillary’s missing e-mails?).

For sport, we’ll continue to handicap the outcome like everyone else, but if Brexit has taught us one thing, it’s that betting on the conventional wisdom can be dangerous. With too many variables still unknown, including the election winner, the make-up of Congress, or how proposals will morph into policy, long-term market implications are uncertain. To be sure, neither candidate has presented a convincing pro-growth policy that would boost economic activity or the equity markets.

Regardless of the winner, Washington gridlock won’t likely produce major policy changes, although some modest corporate tax reform is possible. While long-run return implications are uncertain, we still believe that Mr. Trump’s newcomer status and lack of policy history would make him the source of more short-term volatility.

David Goodsell Executive Director, Durable Portfolio Research Center Natixis Global Asset Management

In our latest 2016 Global Financial Advisor Survey[1] which was released the last week of September, we asked a series of questions related to the projected impact of the U.S. presidential election on key market issues. Our results show clear trends among those who manage client money and distinct difference of opinions between those in the U.S. and those outside the country.

Here are some of our top findings:

U.S. advisors say neither candidate will be better

U.S. advisors appear to be ambivalent or unconvinced when it comes to who they think could have the most positive impact on five key factors: the stock market, bond market, global economy, global trade, and geopolitical risk.

Democratic presidential candidate Hillary Clinton is leading Republican Donald Trump in opinion polls, though her edge over the billionaire has narrowed. What might the outcome, as well as all of the heated political rhetoric, mean for the global economy and financial markets? Are concerns mounting among investors? Is it time for investors to re-adjust portfolio allocations?

An Equity Manager, Chief Market Strategist, and the Director of the Durable Portfolio Construction Research Center share their insights. Given the choice between Clinton, Trump, either, or neither, 40% of respondents in the U.S. chose “neither” for all factors with the exception of global trade, where 32% believe Clinton will fare better, and geopolitical risk where Clinton received the highest number of responses at 35%.

Globally, advisors say Clinton will be better

Outside the U.S., it appears that financial professionals believe Hillary Clinton would have a more positive impact on all five factors. Clinton’s numbers in each run in the mid-40s and mid-50s, while those believing Trump would result in better outcomes numbered in the mid-teens. Country to country there are some variances in responses. But overall, advisor sentiment was relatively consistent from country to country.

What advisors think about next U.S. President

Stock markets

• U.S. respondents over the age of 47 believe Trump will be better for the market (34%) compared to Clinton (21%) while 37% answered neither.
• 57% of women advisors globally believe Clinton will be better for the stock market.

Bond markets

• 47% of advisors globally give Clinton the edge for bonds compared to 14% who believe Trump will be best. Colombia (65%), Chile (61%), Spain (57%), Italy (55%) and Panama (55%) report the strongest inclination that Clinton will be best for bonds. France is a significant outlier from this trend with 47% of advisors choosing “neither.”

Global economy 


• 43% of U.S. women advisors believe Clinton will be better for the global economy compared to 19% who believe Trump will be better.
• Globally, 44% of advisors favor Clinton on the global economy, 27% say neither, 16% favor Trump and 13% call it a toss-up.

Geopolitical risk

• 2% of U.S. Independent Advisors and 45% of U.S. women advisors believe Clinton will be better on geopolitical risk. For women globally, the number reached 62%.
• 41% of advisors with books of business above average ($29.5 million is sampling’s average size) favor Clinton on geopolitical risk, 29% say neither and 23% say Trump. Those with books below average are more likely to say neither (39%).

Chris Wallis, CFA®
CEO, Portfolio Manager
Vaughan Nelson Investment Management

There is no doubt about it – the U.S. has an interesting pair of presidential candidates this election season. They are offering very different policy choices across the board – from foreign, trade, tax, economic, healthcare to immigration policy. But that being said, I really don’t believe it makes any difference to the markets and long-term investors’ portfolios whether Hillary Clinton or Donald Trump wins on November 8.

180-plus years of irrelevancy

If you look back at U.S. presidential history for over 180 years, you will see that the elected president has never really had a big impact on the financial markets. In the longer run – past the short-term market blip that can occur with an election surprise – the president’s policy choices have been pretty irrelevant to financial market performance. History also shows that the average volatility in the market today is about the same as it was in the early 1800s, the mid-1800s, the late 1800s, the early 1900s, the mid-1900s, the postwar period…and so on. Again, U.S. presidents don’t typically drive financial markets. This is really hard for people to grasp, because they believe these elections every four years are extremely important and have dramatic impact on all aspects of their lives. But, again, when it comes to the markets, history proves otherwise.
Whether it’s Clinton or Trump, I’m reasonably bullish we’re going to get some productive fiscal policy that will stimulate economic growth in the U.S. It doesn’t take much to be productive – you can cut a corporate tax rate, add a little bit of infrastructure spending. At the end of the day, no politician gets reelected unless the economy is growing. Therefore, I believe we’re going to grow the economy.
This election year continues to be quite entertaining and great for the networks and media. We should all record Saturday Night Live between now and November. It’s going to probably be the best shows of all times. But for the markets, I just don’t think it matters. I tell people to ignore it, but it’s going to be really tough to ignore.

By David Lafferty, CFA®
Chief Market Strategist

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[1] Natixis Global Asset Management, Global Survey of Financial Advisors conducted by CoreData Research, July 2016. Survey included 2,550 financial advisors in 15 countries

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