September 2, 2015
Scott L. Wren, Senior Global Equity Strategist
Weekly update on current stock market action
- Volatile markets are responding to uncertainties surrounding global growth and the timing of a potential Federal Reserve (Fed) rate hike this year.
What it may mean for investors
- We expect the stock market to remain volatile in the nearer term. Our outlook for modest economic growth with only modest inflation is intact. In our opinion, investors should be looking for opportunities to put sidelined funds to work in equities.
We Are Miles and Miles Away from the Fed’s Inflation Target
As the debate over when the Fed will raise interest rates rages on, little discussion, it seems, revolves around one of the major factors influencing this decision: the level of inflation. For years, Fed governors have been telling us they’re “reasonably confident that inflation will move back to its two percent objective over the medium term.” However, based on a large amount of recent economic data, that just hasn’t been the case. In fact, it would be reasonable to argue that the United States is experiencing a period of “disinflation”.
Many investors would beg to differ. This strategist has talked to literally dozens of clients over the last 18 months who believe the rate of inflation is moving higher, not lower. But the data does not support that opinion. Of course, we can argue all day about the way the government calculates inflation. Let’s just say that if you are putting kids through college or paying real estate taxes, you are likely not a believer in the disinflation viewpoint. Most of us are aware that the cost to attend college has been rising far faster than the general rate of inflation. And in terms of real estate taxes, in many parts of the country our clients are telling us their home values are well below the peaks seen in 2006, yet their taxes are higher than they’ve ever been.
But as Chairwoman Janet Yellen has told us many times, the Fed is looking at something called Personal Consumption Expenditures, or PCE, as its go-to inflation gauge. Remember, the Fed is targeting a “core” inflation rate of two percent. Core inflation excludes the effects of food and energy. The Fed looks at core inflation because commodity prices are volatile and often influenced by weather patterns and other seasonal factors, which make them less responsive to monetary policy initiatives. PCE is an inflation gauge targeted toward individuals and what they consume. PCE is mostly different from the Consumer Price Index (CPI) because of the way health care and housing costs are measured. The latest core PCE reading showed an increase of just 1.2 percent over the 12 months ending in July.
As discussed numerous times over the years in this publication, the Fed wants to see prices increase at a modest rate. While many consumers would welcome lower prices for purchased goods and services, they don’t want to see falling housing or stock prices. Generally falling prices, or outright deflation, also tends to lead to declining wages. This strategist would argue that the only thing central bankers fear more than high inflation is deflation. Our analysis suggests the U.S. will not slip into a deflationary period.
In a normal cycle, the economy and inflation respond to monetary policy. Interest rates are lowered, growth perks up, and rising inflation is soon to follow. But that did not happen in this cycle. In the wake of the bursting of a gigantic credit bubble, driven by housing, the economy has not been able to consistently grow at a pace in line with the historical trend. PCE moving up to two percent may not sound far away, but we are miles and miles from the Fed’s inflation target. This will influence the Fed’s upcoming monetary decisions.
Scott Wren is a senior global equity strategist for Wells Fargo Investment Institute (WFII), an organization that provides global manager research and investment strategy advice to Wells Fargo’s Wealth, Brokerage, and Retirement (WBR) division. WBR is comprised of Wells Fargo Private Bank, Wells Fargo Advisors, Wells Fargo Institutional Retirement, and Abbot Downing businesses, accounting for more than $1.6 trillion* in assets under administration.
Mr. Wren produces strategy and guidance recommendations for global equities. With his knowledge of the financial markets, he is often quoted in national media outlets including Reuters, The Chicago Tribune, The Los Angeles Times, The Washington Post, The Associated Press, and The Wall Street Journal. He has appeared in interviews on CNBC, Bloomberg TV, Fox Business News, and Nightly Business Report. Prior to joining Wells Fargo Advisors predecessor A.G. Edwards in 1998, Mr. Wren worked as a senior foreign exchange dealer for The Boatmen’s National Bank of St. Louis. He began his career on the trading floor of the Chicago Mercantile Exchange and has more than 25 years of experience in financial services.
He received a Bachelor of Science in Business Administration from the University of Kansas and a Master of Finance from Saint Louis University. He is located in St. Louis, Missouri.
*As of Sept. 30, 2014
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