The case for a much lower CIT rate was that higher after-tax profits would boost business investment. But that has turned out to be a mirage.
Globe editors have posted this research report with permission of BlackRock Investment Institute. This should not be construed as an endorsement of the report's recommendations. For more on The Globe's disclaimers please read here. The following is excerpted from the report:
The US Federal Reserve is (reluctantly) ending a long period of abnormally low rates. The world's premier central bank and its peers have quashed volatility helped lift asset prices to great heights and had us obsess about monetary policy.
As we near a US exit from zero interest rates, traditional drivers of portfolio returns such as productivity and earnings growth are set to reassert themselves. We started debating this in a series of global videoconferences and webcasts in mid-June, and updated our 2015 outlook Dealing With Divergence.
Our main conclusions were:
*Our base case – global divergence in monetary policy and asset prices – looks to be playing out. We see the Fed leading the tighteners' camp by raising short-term rates in the autumn on an expected US economic acceleration and rising wages. We expect the Bank of England (BoE) to follow in November or February.
* On the other end of the spectrum, we see the European Central Bank (ECB) keeping up asset purchases until September 2016. The Bank of Japan (BoJ) looks to press on with quantitative easing (QE), and we expect more domestic stimulus from the People's Bank of China (PBoC). It is therefore premature to call an end to global QE – but worth thinking about because markets tend to front-run events.
* As we shift our focus to fundamentals, we see some key indicators flashing red. Productivity growth appears to be flagging. This affects growth rates, monetary policy and, ultimately, corporate margins. We are split on the reasons, but note the possibility of a cyclical rebound in productivity. This would enable central banks to raise rates at a slow pace but end at a higher-than-expected destination.
* Most assets are priced for a prolonged period of low growth, rates and volatility. The pullback of the appreciating US dollar (temporary, we think) and juggernaut rise in German yields from ultra-low levels (stickier, in our view) illustrate how this paradigm is changing. Things only have to go a little awry to become dodgy.
* Heady valuations in many markets, uncertainty over the pace of Fed tightening and intermittent fears of a Greek eurozone exit argue for caution – and selectivity in countries, sectors and securities. We balance this with the knowledge that bull markets often last much longer than expected – and the risk of missing out on gains. We favour lower-risk portfolios with upside hedges in the form of call options.
* Fixed income is looking less expensive after recent yield rises. Yet we brace for volatility. The US term premium – or compensation for interest rate risk – is well below its long-term average. We expect the US yield curve to eventually flatten as the Fed normalises rates. Short-maturity bonds look vulnerable, whereas long-term bonds are supported by a global craving for yield.
* We favour US credit over government debt. In the eurozone, we like QE-supported subordinated bank debt and selected long-maturity peripheral bonds. We see the higher yields of emerging market (EM) hard-currency bonds cushioning price falls caused by Fed rate rises.
* US stocks look pricey and corporate margins high. We prefer cyclical sectors such as consumer discretionary, tech and financials over bond proxies (utilities and consumer staples). We like equities in Europe (banks) and Japan (financials and exporters) on weak currencies and monetary stimulus. We favour EM equities in countries with reform momentum or monetary easing.
Read the full report here.