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By Chuck Lieberman, Co-founder & CIO

The August employment report actually fit in quite well with investor expectations, even though job growth was well below the consensus. Hiring is being held back by the Delta variant and the unwillingness or inability or people to return to work, even as firms increase pay to attract or keep workers. Critically, wage inflation pressures are fully apparent. The latest data will not likely change many minds at the Fed, but tapering is surely coming.

The rise in average wage rates was larger than expected in August, which is the first month rapid job growth in the leisure and hospitality sector didn’t distort that measure to the downside. Leisure and hospitality workers are the lowest paid sector, so when many people are hired in these industries, the average wage rate across the economy is reduced. This August, hiring in these industries was zero. So, the 0.6% rise in wage rates across the economy represents a cleaner look at what’s happening to wage rates more broadly and they are rising fairly rapidly. This news fits quite well with all kinds of anecdotal reports, such as the latest announcement by Walmart that it is boosting wages (again). It is clear that firms are still trying to hire and offering to pay more, but workers are still reluctant to accept jobs for the assorted reasons we all recognize. That imbalance between supply and demand is lifting wage rates, as should be expected.

With somewhat less hiring, growth is likely to moderate in Q3 compared to Q2 and Street estimates have been coming down. Still, it would be highly inappropriate to think the economy will enter a period of stagflation. Growth remains quite strong and it may pick up after schools reopen, extra unemployment insurance benefits expire immediately after Labor Day, and (hopefully) Covid cases begin to moderate.

The Fed will remain highly divided. Some look back to the highs pre-pandemic and believe many people remain to be hired, so policy should remain accommodative for a longer period. Others will look at the decline in the unemployment rate and the rise in wage inflation, which suggests that the Fed’s highly expansionary policies are now inappropriate. It is our judgment that a tapering of the Fed’s bond buying program will be announced soon, although it isn’t clear if it will follow the September FOMC meeting.

The markets will not wait, however. Investors tend to look ahead. Tapering is coming and inflation may not prove as transitory as suggested by Chairman Powell. And interest rates are not high enough to compensate investors for these risks. Smartly, the bond market steepened after the jobs report, with longer term rates rising more than short rates.

The foregoing content reflects the opinions of Advisors Capital Management, LLC and is subject to change at any time without notice. Content provided herein is for informational purposes only and should not be used or construed as investment advice or a recommendation regarding the purchase or sale of any security. There is no guarantee that the statements, opinions or forecasts provided herein will prove to be correct. Past performance may not be indicative of future results. Indices are not available for direct investment. Any investor who attempts to mimic the performance of an index would incur fees and expenses which would reduce returns. Securities investing involves risk, including the potential for loss of principal. There is no assurance that any investment plan or strategy will be successful.

About the Author

Dr. Charles Lieberman

Dr. Charles Lieberman

Dr. Charles Lieberman is the Chief Investment Officer and co-founder of Advisors Capital Management, LLC. Dr. Lieberman began his professional career as an academic at the University of Maryland and Northwestern University. After five years in academia, he joined the…
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By Dr. Alan Greenspan, Senior Economic Advisor

Unprecedented amounts of fiscal and monetary stimulus have driven stock prices to all-time highs, now sitting near double the lows seen during the depths of the coronavirus-driven panic. However, with the debt ceiling holding back further borrowing by the U.S. Treasury, thousand-dollar stimulus checks and trillion-dollar stimulus packages look to be a thing of the past. Meanwhile, on the monetary policy front, Chairman Powell’s speech at the Jackson Hole symposium apparently affirmed that the Federal Reserve is preparing to begin tapering its bond purchases as early as the end of this year. Investors are now left to wonder what will drive asset prices in the vacuum left by the end of these enormous catalysts of market returns over the past year and a half. I believe a review of the animal spirits that drive individual investment decisions would be helpful at this time.Throughout my career, I always viewed animal spirits as the human propensities driven largely by random irrationalities not readily integrated into formal models of the way market economies function. The 2008 financial crisis was a watershed moment for forecasters, myself included. It forced us to find ways to incorporate into our macro models those animal spirits that dominate finance.

All such spirits are tempered by reason to a greater or lesser degree, and hence I more formally choose to describe such marketplace behavior as “propensities.” The technologies that have driven productivity since the Enlightenment were, at root, reasoned insights. Random irrationality produces nothing. If reason were not ultimately prevailing, we could not explain the dramatic improvements in standards of living that the world has achieved in the past two centuries.

These reason-tempered animal spirits significantly affect macroeconomic decision making and outcomes. Newly popular behavioral economics is forcing forecasters to evaluate economic data in the context of a more complex model than that to which most of us had become accustomed.

My ultimate purpose is defining a set of economic stabilities of human actions that are statistically measurable and hence capable of being modeled. I am fully aware that in the process I am delving into disciplines with which I have little experience, and have tried to temper my conclusions accordingly.

We all directly experience threats to our self and our values (fear) and the sense of well-being or elation (euphoria) triggered in the course of our pursuit of our economic interests. Fear, a major component of animal spirits, is a response to a threat to life, limb, and net worth. That emotion is decidedly inbred—no one is immune to it. But people respond to fear in different ways, and the differences are part of what defines the individuality of people. We are all alike fundamentally, but it is our individuality that makes for differences in values and our position in the hierarchy of society. Moreover, it is our individuality that creates markets, division of labor, and economic activity as we know it.

Risk aversion is a complex animal spirit crucial to forecasting. It reflects the ambivalent attitude people exhibit to the taking of risk. That we need to act to obtain food, shelter, and all the necessities of life is evident to all, as is the fact that we can’t necessarily know in advance how successful our actions will be. The process of choosing which risks to take and which to avoid determines the relative pricing structure of markets, which in turn guides the flow of savings into investment, the critical function of finance.

If risk taking is essential to living, is more risk taking better than less? If more risk were better than less risk, demand for lower quality bonds would exceed demand for riskless bonds, and high-quality bonds would yield more than low-quality bonds. They do not, from which we can infer the obvious: Risk taking is a necessary part of living, but it is not something the vast majority of us actively seek. Finding the proper balance of risks is critical to all of us in our day-to-day lives and perhaps manifests itself most obviously in finance in the management of portfolio risk.

The extremes of zero and full risk aversion (or its obverse, full and zero risk taking) are outside all human experience. Zero risk aversion—that is, the absence of any aversion to engaging in risky actions—implies that an individual does not care about, or cannot discriminate among, objective states of risk to life and limb. Such individuals cannot (or do not choose to) recognize life-threatening events. But to acquire the staples of life requires action, that is, the taking of risks, either by an individual or by others, such as parents taking risks on a child’s behalf.

We live our lives day by day well within these outer boundaries of risk aversion and risk taking, which can be measured approximately by financial market yield spreads with respect to both credit rating and maturity. Those boundaries are critical to forecasting. The turn in stock prices in early 2009 following the crash of 2008 was a sign of the level of human angst approaching its historical limit. The limits of angst are also evident in credit spreads, which exhibit few or no long-term historical trends. Prime railroad bonds of the immediate post‒Civil War years, for example, reflect spreads over U.S. Treasuries that are similar to our post‒World War II experience, suggesting long-term stability in the degree and spread of human risk aversion.

I calibrate how people respond to risk in nonfinancial markets, both rationally and emotionally, with a measure I have employed for years—the share of liquid cash flow that management chooses to commit to illiquid, especially long-term, capital investments. That share is a measure of corporate managers’ degree of uncertainty and hence their willingness to take risks. In 2009, it had fallen to its lowest peacetime level since 1938. The equivalent measure of risk aversion for households is the share of household cash flow invested in homes. This measure reached its lowest postwar level in 2010. That collapse in investment, especially in long-lived assets, explains most of the recent failure of the American economy to follow a path of recovery similar to the other ten post‒World War II recoveries.

Alan Greenspan served five terms as chairman of the Board of Governors of the Federal Reserve System from August 11, 1987, when he was first appointed by President Ronald Reagan. His last term ended on January 31, 2006. He was appointed chairman by four different presidents.

The foregoing content reflects the opinions of Advisors Capital Management, LLC and is subject to change at any time without notice. Content provided herein is for informational purposes only and should not be used or construed as investment advice or a recommendation regarding the purchase or sale of any security. There is no guarantee that the statements, opinions or forecasts provided herein will prove to be correct. Past performance may not be indicative of future results. Indices are not available for direct investment. Any investor who attempts to mimic the performance of an index would incur fees and expenses which would reduce returns. Securities investing involves risk, including the potential for loss of principal. There is no assurance that any investment plan or strategy will be successful.

About the Author

Dr. Alan Greenspan

Dr. Alan Greenspan

Alan Greenspan served five terms as chairman of the Board of Governors of the Federal Reserve System from August 11, 1987, when he was first appointed by President Ronald Reagan. His last term ended on January 31, 2006. He was…
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By Paul Brighton, Portfolio Manager

Summer is winding down as we get close to the Labor Day weekend. Schools are reopening and fall football and the month of September are right around the corner. By happenstance, September can be a difficult month for equity markets. This brief commentary will be a gentle reminder of the possible choppiness and why it’s important to look past the volatility and the ever-present negative news-cycle headlines. It is far better to stay focused on the strong fundamentals that are still in place.The S&P 500 is up a very strong 19.4% year-to-date and an even stronger 103% since the March 23, 2020 low at the depth of the pandemic-engendered selloff last year. That being said, we haven’t had a drawdown in the market of 5% or more since October of last year (from Oct 12th through Oct 30th the S&P 500 declined by -7.43%). Early Fall has been a seasonally challenging time of the year for the market. Over the past 92 years – going back to 1928 – September has been the weakest month of the year averaging a return of -1.0% with 50 out of the 92 months being negative. (Of course, since there are only twelve months in the year and they are highly unlikely to be equally good or bad, one must stand out as the worst, but that’s a worthless forecasting tool.) Statistically, a pullback of something more than 5% would not be unusual; such declines are common. If it happens, it could be viewed as somewhat healthy in that it can reset expectations and valuations which in turn can allow the market to resume its path higher as it discounts future earnings growth of about 9.2% for 2022. The market has averaged about 7.9% annual earnings growth over the last 10 years.

Market headlines and concerns that may be affecting investor sentiment include higher tax rates (corporate and capital gains in particular), higher inflation (the bond market seems to be indicating that it may be mostly transitory), the supply chain issues which continue to be affecting many parts of the economy, and an upturn in Covid cases. These four issues are widely known and you could argue they’re already being discounted by the market. The delta variant is obviously a concern, but new cases in the U.S. are expected to peak in coming weeks. This doesn’t mean that it’s gone or going away completely, but again the market is aware of this and it appears already to be factored into stock prices. We may also need to deal with any new variants on a go-forward basis.

The current S&P 500 valuation of 20 times forward earnings looks high relative to the average over the last five years of 17x, but not when adjusted for prevailing interest rates. The 10-year Treasury rate of 1.26% is much lower than the average of 1.97% for the past five years. Note, however, that the current earnings yield on the S&P 500 of 4.93% looks very attractive compared to that 10-year yield. And Bloomberg’s full year 2021 GDP is forecast to be well above long-term trends at 6.2% and to remain above trend at 4.3% in 2022. These are really strong GDP numbers that will support continued solid growth in corporate earnings. Also, it’s worth noting that we still have extraordinarily supportive monetary measures in the system and a bipartisan infrastructure bill may be passed in the coming months. As noted above, September can be a volatile month for the market, but the economy is strong and the outlook over the next few quarters is as well.

The foregoing content reflects the opinions of Advisors Capital Management, LLC and is subject to change at any time without notice. Content provided herein is for informational purposes only and should not be used or construed as investment advice or a recommendation regarding the purchase or sale of any security. There is no guarantee that the statements, opinions or forecasts provided herein will prove to be correct. Past performance may not be indicative of future results. Indices are not available for direct investment. Any investor who attempts to mimic the performance of an index would incur fees and expenses which would reduce returns. Securities investing involves risk, including the potential for loss of principal. There is no assurance that any investment plan or strategy will be successful.

About the Author

Paul Broughton

Paul Broughton

Paul Broughton is an equity portfolio manager with ACM. Prior to joining the firm, he was a co-manager of the Salient Dividend Signal Strategy® portfolios. Prior to joining Salient in 2010, Paul held various roles in fixed income portfolio management…
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By Kevin Kelly, Portfolio Manager

If analyzed carefully, I believe most fixed investors would not be happy with the current risk versus reward trade-offs they are consciously or unconsciously accepting. Many investors have resorted to one of the following three options in this low yield environment: 1) to essentially avoid interest rate and credit spread (risk premium) risk and dramatically sacrifice yield; 2) to increase yield by owning high quality longer-dated bonds with substantial rate risk; or 3) to increase yield by dramatically raising the risk profile using high yield and/or preferreds with both major interest rate and credit spread risk. Alternatively, there is a sweet spot in fixed income that generates double or triple the first extremely conservative strategy, while also avoiding an unreasonable amount of both interest rate and credit spread risk. The key is security selection, which is critical in the current low yielding fixed income market.Some investors want fixed income portfolio holdings to contain as little credit risk as possible and/or they are afraid of interest rates rising, so they have chosen to own short-dated or floating coupon investment grade securities. While these options are safe, because they are so safe, you are not paid much to own them. The average floating investment grade bond only yields around 0.4% (before any ETF expenses or management fees). Short-dated fixed coupon investment grade bonds do not offer much more yield. The average 1-year investment grade bond yields less than 0.4%, and 3-year investment grade bonds only yield approximately 0.8% (before any fees). These securities are too conservative for investors looking to preserve value over time, once we take inflation and taxes into account.

Other investors opt to own very long-dated investment grade bonds, because they are chasing yield, but they are taking considerable interest rate and credit spread risk. What is worse is sometimes investors forget that a higher price dictates a lower yield. Investors should be careful not to adopt a ‘stock mentality’ that bond investments that have already worked can keep working. Unfortunately, a higher bond price means less future return (fixed income security prices cannot rise indefinitely because all yields would then eventually go negative). On the other hand, a stock can rise 10%+ a year forever if the company keeps growing. Additionally, owning longer-dated securities can be very stressful when interest rates start rising as happened early in 2021 and again recently, driven by relatively high inflation data and strong economic growth. As a reminder, the average investment grade bond has substantial interest rate risk and still only yields just over 2% currently. This very high interest rate sensitivity explains why, despite earning interest for seven and a half months in 2021, the return on the average investment grade bond is still negative in 2021.

Aggressive fixed investors in their search for yield have increased their risk exposure and now own primarily high yield and/or preferreds. However, if high yield and preferred securities are not chosen extremely carefully, the chance of losses increases considerably. The expected yield on high yield bonds is now near all-time lows (see the graph below), so there is considerable risk in such positions. While the economy is continuing to recover from the Covid-induced recession, investors are simply not getting compensated very much to take on incremental risk. The thirst for yield appears to have overpowered the discipline among many fixed-income investors. Any potential market sell-off or economic hiccup could be quite painful given the minimal margin of error of owning high yield bonds. Are there still interesting high yield bond opportunities? Absolutely. Investors, however, must be very selective. We generally prefer to stick with relatively good quality names that mature in the relatively near future.

Regarding preferreds, the market’s appetite appears insatiable. We are seeing several I.G. rated preferreds issued in the low 4% coupon range. The enormous risk of owning low, fixed coupon preferreds is often underappreciated. If a company issues a 4% coupon preferred, and subsequently interest rates increase or credit spreads (risk premiums) revert to wider levels, an additional 1% in yield could depress the value of the preferred by 20%. It is doubtful that most investors who bought many of the new issues realize the risk they are taking. Therefore, while attempting to earn an extra 1% a year for 5 years, an investor risks losing 20% should interest rates or credit spreads rise by 1%. If you consider the recent pre-Covid environment, preferred yields rising by 1% is clearly feasible (due to interest rates and/or credit spreads.

The reality is that each fixed income security is quite unique given the significant differences in credit quality, coupon, maturity, trading price, and of course yield. Recognizing if a security is potentially compelling or troublesome requires individual security analysis. At ACM, we currently focus on offerings at the lower end of investment grade (BBB/BBB-), because these securities typically provide incremental yield for what we deem as marginally more risk. We can also choose investment grade options with less interest rate sensitivity. Among preferreds, we are choosing investment grade opportunities that provide attractive additional yield well in excess of most investment grade bond yields. We are exceedingly picky, which is essential, to safeguard against the sort of downside risks illustrated by the example previously discussed.

The foregoing content reflects the opinions of Advisors Capital Management, LLC and is subject to change at any time without notice. Content provided herein is for informational purposes only and should not be used or construed as investment advice or a recommendation regarding the purchase or sale of any security. There is no guarantee that the statements, opinions or forecasts provided herein will prove to be correct. Past performance may not be indicative of future results. Indices are not available for direct investment. Any investor who attempts to mimic the performance of an index would incur fees and expenses which would reduce returns. Securities investing involves risk, including the potential for loss of principal. There is no assurance that any investment plan or strategy will be successful.

About the Author

Kevin Kelly

Kevin Kelly

Mr. Kelly is the Portfolio Manager of Fixed Income and a member of the Investment Committee. Before joining ACM, Mr. Kelly was a portfolio manager at Verition Fund Management in New York, NY where his duties included managing a long/short…
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By Dr. Chuck Lieberman, Co-founder and CIO

Economic growth is very strong, profits significantly outperformed optimistic expectations and hiring is robust, even as bottlenecks and labor scarcity hamper the pace of recovery. The rally in the bond market turned on a dime. Most Fed officials still seem to prefer maintaining the current highly accommodative policy stance, but the data are making an eloquent case, at a minimum, that the Fed’s bond buying program should be brought to a swift end. These conditions keep us positively disposed towards stocks and highly cautious about prospects for the bond market.

Evidence for a robust recovery is everywhere and crystal clear in the labor market. With 935,000 new hires in July, an upward revision of 119,000 to prior months, and a 0.5% decline in the unemployment rate to 5.4%, the strong pace of growth is indisputable. The difficulties firms are encountering in hiring are spilling over into wage rates, which have risen 4.7% over the past year and 5.5% at an annual rate over the latest two months for nonsupervisory workers. These cost increases are unlikely to stop.

Delta variant cases raised concerns that growth might weaken and the bond market rallied sharply since mid-March. With the Fed buying Treasury debt as fast as Treasury was issuing new bonds, the enormous deficit was not dumping large new supplies of bonds into the market. Even so, with strong growth and rising labor costs, the Fed’s hopes that inflation pressures will prove to be entirely transitory look increasingly like wishful thinking, so the bond market fell very sharply for two days. Conversations on when the Fed should start to taper its bond buying programs have surely been underway for months, but disagreements are now being expressed in public. Some are suggesting that the bond buying program should be tapered this year instead of waiting until next year. It appears Fed Chair Powell and a number of others would prefer to keep rates low by continuing to add more liquidity, despite the strength of the housing and labor markets, but the strength of the economy and wage inflation make that view harder to sustain. Chair Powell will speak later this month at the Jackson Hole Conference, a venue that has previously been used to announce changes in policy. Even if they choose to defer that decision a bit longer, they are running out of runway. Tapering will begin by the beginning of next year, at the latest, and could start sooner, unless Delta becomes much more problematical. But we suspect the rise in Covid cases will reverse within a few weeks, following the tracks of the U.K. and India.

The implications for investors are really straightforward. The economy is roaring ahead and profit projections are being revised higher, so the stock market should continue its ascent. On the other hand, we have likely hit the low yields for the bond market for the year and rates could rise substantially in the coming months. So, we remain positioned for more economic reopening in stocks and remain fairly defensive in our bond exposure, a game plan that has worked well this year and that should continue to work for the near term.

The foregoing content reflects the opinions of Advisors Capital Management, LLC and is subject to change at any time without notice. Content provided herein is for informational purposes only and should not be used or construed as investment advice or a recommendation regarding the purchase or sale of any security. There is no guarantee that the statements, opinions or forecasts provided herein will prove to be correct. Past performance may not be indicative of future results. Indices are not available for direct investment. Any investor who attempts to mimic the performance of an index would incur fees and expenses which would reduce returns. Securities investing involves risk, including the potential for loss of principal. There is no assurance that any investment plan or strategy will be successful.
About the Author
Dr. Charles Lieberman
Dr. Charles Lieberman

Dr. Charles Lieberman is the Chief Investment Officer and co-founder of Advisors Capital Management, LLC. Dr. Lieberman began his professional career as an academic at the University of Maryland and Northwestern University. After five years in academia, he joined the…
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By Dr. Chuck Lieberman, Co-founder and CIO

This morning’s Q2 GDP came in at 6.5%, well below the 8% or higher that was expected. But digging into the details shows strong underlying demand and sets the stage for ongoing solid growth.

1. Consumption +11.8%. Services rose 12.0%, a sharp rise from Q1.

2. Nonresidential capital investment rose 8.0%. Structures actually declined at a 7.0% annual rate, while investment in equipment rose 13% and intellectual property grew 10.7%.

3. Residential investment actually declined 9.8% in Q2. Seemingly, labor scarcity is holding back construction activity and this should ease over time.

4. Government spending declined 1.5%, another drag on the economy that is unlikely to continue. (Federal spending declined, while state and local rose.)

5. Inventories were a major shocker. After declining by a sharp $74.4 billion in Q1, significantly slowing growth, inventories declined even more sharply in Q2, by $146.6 billion, accounting for around half of the “miss” in GDP relative to expectations. This is a greater decline than in Q2 2020 during the pandemic shutdown and it is simply unsustainable. The inevitable rebuilding of stocks ensure that growth will remain robust through the entire second half of the year and possibly even into the early parts of 2022.

6. Consumer inflation came in very hot at 6.4%. With bottlenecks holding back growth in Q2 (and possible also a factor in Q1), inflation pressures are likely to remain pretty firm for a number of quarters, which raises questions whether all of the surge can be considered transitory.

7. Final demand was very strong, but production couldn’t keep up, so a sizable portion of the difference was satisfied by depleting inventories. This is unambiguously unsustainable, but it also stretches out the period of above normal growth as supply revs up to meet demand. It also implies there are meaningful limits to how fast a mature, advanced economy like the U.S. can possibly grow without demand spilling over into inflation. Growth needs to moderate to avoid such an outcome. If the new spending programs now before Congress are passed, it will take longer to alleviate the economy’s bottlenecks and inflation pressures will continue for a longer time period.

The foregoing content reflects the opinions of Advisors Capital Management, LLC and is subject to change at any time without notice. Content provided herein is for informational purposes only and should not be used or construed as investment advice or a recommendation regarding the purchase or sale of any security. There is no guarantee that the statements, opinions or forecasts provided herein will prove to be correct. Past performance may not be indicative of future results. Indices are not available for direct investment. Any investor who attempts to mimic the performance of an index would incur fees and expenses which would reduce returns. Securities investing involves risk, including the potential for loss of principal. There is no assurance that any investment plan or strategy will be successful.
About the Author
Dr. Charles Lieberman
Dr. Charles Lieberman

Dr. Charles Lieberman is the Chief Investment Officer and co-founder of Advisors Capital Management, LLC. Dr. Lieberman began his professional career as an academic at the University of Maryland and Northwestern University. After five years in academia, he joined the…
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By Dr. Alan Greenspan, Senior Economic Advisor

With a majority of the work force now vaccinated, and vaccines readily available to those who are not, large corporations across the U.S. have decided that the time to return to the office has come. From banks to technology companies, there seems to be a consensus forming that workers should return to some degree, whether full-time or a hybrid model, by this fall. Unsurprisingly, there has been push-back from employees—according to a May survey conducted by Morning Consult on behalf of Bloomberg News, nearly 40% of the 1,000 adults polled said they would consider quitting their jobs if their employers are not flexible about remote work going forward. While some occupations certainly require a physical presence, the data show that by and large the workers have a valid point. Indeed, what I have found to be a silver lining of the pandemic is that it appears to have engendered a rise in the level of worker productivity.

In the chart below, we see that U.S. nonfarm business productivity fell dramatically in March 2020 as the country shut down in response to the novel coronavirus. However, productivity rebounded to new heights just one month later. By itself, this phenomenon is not all that unexpected. When recession first takes hold, businesses reflexively begin “cutting the fat.” The least productive workers will be culled first, and discretionary spending will be reined in, leaving businesses in a more productive posture in the early periods of a recession even as aggregate output falls. That dynamic was magnified by the extraordinary nature of the pandemic response as low-productivity service industries were shut down en masse.

What is both surprising and encouraging to me is that, after a year of additional data, productivity has yet to show any signs of giving back its pandemic gains. Following a decline in November 2020, I was initially concerned that a reversion in productivity back to the pre-pandemic trajectory was in the offing. But the data show that real output per hour rebounded once again, rising a more than expected 5.4% in the first quarter of 2021, and the year-over-year rate of growth rose 1.5ppts to 4.1%. A further increase is expected for the second quarter when the data are published in August. Whether this higher level of productivity can be sustained as the economy continues to reopen and reassimilate the workers lost since the onset of the pandemic carries important implications for the U.S. economy going forward.

In the big picture, productivity is arguably the most central measure of the material success of an economy. The level of productivity ultimately determines the average standard of living and is a defining characteristic that separates the so-called developed world from the developing world. In the near-term, the path of productivity may be even more important as it could play a crucial role in combatting the inflationary pressures that, for now, appear transitory. A higher level of productivity would allow businesses to maintain their profit margins without raising prices too quickly while also rewarding workers with higher compensation. Indeed, the various instances of worker shortages documented in recent headlines could be alleviated if businesses feel confident enough that productivity gains are lasting and therefore wages can be increased to attract new employees without hurting profits.

To be sure, there are numerous challenges the nascent recovery has yet to confront (pullback of monetary and fiscal support) and new risks emerging (Delta variant, stagnating vaccination rate). For now at least, worker productivity provides an unexpected and encouraging tail wind.

The foregoing content reflects the opinions of Advisors Capital Management, LLC and is subject to change at any time without notice. Content provided herein is for informational purposes only and should not be used or construed as investment advice or a recommendation regarding the purchase or sale of any security. There is no guarantee that the statements, opinions or forecasts provided herein will prove to be correct. Past performance may not be indicative of future results. Indices are not available for direct investment. Any investor who attempts to mimic the performance of an index would incur fees and expenses which would reduce returns. Securities investing involves risk, including the potential for loss of principal. There is no assurance that any investment plan or strategy will be successful.
About the Author
Dr. Alan Greenspan
Dr. Alan Greenspan

Alan Greenspan served five terms as chairman of the Board of Governors of the Federal Reserve System from August 11, 1987, when he was first appointed by President Ronald Reagan. His last term ended on January 31, 2006. He was…
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School’s out for the summer, but the Fed’s policy stance is already being tested. Job growth has picked up sharply and should remain fairly strong even before schools resume in September. But rising labor costs and their effects on inflation will test the Fed’s view that the surge in inflation will be just transitory.

Much of the strength in the labor report was evident to all, but the full extent of the inflation pressures brewing with respect to labor cost requires some calculations. The average wage rate rose 0.3% compared to May, a robust 3.6% annual rate, following even stronger gains in prior months. In fact, wage inflation is understated. The employment report shows wage inflation based on the average wage rate. When hiring is particularly strong for lower paid workers, the average wage rate is pushed down, as has been happening in recent months. (The same effect was seen in reverse early in the pandemic when job losses were extremely high for low wage workers, which elevated the average wage for those who remained employed.) In June, almost every subsector showed a rise in wage of more than 0.3%, sometimes considerably more, yet the average wage rose only 0.33%.

A more accurate and telling calculation can be constructed by using the actual wage increase for each subsector and weighting that increase by that sector’s weight. Such a calculation produces a wage increase of 0.45%, more than one third larger than the 0.33% shown in the report’s table. At an annual rate, it suggests wages are rising at a 5.4% pace, instead of the 4.0% reported. So, wage inflation is already meaningfully higher than indicated by the average wage. Doing the same calculation for the latest twelve months indicated a wage inflation rate of 4.52% versus the 3.57% reported.

Nonetheless, such calculations still leave unanswered whether the surge in labor costs will abate as the unemployed go back to work. Wage pressures are likely to remain elevated this summer. States accounting for roughly 40% of the labor force have already or will soon terminate the extra $300 in unemployment insurance benefits that enabled many workers to remain home. With the pandemic receding and reduced unemployment benefits, labor supply should rise a bit over the summer, enabling firms to hire. But wage pressures are likely to remain fairly high, since firms will see a supply constrained labor market. The real test won’t come until after Labor Day, when almost all schools reopen and parents can fully return to work. Will wage pressures moderate then, as the Fed expects? There is no useful precedent for this situation. But the economy will enter that test period with considerable momentum and strongly rising wages that reflect prevailing labor shortages. So, it is highly uncertain whether wages will recede as much as needed to avoid the increase in labor costs from flowing through into prices for goods and services.

Labor supply constraints now also ensure that the recovery will be attenuated and extended. While some estimates suggest second quarter GDP could be as high as 10%, a massive and unsustainable pace, solid growth lies ahead for at least the balance of the year and into the first half of 2022. Such strong growth augers very positively for corporate profits, providing very solid support for stock prices.

About the Author

Dr. Charles Lieberman

Dr. Charles Lieberman

Dr. Charles Lieberman is the Chief Investment Officer and co-founder of Advisors Capital Management, LLC. Dr. Lieberman began his professional career as an academic at the University of Maryland and Northwestern University. After five years in academia, he joined the…
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Interest rates and risk premiums (credit spreads) are both very low. This has caused some investors to chase yield via more aggressive fixed income opportunities without appreciating the incremental risk associated with those decisions. To increase yield, investors must increase interest rate exposure (duration) and/or increase the amount of credit risk they are taking. The fact that risk spreads are so low is evidence that many investors have taken on additional risk in their search for yield. This also means that investors are not being compensated for the risk they are taking. We would strongly advise more conservative fixed investors, who highly value preservation of capital, to stay the course or only consider increasing risk in moderation. However, we are confident many non-ACM investors could likely benefit from some adjustments to their current fixed income portfolios.

The topics of inflation and low interest rates are currently dominating both equity and fixed income market conversations. Even Fed Chair, Jerome Powell, acknowledges that everyone is trying to parse transitory from systemic inflation. As he discussed at the Fed press conference last week, experience provides a poor guide to predicting future growth and inflation dynamics. The shutdown and its recent reversal are simply unprecedented. Consequently, both the Fed and investors are watching the data carefully. Powell signaled that the Fed would tolerate higher inflation in the near-term provided employment continues to improve. However, Powell acknowledged the risk that inflation could exceed the Fed’s objectives. The Fed reflected the stronger economic and inflation outlook in its projections of policy rate hikes becoming more likely in as early as late 2022. So far, investors appear confident that while near-term inflation will be higher, the Fed will be able to achieve its 2% longer term, average target.

With rates remaining so low, many investors are considering high yield bonds. While high yield bonds are typically a step change greater in risk than investment grade bonds, they can offer investors who do their homework a good opportunity to get paid a bit more. The problem with moving to all high yield right now is that most investors do not realize that high yield spreads are near all-time lows at the same time interest rates are so low. Normally, high yield bonds are generally much more driven by risk premiums than interest rates, so investors should be cautious. And record low interest rates create another potential headwind because even high yield bonds will trade lower if rates rise (especially when spreads are tight). While there are select compelling high yield opportunities, investors need to realize the importance of keeping portfolios short-dated and higher quality. Short-dated bonds have less exposure to both credit risk and rates, so they protect capital when interest rates increase. If you are not paid adequately to take additional risk, you should not.

The graph below shows High yield spreads in the U.S. for the past 10 years. Spreads are near the lows!

Likewise yield seeking investors may also consider preferreds, but these suffer from precisely the same problem afflicting bonds; they also have low yields and low risk spreads. The coupon rate on the preferred is extremely important. Low fixed coupons imply large losses in value when interest rates or risk premiums increase. On the other hand, there are many preferreds that become floating rate in the future, and therefore limit the amount of interest rate exposure to typically only a 5 or 10-year period. But while these securities do have less rate exposure, they have substantial credit risk exposure. So, understanding the quality of the credit and making sure that the floating spread will remain attractive in most market environments is crucial. Many recent preferreds have been issued with a low fixed rate coupon or a low floating rate spread, which is fine only if interest rates remain low. Many investors simply do not realize that if they buy a 4% fixed coupon preferred, and long-term rates rise 1%, the preferred will lose nearly 20% of its value. Therefore, the penalty for buying the wrong preferred can be permanent and painful.

So what are fixed income investors to do? Well first, investors must understand that rising interest rates do not necessarily mean your fixed income portfolio will lose money over a one-year period. Even if rates rise, the magnitude and timing of rate increases determine how large of a potential headwind rising rates are. For example, a 0.25% rate increase per year in a solid macro environment will likely still provide solid fixed income returns as the interest rate headwind is minimal in context of the yield earned. Importantly, and we simply cannot stress this point enough, not all investment grade is created equal. At ACM we currently focus on the lower end of investment grade (BBB/BBB-), because these credits typically provide incremental yield for what we deem as marginally more risk. Additionally, investment grade fixed income portfolios can be constructed with bonds with less interest rate sensitivity than very long-dated bonds that are extremely interest rate sensitive.

Fixed income is clearly not easy right now, but our advice is to be defensive, rather than overly aggressive. That does not mean just do nothing. If you do not want to increase risk, then you should simply ensure that you or your investment firm is creative and clever because plain vanilla investment grade is unlikely to be sufficient in the current environment. (Note the average investment grade bond is down over 1.5% while the average ACM fixed portfolio is positive for the year.)

If you are considering getting more aggressive with your fixed income, we simply suggest that you have a conversation with your financial advisor before significantly increasing the risk in your fixed income portfolio. For example, at ACM we offer a Fixed Plus which typically allocates about a quarter of a fixed portfolio to non-investment grade securities. This smaller percentage allows us to be very picky and carefully choose a limited number of high yield securities that we find quite attractive. This is extremely different than having to construct a high yield portfolio of 25 individual securities that we find attractive in the current environment.

Regardless of your risk tolerance, even in a low yield environment, a fixed income portfolio consisting of individually selected securities can deliver value. If you think we can help you better understand your potential fixed income options, please do not hesitate to contact us.

About the Author

Kevin Kelly

Kevin Kelly

Mr. Kelly is the Portfolio Manager of Fixed Income and a member of the Investment Committee. Before joining ACM, Mr. Kelly was a portfolio manager at Verition Fund Management in New York, NY where his duties included managing a long/short…
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As we enter what may be remembered as our first post-COVID summer in the United States, the domestic landscape seems to be settling into a far less chaotic rhythm. Encouraging vaccination numbers have seen mask mandates disappearing. Businesses that were concerned with simply being open only a year ago are now turning toward increasing capacity limits. But while the home front seems back on track, the foreign policy challenges facing America are as pressing as ever. Recent cyberattacks have disrupted America’s oil infrastructure and meat production, and conflicts in the Middle East have flared anew. However, as I wrote in my August newsletter of last year, I believe the defining foreign policy issue facing America in the coming decades will be China.

Shortly after his inauguration, President Biden acknowledged that his administration is prepared for “extreme competition” with China. Biden has ratcheted up the stakes by arguing in essence that China seeks to challenge the liberal democratic order established by the U.S. and its Western allies following World War II. Just last week, Biden’s Asia Czar Kurt Campbell said that “the period that was broadly described as engagement (with China) has come to an end.” Campbell points to policies under Chinese President Xi Jinping as largely responsible for this shift from engagement to competition.

While Biden’s main objective of competition with China is clear, some core planks of his policy, including trade and military strategy remain undefined. Several China experts said that overall, much of Biden’s policy, while different in tone from the Trump administration’s, remains vague. He has kept in place for now Trump’s controversial tariffs on Chinese goods. Average U.S. tariffs on imports from China are currently at 19.3 percent, and cover 66.4 percent of Chinese exports to the U.S. These tariffs are more than six times higher than before the trade war began in 2018.

In an ideal world, I am an advocate of a free and open market. However, the proponents of tariffs are warranted in arguing that action to address China’s trade-distorting practices is necessary. At the same time, as Secretary of State Tony Blinken has said, it’s important that the tariffs are not “doing more harm to us than the country they’re being wielded against.” The tariffs, along with China’s retaliatory tariffs on U.S. imports, have jeopardized American jobs, increased costs for businesses, raised consumer prices and impeded access to medical products desperately needed during the pandemic. Many analysts argue that the Biden administration’s goal should be to minimize these costs to U.S. workers, companies, and consumers, while maintaining pressure on China to improve its behavior. That will require carefully picking and choosing which tariffs to lift and how.

Trade war aside, competition in science and technology is another major focus of the US-China relationship. President Xi recently called for China to accelerate efforts to become self-reliant when it comes to science and technology. Meanwhile in the U.S., the Senate is considering the U.S. Innovation and Competition Act (USICA), a $250 billion bill to boost U.S. science and technology. It is a widely-backed attempt to put new economic pressure on China while helping to give the U.S. an edge in producing high-power computer chips and other cutting-edge tools seen as critical to the digital age. Just last week, the Senate integrated the Trade Act of 2021 into the USICA in an effort to combat China’s manufacturing imbalances, threats to free and fair trade, and illicit activity which undermine America’s leadership in innovation.

The Biden administration has a complicated road to navigate with respect to U.S.-China relations. I am optimistic they will hammer out a plan which keeps in mind the ultimate goal of keeping our economy growing, bolstering our technological independence, and remaining competitive with China.

About the Author

Dr. Alan Greenspan

Dr. Alan Greenspan

Alan Greenspan served five terms as chairman of the Board of Governors of the Federal Reserve System from August 11, 1987, when he was first appointed by President Ronald Reagan. His last term ended on January 31, 2006. He was…
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Global Wealth Partners, Inc (“GWP”) offers wealth management services through various affiliated companies including advisory services offered by Diversify Advisory Services, LLC (“Diversify”), an SEC registered investment adviser. GWP offers additional investment services and securities through DFPG Investments, LLC., a broker/dealer, member FINRA/SIPC, and an affiliate of Diversify. GWP and Diversify are not affiliated.

https://reports.adviserinfo.sec.gov/crs/crs_326060.pdf