Natalie Trunow is Senior Vice President and Chief Investment Officer, Equities, at Maryland-based Calvert Investments. Previously she was a Section Head and a Portfolio Manager in the global markets group at General Motors Asset Management.
Harlan Levy: Did Thursday's stock market baby crash reflect justifiable skepticism of the U.S. economy's health, or was it just reacting to Federal Reserve Chairman Ben Bernanke's statement that the Fed's monthly $85 billion purchases of Treasury and mortgage-backed securities may end at year-end, causing interest rates to rise and stocks to lose steam?
Natalie Trunow: I believe it's more the case of the latter and not the former. Unfortunately, unlike in a more normalized market, we have this counterintuitive dynamic now such that when the economy is actually doing better or showing signs of improvement, the market sells off, because it expects the Fed to taper off Quantitative Easing and its monthly purchases of Treasurys and mortgage-backed securities.
Even if it's reduced, even if the perception is that QE will be tapering off but not necessarily ending by the end of the year -- and I don't think it will end by then -- the market is expecting QE to taper off sooner than the consensus thought it would, and the equity markets will get nervous.
The underlying economic fundamentals are continuing to improve, albeit at a slower pace than we would like, and as a result market sentiment deteriorates because of an expectation of a reduction in QE, and markets sell off, which is what we're seeing right now. Under normal market conditions when an economy improves and economic data show signs of health, the markets would be positive. Here it's the opposite.
That's not the only dynamic. Frankly, the equity markets in the U.S. have done phenomenally well and have achieved healthy returns in the year to date that some investors would be happy with for a full year. So it's not surprising that some investors are taking profits.
H.L.: So what do you think the stock market will do in the coming months?
N.T.: I think we were due for a bit of a correction. We're seeing some of the jitters in the marketplace as we speak. It could continue at least until the next earning season. And if we have reasonable earnings reports, equity markets could bottom out and recover from there.
I think we could be looking at a 5 to 10 percent correction from the very top levels so far this year. But my long-term outlook on U.S. equity markets is positive. I think the current sell-off is probably justified, and I wouldn't be surprised if we follow it with further pressure through the summer. But later in the year we should find a bottom and start recovering.
I'm not saying the correction would be more than another 5 to 10 percent, because the economic fundamentals are improving, and that should help support earnings of U.S. companies, which in turn will help support U.S. equity markets.
H.L.: If bond rates start rising more than for just a day or two, how might that affect the economy?
N.T.: It will be a mixed bag. Overall, of course, it is more taxing on the economy, because money becomes more expensive to borrowers. However, it could actually trigger a positive impact on the housing market, because to the extent that U.S. mortgage rates increase gradually, that could prompt real estate buyers to step in sooner than later, which is likely to push housing prices up. In the short term it could have a positive impact on the housing market and, through a multiplier effect, the overall economy.
H.L.: Is the housing market's healthy recovery sustainable no matter what happens with the Fed easing program?
N.T.: In the long run, yes. In the short run, if the rates increase too much too soon, that could have a negative effect on the housing market. Mortgage rates moving up too high too quickly could prompt real-estate buyers to pause and wait until rates come back down.
However, as I said above, gradual small rate increases will likely have a short-term positive impact on the U.S. housing market. That dynamic will likely prompt U.S. home-buyers to step in and buy earlier while they can, because they will have the expectation that rates will be going up in the future.
However, unanticipated abrupt increases in rates could have the opposite effect both for the housing market, the U.S. economy overall, and the stock market. You don't want to see a spike, and I think the Fed is attempting to engineer an exit strategy for its purchases in such a way that interest rates increase very gradually over time.
H.L.: Is the weak job market going to get much better, and if not, what do you expect to happen?
N.T.: I think it will get better. It has been getting better, but not quickly enough. Improvement in the economic fundamentals, including the improving economic activity in the U.S. private sector, will help drive further improvements in unemployment over time.
We could have a 6.7 percent jobless rate sometime next year. That's not out of the question if we continue at the current pace. It also depends on the workforce participation rate. If folks who have not been seeking jobs decide to reenter the workforce, that will dampen the improvements in the jobless rate and increase unemployment levels. So far we've had the opposite dynamic, with more and more people leaving the workforce. That's partially why it's difficult to make accurate predictions of unemployment.
H.L.: How much of a hindrance to the economy is the standoff in Congress over increasing stimulus spending for public sector jobs in infrastructure repair, police, teachers, etc. and increasing aid to keep poor people afloat versus across-the-board austerity measures and spending cuts that hurt the poor?
N.T.: This is not a trivial question. While increases in stimulus spending for public sector jobs and projects could have very positive impacts on the economy in the short term and support economic recovery in the U.S., they will contribute to an already alarming debt levels in the U.S. which could hurt the economy in the long run. Unlike the private sector, public-sector projects are not regulated by the markets, so too much stimulus left in place for too long may be detrimental. Having said that, U.S. infrastructure could surely use some upgrading and some of the cuts in public-sector jobs, especially in education, could have a negative impact on U.S. competitiveness in the long run. I trust in the U.S. system and believe that the issue will be resolved for the better of the country at some point.
H.L.: Is the euro zone still deteriorating as poorer countries struggle more and more with austerity, and if so, where is the zone going in the short term and will it have much of an effect on the U.S. economy?
N.T.: The euro zone is likely to take longer to recover than the consensus anticipates, so I wouldn't sell U.S. stocks in favor of their European counterparts quite yet. Having said that, there are pockets of very interesting investment opportunities in both the core and peripheral economies of Europe. But I don't see significant positive catalysts in Europe in the short run.
While this will continue to have a negative impact on Europe's trading partners, including the U.S. and emerging markets, I believe the U.S. will continue to be better shielded from the impact than the emerging economies.