Keeping Things Elegantly Simple

KOHLER, Wis., September 26, 2016 – For the 17th straight year, Baird Advisors hosted its annual Institutional Investors Conference in Kohler Wisconsin. Attendees listened to Manpower Chairman CEO Jonas Prising discuss global employment trends and former Ford and Boeing CEO Alan Mulally address innovation and management topics. Baird Advisors Managing Director and Chief Investment Officer Mary Ellen Stanek provided Baird’s annual investment outlook.

Said Stanek, “We try to keep it elegantly simple. We aren’t economists, we are practitioners. We sort through the work of a variety of economists and strategists, look for the missing pieces in the puzzle, and find the opportunity.” Following are the highlights of her remarks.

2016 Market Review

Looking back at the past year, there was a lot about the macroeconomic environment we got right in our forecast. The broad based, durable U.S. expansion continued. The U.S. economy faced considerable headwinds from other parts of the world and while the current expansion has been disappointing in magnitude, it remains one of the longest in post-World War II history. Furthermore, there is convincing evidence that the expansion should continue with housing improving, solid job growth and the U.S. consumer in good shape.

Last year we didn’t talk about the expected Fed actions as tightening, but more as normalizing interest rates away from the “emergency” zero rate policy that had been in place for almost seven years. Back in December 2008 the Fed launched extraordinary monetary policy by moving interest rates to zero in an attempt to ease financial conditions and move investors off the sidelines (cash), out the yield curve and into other “risk” assets classes like equities. Coming into this year, with modest growth, unemployment continuing to fall, and wages showing early signs of rising, the Fed was poised to enact a series of quarter-point increases in the Fed Funds rate to finally give it some breathing room off of zero. But the markets took exception to the Fed’s plans and got spooked by its expected path of ELEVEN additional rate hikes over the next three years.

The sharp decline in energy and commodity prices that began in 2015 also intensified early in the year, to such an extent that hope for stronger growth in the U.S. faded into concern that global growth was faltering. In the first six weeks of the year, a decisive risk-off mood came over investors and volatility surged, equities plunged and credit spreads gapped wider. This severe market reaction acted like a speed bump to an already subpar U.S. economic expansion, and real GDP for the first half of 2016 fell to just 1% after averaging 2% since the end of the 2008-2009 recession.

A decline in productivity has contributed to subpar U.S. growth. The primary driver in our view has been muted business investment/capex during this expansion. Cautious business leaders have decided to hire more people in lieu of investing in productivity enhancing machines and other technology. Other contributors include fewer start-ups and less dynamism in the economy given increased regulation and the loss of the experience and “institutional knowledge” of retiring baby boomers. This decline in productivity points to why job growth in the U.S. has remained robust at the same time GDP growth has only been subpar post crisis.

While globalization increased real incomes overall, it has had clear winners and losers. Winners include the Asian middle class, primarily the Chinese, and the top 1% globally. The middle and lower-middle income classes in the U.S. and Western Europe were the losers and have seen little real wage growth in over 20 years. The evidence of their frustration is the rejection of the political establishment which embodies the status quo, as we’ve seen here in the U.S. with the rise of Bernie Sanders and Donald Trump, and movements toward nationalism and away from globalization.