4 highlights of the May 2015 Market Outlook Share Written By AAFMAA Team Tags Personal Finance Financial Planning & Investment 2015-05-20 1.) Timing of Fed policy changes still uncertain. Just as Federal Reserve officials indicated they would be ready to start raising interest rates as early as June, the Labor Department stunned investors with a very weak March employment report showing payroll growth of only 126,000 jobs, the lowest reading since December 2013. To add to Fed worries, the Bureau of Labor Statistics then revised January and February numbers sharply lower by a combined 69,000 jobs. While the unemployment rate remained steady at 5.5%, we believe this is primarily driven by a reduction in the labor force as reflected in the labor participation rate which hit a twenty year low of 62.7%. The weak March jobs report would seem to reduce (but not outright eliminate) the likelihood of a June rate hike. To be sure, we still have two more monthly employment reports (May and June) for the Fed to digest before their June meeting. 2.) The Fed is working with conflicting data. If the Fed does not time the rate increase correctly, they risk pulling the economy back into recession. If they wait too long, they risk igniting inflationary forces that would be difficult to extinguish. We believe that the Fed will have to shift from their current accommodative rate policies to a more neutral stance fairly soon. Maintaining rates at near zero levels and the financial repression it inflects on savers cannot be maintained forever. The possibility of higher short term rates later this year keeps us defensive with the bond portion of client portfolios. 3.) Value of the Euro reaching parity with the dollar. Internationally, it looks like the European Central Bank (ECB) has decided to pull from the Fed’s playbook. Following in the Fed’s footsteps, the ECB began buying 60 billion euros of bonds in March. The majority of the purchases are sovereign bonds of various Eurozone countries, helping drive interest rates into negative territory. For example, a German bund investor must go out on the curve eight years to reach a break-even yield, meaning that for those eight years, that investor is paying the German government to hold their money for them. Negative rates have forced European investors into dollar-denominated assets, which in turn has pulled the value of the Euro vs. the dollar down to near parity. We expect this trend to continue in the coming months, which could make this a great time to take that European excursion you have been planning! 4.) Equity markets continue to tread water. Year-to-date, investors have weighed equity valuations at the high end of historical ranges against the possibility of continued earnings growth. We believe the market is fairly valued as certain valuation indicators (price/earnings, price/cash flow) have reached historically high levels while other indicators (earnings yield vs. bond yield) still show under-valuation. Until we see the Fed begin an aggressive tightening cycle (not anytime soon), we will maintain mid-point equity allocations in client portfolios.