Category Archives: Brexit

Tectonic Shifts – Looking Ahead to 2017

The election has created tectonic shifts in government and promises to make bold changes in the economy.  We have been gathering consensus views from some leading financial analysts for 2017

  • Global interest rates are going up.
  • Global inflation is going up.
  • Global growth is going up.
  • Recession risk is going down.

A new consensus is also building.  The rise of nationalistic self-interest is upsetting the old order the world over.  For the past decade central bankers have been in control of economic policy throughout the world.  It has resulted in low or even negative interest rates in an effort to stimulate economic growth.  The result has been like pushing on a string.  Growth has been slow (the string as a whole hasn’t been moving) and the middle class in the developed world has seen their wages stagnate and their jobs disappear (the middle of the string) while those at the top (the far end of the string) have been virtually unaffected.  It’s part of the reason for the change in political leadership in the U.S. and the re-emergence of economic nationalism as evidenced by the Brexit vote in Britain.

As central bank leadership takes a back seat to aggressive fiscal policy, we can expect political leadership to focus on job growth and economic relief for the long-neglected middle class.  Domestically, here is what we expect to see:

Tax reform:  Trump’s campaign promised corporate tax reform.  To make American companies more competitive globally, he has proposed reducing corporate tax rates from 35% to 15%.  A special 10% rate is designed to repatriate corporate profits held offshore.

Individuals will be taxed at three rates depending on income: 12%, 25% and 33%.

Fiscal policy: The Trump administration wants to spend new money on infrastructure: transportation, clean water, the electric grid, telecommunications, security, and energy.

Health care: Trump wants to repeal and replace Obamacare.

Trade: The new administration has vowed to withdraw from TPP (Trans Pacific Partnership) and renegotiate NAFTA (North American Free Trade Agreement).  They also intend to challenge China regarding currency manipulation and unfair trade practices.

Immigration: President-elect Trump intends to establish new, tougher immigration controls to boost wages, build a wall along the U.S./Mexico border, deport criminal aliens and end sanctuary cities.

Economy: 25 million new jobs over the next decade is the goal of the incoming administration.  They aim to boost economic growth from 1.5% to 3.5% or 4.0% annually.

The Trump administration will focus on job creation, economic growth, infrastructure spending, reduced regulation, and energy independence while reducing governmental efforts to prevent climate change.  The people that Donald Trump has chosen for his cabinet are largely from the private sector; people that have backgrounds in running successful businesses and creating jobs.

These things are the primary reason that the stock market has reacted well to the election of Donald Trump.  Corporate earnings have been essentially flat for the past three years.  Professional investors see opportunities for renewed economic growth, which will increase corporate profits.  While we view this development with optimism, we always remain cautious.  We expect increased market volatility, especially if terrorist attacks continue throughout the globe.  We also expect interest rates to rise as the Federal Reserve brings rates to a more historically normal level.

We also see opportunities for the creation of new companies.  The number of publicly traded companies has dropped by nearly 50% since 2000.  At the same time, the number of companies that are held by private equity firms has grown explosively – by a factor of six!  This provides a great opportunity for privately held companies to go public and provide yet another opportunity for greater market growth.

As always, we remain cautious in keeping with our philosophy of preserving our clients’ capital.  Over the long term, we see the potential for a new American renaissance.

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Negative Interest Rates – Searching for Meaning

We have mentioned negative interest rates in the past.  Let’s take a look at what it means to you.

Central banks lower interest rates to encourage economic activity.  The theory is that low interest rates allow companies to borrow money at lower costs, encouraging them to expand, invest in and grow their business.  It also encourages consumers to borrow money for things like new homes, cars, furniture and all the other things for which people borrow money.

It’s the reason the Federal Reserve has lowered rates to practically zero and kept them there for years.  It’s also why the Fed has not raised rates; they’re afraid that doing so will reduce the current slow rate of growth even more.

But if low rates are good for the economy, would negative interest rates be even better?  Some governments seem to think so.

Negative interest rates in Japan mean that if you buy a Japanese government bond due in 10 years you will lose 0.275% per year.  If you buy a 10 year German government bond today  your interest rate is negative 0.16%.   Why would you lend your money to someone if they guaranteed you that you would get less than the full amount back?  Good question.  Perhaps the answer is that you have little choice or are even more afraid of the alternative.

Per the Wall Street Journal:

There is now $13 trillion of global negative-yielding debt, according to Bank of America Merrill Lynch. That compares with $11 trillion before the
Brexit vote, and barely none with a negative yield in mid-2014.

In Switzerland, government bonds through the longest maturity, a bond due in nearly half a century, are now yielding below zero. Nearly 80% of Japanese and German government bonds have negative yields, according to Citigroup.

This leaves investors are searching the world for securities that have a positive yield.  That includes stocks that pay dividends and bonds like U.S. Treasuries that still have a positive yield: currently 1.4% for ten years.  However, the search for yield also leads investors to more risky investments like emerging market debt and junk bonds.  The effect is that all of these alternatives are being bid up in price, which has the effect of reducing their yield.

The yield on Lithuania’s 10-year government debt has more than halved this year to around 0.5%, according to Tradeweb. The yield on Taiwan’s 10-year bonds has fallen to about 0.7% from about 1% this year, according to Thomson Reuters.

Elsewhere in the developed world, New Zealand’s 10-year-bond yields have fallen to about 2.3% from 3.6% as investors cast their nets across the globe.

Rashique Rahman, head of emerging markets at Invesco, said his firm has been getting consistent inflows from institutional clients in Western Europe and Asia interested in buying investment-grade emerging-market debt to “mimic the yield they used to get” from their home markets.

Clients don’t care if it is Mexico or Poland or South Korea, he said, “they just want a higher yield.” ….

Ricky Liu, a high-yield-bond portfolio manager at HSBC Global Asset Management, said his firm has clients from Asia who are willing for the first time to invest in portfolios that include the highest-rated junk bonds.

How and where this will end is anybody’s guess.  In our view, negative interest rates are an indication that central bankers are wandering into uncharted territory.  We’re not convinced that they really know how things will turn out.  We remain cautiously optimistic about the U.S. economy and are staying the course, but we are not chasing yield.

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BREXIT is a political crisis, not a financial crisis

We have a tendency to take a dispassionate view of world affairs.  It helps us avoid getting caught up in the hype that the media sells when things happen.  When the unexpected happens, as it so often does, the initial reports and the initial reactions are often the opposite of the truth and have little relationship to reality.

We have some insight into European affairs for personal reasons and have always felt that the EU was an artificial construct in a continent that is home to so many disparate cultures.  So we are not surprised that the whole rickety structure is showing signs of coming apart.  But Europe has been the home of little countries and big countries for millennia and has thrived over that time.  There’s no reason to think that the EU is either critical or even necessary.  It has its uses but it also has its failures and it’s the failures that have grown larger over time.  So finally, when put to a vote, the people on an island off the coast of Europe has decided it was time to declare its independence from the EU and reclaim their heritage.

We also found the commentary from  Jenna Barnard of Henderson Global Investors compelling and wanted to share it.

While the result of the referendum “Brexit” last week may be the biggest political crisis in the United Kingdom since the Second World War, this is not a financial crisis in our view.  Credit markets are not suggesting systemic risk at present as the banks are in a relatively healthy place due to rigorous regulation and stress testing over the last few years.

Clearly the result is a significant blow to confidence / “animal spirits” in the short term and will put a least a temporary break on growth in the UK and perhaps Europe. Bank share prices have also been hammered and their willingness to lend remains muted. European companies are therefore likely to remain relatively conservative – more about dividends and conservative balance sheets than share buybacks /M&A.

The Bank of England is planning to cut rates to 0% from 0.5% but the central bank doesn’t want to take them negative.  We expect further credit easing – free money to the banks for mortgage lending (“funding for lending”), more QE possibly.  We believe another central bank heading to the zero lower band fuels the global grab for yield.

The issue at stake as of today is HOW the UK exits. There are soft and hard version of exit with soft (maintaining access to the free trade area) being the preferable version for the economy. Today the leading “leave” politician in the UK (and likely the next Prime Minister), former Mayor of London Boris Johnson, has written his weekly column for a national newspaper that suggests a very soft form of exit; along the lines of Norway and Switzerland i.e. retain access to the free trade area. To do this the UK would have to agree to free movement of labor (to be clear, not people, but the labor market; new migrants would need a job to come to the UK).

We will continue to watch and advise you to events as they unfold.  As we write these comments on Tuesday morning the US stock markets are up over 1% and the European markets are up over 3%.  Reality is overtaking panic.  If you have questions, don’t hesitate to contact us.

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BREXIT! A Rational View

Today’s markets are roiled by the decision of voters in Great Britain to exit the European Union (EU), which has been dubbed “BREXIT.”  As with most events in the investment world, there are people out there who make a living scaring you.  Rather than panic, we recommend you step back and think rationally what this means.

KEEP CALM

First, why did the British people vote to leave the EU despite the unified opposition of both of Great Britain’s major political parties?  The answer is that more than half of their voting public was tired of being told what to do by un-elected bureaucrats in Brussels (the capitol of the EU).  The people wanted to have a say in how they were going to be governed.  In effect, BREXIT was a revolt of the masses against the classes.

Polls prior to the election indicated that the vote would be against BREXIT, opting to stay in the EU.  The result surprised much of the big money which led to today’s panicked selling at the open.

As we prepare these comments we see a small rebound from the opening bell but the day is young and we don’t know where we’ll be at the end.  But if we step back, we think that Brian Wesbury of First Trust has some worthwhile thoughts:

The bottom line is that investors should ignore scare stories about what would happen if BREXIT wins.  Great Britain runs consistent trade deficits with the rest of Europe. Regardless of what foreign leaders say before the vote, if the British vote to leave, the rest of the EU is going to chase them to the ends of the earth.  No way will they allow one of their biggest export markets to become more distant.  They will beg the UK to sign a free trade deal.  In addition, and this is actually great economic news, it would free the US and UK to sign a free trade deal that the EU is now holding up.

Any market volatility would be short-lived and any swing to the downside would be a buying opportunity.  BREXIT is not a reason to sell.  In fact, freedom is a good thing

Have questions?  Ask us.

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