Category Archives: global markets

Market reacts to French election, tax cuts and earnings

The stock market had two back-to-back days with the Dow Jones Industrial Average (DJIA) up over 200 points.  On Monday the market was reacting to the first round of elections in France.

The French election for President is often a two step process.  If a candidate gets over 50% of the vote in the first round of voting he or she is declared the winner and becomes President.  If no one gets to 50%, the two top vote getters face a run-off election which decides the Presidency.

In the first round that just ended, the candidates of the major French parties that had run the country for decades did not make it to the run-off.  Instead, Marine Le Pen (usually described as “Far Right”) and Emmanuel Macron (usually described as a “centrist”) were the two top vote getters.  They will face off on May 7th with the winner becoming President of France.

Macron, age 39, received 23.8% of the vote while Le Pen scooped up 21.4%.  Macron formed his own party, splitting off from the Socialists.  Macron is best known for marrying his teacher, a woman 25 years his senior.

It is generally assumed that Macron will win the next round with the French establishment uniting against Le Pen who wants to stop immigration and wants France to pull out of the EU.  The results of the balloting caused a relief rally in expectation that France will stay the current course and remain in the EU.

The Tuesday market action was driven by exuberance over the Trump administration announcement that they were proposing a reduction in the corporate tax rate from 35% to 15%.  If this passes, next year’s corporate earnings would be higher.

On the earnings front some of the big names in the DJIA reported better-than-expected earnings.  Caterpillar, McDonald, Du Pont and Goldman Sachs were the biggest beneficiaries.

Stay tuned.

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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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The New Trump Economy

We have been talking about the “Plow Horse Economy” for quite a while now.  Low interest rates designed to spur economic growth have been offset by other government policies that have acted as a “Plow” holding the economy back.

Market watchers have assumed that the November election would see a continuation of those policies.  The general prediction was for slow growth, falling corporate profits, a possible deflationary spiral, and flat yield curves.

What a difference a week makes.  The market shocked political prognosticators by standing those expectations on their heads.

Bank of America surveyed 177 fund managers in the week following the elections who say they’re putting cash to work this month at the fastest pace since August 2009.

The U.S. election result is “seen as unambiguously positive for nominal GDP,” writes Bank of America Merrill Lynch Chief Investment Strategist Michael Hartnett, in a note accompanying the monthly survey. 

The stock market has reached several new all-time highs, moving the DJIA to a record 18,924 on November 15th, up 3.6% in one week.

Interest rates on the benchmark 10-year US Treasury bond have risen from 1.83% on November 7th to 2.25% today (November 17th), a 23% increase.  Expectations for the yield curve to steepen — in other words, for the gap between short and long-term rates to widen — saw their biggest monthly jump on record.

 WealthManagement.com says that

Global growth and inflation expectations are also tracking the ascent of Trump. The net share of fund managers expecting a stronger economy nearly doubled from last month’s reading, while those surveyed are the most bullish on the prospect of a pick-up in inflation since June 2004.

Investors are now also more optimistic about profit growth than they have been in 15 months.

Whether this new-found optimism is justified is something that only time will tell.  In the meantime to US market is reacting well to Trump’s plans for tax cuts and infrastructure spending.  Spending on roads, bridges and other parts of the infrastructure has been part of Trump’s platform since he entered the race for President.  It’s the tax reform that could be the key to a new economic stimulus.

According to CNBC American corporations are holding $2.5 trillion dollars in cash overseas. That’s equal to 14% of the US gross domestic product.  If companies bring that back to the US it would be taxed at the current corporate tax rate of 35%.  The US has the highest corporate tax rate in the world.  The promise of lower corporate tax rates – Trump has spoken of 15% – could spur the repatriation of that cash to the US, giving a big boost to a slow growth US economy.

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Diversification and Emerging Markets

A well-diversified portfolio typically includes emerging markets as one of its components.  “Emerging markets” is a generic term to identify those countries whose economies are developed, but still smaller than those of the world’s superpowers (i.e., USA, Europe, Japan).

To professional investors, a well-diversified portfolio includes many asset classes, not just the most obvious: U.S. Stocks (the S&P 500) and a U.S. bond fund.

The following illustration is a great illustration of the relative performance of some of the major asset classes.

callan-periodic-table-of-investment-returns

Here we have ten key indices ranked by performance over a 20-year period.  The best-performing index for each year is at the top of each column, and the worst is at the bottom.

It is natural for investors to want to own the stock, or the asset class that is currently “hot.”  It’s called the Bandwagon Effect and it’s one of the reasons that the average investor typically underperforms.  The top performer in any one year isn’t always the best performer the next year.

A successful investment strategy is to:

  • Maintain a portfolio diversified among asset classes,
  • Stick to an appropriate asset allocation for your particular goals and objectives,
  • Rebalance your portfolio once or twice a year to keep your asset allocation in line, essentially forcing you to sell what’s become expensive and buy what’s become cheap.

In other words, re-balance your portfolio regularly and you will benefit from the fact that some assets become cheap and provide buying opportunities and some become expensive and we should take some profits.

Which brings us to emerging markets, which have been a drag on the performance of diversified portfolios for several years.

“It was a summer of love for investment in emerging markets,” according to the latest MSCI Research Spotlight.  For example, Brazil, Taiwan, South Africa and India have all been big winners, MSCI said.

The MSCI Emerging Markets Index ended August up for the year 15 percent compared to a loss of 20 percent the prior year.

“We are seeing very strong performance,” Martin Small, head of U.S. i-Shares BlackRock, told the conference.

Emerging market equities “have outperformed the S&P so far this year by more than 800 basis points and the broader universe of developed markets by almost 1,000 basis points,” according to the October BlackRock report, “Is the Rally in Emerging Markets Sustainable?” The report said EM outperformance “is likely to continue into 2017.”

For investors who have included emerging markets in their portfolios, their patience and discipline is being rewarded this year.  For those who want to have a portfolio that’s properly diversified but don’t have the expertise to do it themselves, give us a call.

 

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When is the Next Recession?

One of our favorite market analysts, Brian Wesbury – who coined the term “Plow horse Economy” to describe the current economic situation – has been accused of being a “perma-bull” because he had discounted all the predictions of recession over the last 7 1/2 years.  We can understand why people are concerned about recessions because 2008 is still fresh in our minds.  The recovery that began in 2009 has been anemic.  Millions of people have not seen their financial situation improve.

Remember fears about adjustable-rate mortgage re-sets, or the looming wave of foreclosures that would lead to a double-dip recession? Remember the threat of widespread defaults on municipal debt? Remember the hyperinflation that was supposed to come from Quantitative Easing? Or how about the Fiscal Cliff, Sequester, or the federal government shutdown? Or the recession we were supposed to get from higher oil prices…and then from lower oil prices? How about the recession from the looming breakup of the Euro or Grexit or Brexit?

None of these things has brought on the oft-predicted recession.  Wesbury says that at some point a recession will come.  We have not reached the point where fiscal or economic policy has eliminated that possibility.  He mentions several indicators, including truck sales and “core” industrial production as indicators that should be watched.

Meanwhile,

Job growth continues at a healthy clip. Initial unemployment claims have averaged 261,000 over the past four weeks and have been below 300,000 for 80 straight weeks. Consumer debt payments are an unusually low share of income and consumers’ seriously delinquent debts are still dropping.   Wages are accelerating. Home building has risen the past few years even as the homeownership rate has declined, making room for plenty of growth in the years ahead.

Meanwhile, there haven’t been any huge shifts in government policy in the past two years. Yes, policy could be much better, but the pace of bad policies hasn’t shifted into overdrive lately.

In other words, our forecast remains as it has been the past several years, for more Plow Horse economic growth.   But you should never have any doubt that we are constantly on the lookout for something that can change our minds.

While the next recession may or may not be right around the corner, serious investors should be prepared for the eventuality so that when it does arrive, they will be ready.   We invite your inquiries.

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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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Interest rates around the world.

And you think that interest rates are low here?  You should be Japanese.

The Japanese people are paying the Japanese government to buy government bonds.  The rate on 10 year bonds is minus 0.159%.  Lenders are willing to pay the Japanese government for the privilege of getting back their principal, ten years from now.

Things are just slightly better in Germany.  The German government bond is yielding 0.025%.  That means if you lend the German government $1000 today they will give you back $1002.50 in ten years.

UPDATE:  June 14th, the morning the rate on the German bond has dropped to zero.

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The View on Brexit

Britains will soon be voting on whether to stay in the EU (the European Union) or leave.   Polls are divided on exiting the EU, or “Brexit” for short.  The British establishment is all for remaining in the EU but a lot of people are for getting out.  Voters are being deluged by scare stories about what will happen if they exit the EU, everything from loss of jobs to depression.  There has even been a claim that Britain leaving the EU will cause the climate to change even faster.  Some have labeled the tactics “Project Fear.”

The issue driving Brexit is that people are fed up with an unelected European bureaucracy making important political decisions for them.  People are seeing many of the decisions that were once made through Parliamentary democracy delegated to strangers in foreign capitals.

People are also becoming wary about a massive influx of refugees what under EU rules can move freely throughout Europe.  People who do not share the cultural or political beliefs of the British and who have no wish to assimilate.  We will undoubtedly be hearing more about this as the vote nears.

Brian Wesbury of First Trust has this take:

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.

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