The last few trading sessions in stock markets around the globe have been painful. The sell-off on Friday February 2nd was the steepest in nearly two years, only to be followed by a deeper fall Monday. The prompt for the market rout appears to be a strong jobs report in the US that included signs of increasing wage inflation. Benchmark interest rates, in turn, rose with the yield on the 10-year U.S. treasury climbing to 2.84% on Friday only to fall to 2.7% on Monday evening. The perception that interest rates may rise faster than the market expects unnerved equity investors. In our view, the US stock market is consolidating strong gains posted over the past year and its longer term trends are still upward-sloping. With economic conditions showing continued improvement and corporate earnings accelerating, equities should resume their upward trajectory after this bout of selling pressure recedes. For now, we view the stock market as experiencing a healthy, albeit harrowing, correction.
Category: General (Page 12 of 17)
The yield on the 10 Year US Treasury bond reached 2.72% today and has climbed over 65 basis points since early September 2017. This is not wholly unexpected given the strengthening of the US and world economies that has been building over the past several quarters. What we find interesting is that global government bond spreads (the difference between yields in the US and international markets) are staying persistently high, especially in the face of a weakening US dollar. The chart below shows spreads in the US versus comparable yields in the Eurozone, the United Kingdom and Japan going back two decades. US Treasury – Japanese Government Bond (JGBs) spreads have been historically wider, notably in the 2000s, while US Treasury spreads versus the UK (Gilts) and European equivalents are near all-time highs and significantly above 1.0% which served as an upper boundary.
It appears “something has to give” – either the US dollar strengthens, rates in the US recede or yields in Europe rise, thus closing the gap with US Treasury yields. We have our doubts that European economies can absorb materially higher rates even with welcomed improving economic trends.
Our key position in Asian emerging market equities faced headwinds towards the end of 2017 but appears to have regained lost ground over the past month. Many economies in Asia are export-oriented and many currencies, while not explicitly pegged to the US dollar, remain managed against the greenback. A weaker dollar against the major currencies could serve as a tailwind for Asian corporate earnings. Stronger global economic growth should buttress demand in the region and valuations remain favorable compared to developed markets. The fundamental case for emerging Asia is sound, but political risk from the Korean peninsula or rising interest rates and tighter monetary policy could place downward pressure on regional bourses.
Weakness in the US Dollar has been a focus of global investors as the greenback has weakened considerably versus the Euro and British pound. While the Japanese Yen has also strengthened against the US dollar over the course of the past several weeks, it doesn’t appear to have the strong momentum that the European currencies are exhibiting. The chart below shows the Euro – Yen cross rate, and the Euro has dominated the Yen for the better part of the past 12 months. Euro strength could prove a headwind for European equities in coming quarters, whereas Yen weakness could provide a boost for Japanese corporate earnings through the currency translation effect. Equities in these geographic regions tend to have a high degree of dependency on export markets and currency movements can have meaningful impact.
On Dr. Martin Luther King, Jr. Day, it is a good time to listen rather than speak. Here are a few places to go to hear about both the legacy and the present day state of social and economic justice in the United States:
Equal Justice Initiative – https://eji.org
Southern Poverty Law Center – https://www.splcenter.org
The Innocence Project – https://www.innocenceproject.org
And, a compendium of discussions and excerpts from Dr. King’s sermons and speeches — https://www.npr.org/news/specials/march40th/speeches.html
And we’re back! Happy New Year to our friends, clients and partners.
US Personal Consumption Expenditure (PCE) Prices, depicted in this week’s chart, is an inflation indicator that we follow closely. It is still below the US Federal Reserve’s 2% target, but getting closer. This has historically been among the favorite inflation indicators monitored by the Fed and Fed watchers. Our concern is that, if inflationary pressures prompt the new Fed leadership to adopt a more rapid approach to raising the Fed funds target rate, the yield curve could flatten further or even invert. Complicating this picture is that comparable longer-term yields in Europe and Japan will likely stay lower for longer due to central bank intervention. The result could continue to tether comparable US treasury yields and lead to a yield curve inversion in the US, which in the past has been a reliable precursor to recession. However, such an inversion caused by central bank intervention rather than from the natural course of the business cycle could produce unpredictable consequences. This relationship bears watching.
I saved this note until today as a thought experiment even though much of the news on the subject has unfolded over the last few weeks. Circulating at various friend-and-family events through the holiday season I wanted to take inventory of how often Bitcoin and crypto-currencies in general came up since I am usually the “investment guy” in the room. The questions have run along the line of “Should I be getting into this?”, “Am I missing an opportunity?”, and “Are you guys in Bitcoin?”.
Well, actually regifted from last week’s Facebook, Instagram and LinkedIn postings as a reminder to follow us on social media (link icons on the right of your screen).
We highlighted this chart back in late October showing the relationship between the US Institute of Supply Management (ISM) Purchasing Managers Index and Global Corporate Earnings. One of the risks we were concerned about then was if tax reform stalled. That risk appears to be behind us as Congress is set to approve the somewhat controversial tax plan.
Several Wall Street investment firms, notably Goldman Sachs and Barclays, have recently increased their forecasts for global GDP growth to 4% based on improving manufacturing survey data and consumer spending trends. The positive impact on global earnings levels should continue to support global equity price levels even with many market valuation metrics full or in some cases stretched. Robust global economic activity is a welcome development but risks still remain including the path of interest rates in several of the G7 bond markets and geopolitical risks associated with the Korean Peninsula and elsewhere.
Democracy always feels better when standing on the winning side. PM Theresa May got a sense of that in the British snap election a couple months back. PM Angela Merkel is still struggling to assemble a coalition to govern since losing a controlling majority. In Catalonia, PM Rajoy dissolved the regional government, and members of the dissident leadership found themselves in jail or in exile as he called snap elections. That may have added fuel to the fire as Puigdemont and his cadre campaigned from Belgium, or even prison. A theory had been circulating since the separatist movement succeeded in their earlier referendum on independence that the victory, if even legitimate, was the consequence of a vocal and active minority of the electorate, and the majority of Catalans were with greater Spain. That was undoubtedly part of Rajoy’s calculus in calling the election — let the wheels of democracy turn and reassert the will of the true majority.
In thinking about our portfolios, we are not arguing about the merits of the movement. We are contemplating the implications for Spain and for Europe. The international community has come down on the side of Spanish unity, but in a modern Western democracy, the options are becoming increasingly limited when election after election states that a sizeable portion of the population wants an exit. We think it is unlikely that a program of sanctions or even military action would or could be pursued without creating destabilizing ripples in other regions of Spain and across Europe. If democracy, ugly and painful as it is, is to hold and free markets are to follow, we would anticipate Spanish and European concessions to give Catalonia just enough of what it seeks to make it more attractive to stay than to leave. We see strength in the broad European market and have a long-term view that the Euro will rise, but in the nearer term we could see instability and even retreat in both as concerns about the integrity of the currency come back to the fore and discontent in peripheral Europe puts a tarnish on the economic shine. Germans are having trouble leading the region while they cannot lead themselves, Britain is on its way out, isolationism and nativism are still on the rise, and Macron’s France does not have the economic and political muscle to maintain regional stability on its own. Absent strong, coherent regional leadership, we believe the path to confidence and stability does not begin or end in but certainly runs through Barcelona.
US Large Cap stocks have begun to outpace their global counterparts in the past several months. Stronger employment trends, improving economic activity, moderate inflation measures, expanding corporate earnings and stable, albeit modestly rising interest rates should buffer US corporate securities heading into 2018, in our view.