It is hard to fathom how low interest rates have gone--negative in some cases--due to the aggressive buying across the total debt spectrum by the ECB as well as the move by investors to take risk off, having zero confidence in the ECB and BOJ to effect change in their markets.
The dollar is caught between widening yield differentials, which should support the dollar on one hand, and foreign investors taking risk off to add to their cash reserves, which in turn boosts their local currencies.
Then there is the prospect of Brexit with scare tactics being used by both sides to influence the upcoming vote, which is another reason for European investors to take risk off, also negatively impacting the markets. The U.S markets are not immune to these issues and are also being hurt by these actions. All of these factors are support a VUCA (Volatile, uncertain, complex ambiguous) environment leading to reducing risk assets.
At the same time, opportunities to profit are being created for investors willing to look beyond these issues and are able to profit from others being forced to liquidate or reduce their positions.
Let me repeat. Negative rates are bad! The implications scare investors, as it is bad for our entire financial system. It penalizes the banks ability to make a profit, therefore, inhibiting lending, the very fuel that drives the economy.
Have you thought about the impact on retirees who live off of interest income? Devastating! In fact, these actions by the financial authorities may hold back economic growth rather than boosting it as intended. The World Bank just cut its global forecast to 2.4% growth this year down from a previous forecast of 2.9% and 2.8% in 2017 down from 3.1%.
Don't expect the Fed to do anything in this environment! Our yield curve is being flattened by actions abroad which are not good for our growth. I stand by my prior comment on raising rates--"One and Done"--until possibly after the election.
I have to admit that it disturbs me that the Fed governors still run around talking about two increases this year. Does this instill confidence or not? I recognize the need to return to normalcy but not now when global growth is so slow, inflation non-existent and the Brexit vote so near.
Against this backdrop, most governments here and abroad are doing absolutely nothing to enact policies so sorely needed to stimulate consumer demand and investment spending. The FRB, ECB, BOJ, OECD and other major financial bodies all say that monetary policy has gone as far as possible to boost global growth and call on governments to do what is needed. It seems to have fallen on deaf ears and that is the problem facing all of us today. Where are the mind shifts so sorely needed to right the global ship and promote growth-oriented policies? Are they all so blind or paralyzed that they can't see or do what is needed?
So what is the answer? Vote the bums out and let's bring in those willing to make the hard but clearly obvious changes to policies and regulations needed to liberate the system and promote growth. Can you see how the rise in popularism around the globe has enhanced Donald Trump's chance to win in November? It is not a vote for him but a vote against the establishment. And Hillary represents the status quo.
The U.S is in much better shape than other major industrialized nations but in the end we will be hurt by problems oversees. You need to know and understand what is happening everywhere in the world, and the implications of one economy on another in order to effectively manage money today.
Like us, you need to be global asset managers!
While I do not believe that Britain exiting the Eurozone would have long term implications on global growth, the uncertainty about the near term effects has destabilized all markets. No one truly understands the process of exiting, nor what the near term disruptions will be. There will be geopolitical risks for sure and most of the real impact will fall on Europe with very little "real" spillover to other parts of the world. I understand the arguments for and against Britain remaining as a member of the Eurozone. The truth is that the concept of one Eurozone for all members is good but it has not reached its potential, as benefits are limited to trade and currency. To be successful, a true Eurozone must include uniform regulatory, tax and other policies as well.
The global financial markets appear on hold until resolution of the Brexit vote on June 23, 2016. I expect the financial markets to fall initially if the vote supports Britain exiting the Eurozone until we better understand how the transition period will work and the impact it may have on the mood of other European nations. Who knows if they may who may follow suit with a similar vote. The real issue is whether the Eurozone survives in its current form or if the changes needed are enacted to make it work better for all its members. The Brexit vote is a wakeup call for all its members regardless of how the vote goes.
So, we have a push down in global rates and an upcoming Brexit vote is paralyzing the financial markets.
Let's look at the most recent economic data by region and see if there are any changes in our core beliefs, capital allocation and investments.
Data points support a near term acceleration in second quarter growth in the U.S: consumer confidence remains near an 11 year high in the U.S at 94.3 in June however consumer confidence in the future continues to fall; U.S 10 year bond yields fell near a low for the year breaking beneath 1.67%; the dollar rallied as the yield differential widened with foreign bond yields; consumer credit rose by 4.49% in April down from a torrid rate of 9.57% in March; consumer debt to disposable income is 18.9% down from a peak 23.4% in 2004 supporting our notion of a mindset change in consumer psychology; labor productivity fell at a 0.6% annual rate in the first quarter as hourly compensation surged to a 3.9% annual gain and Fed Chairman Janet Yellen virtually said that the next Fed rate hike will be delayed until employment growth re-accelerated and global growth improved. The Fed will come out with new economic projections shortly which will show a reduction in growth this year from its prior forecast but also a bounce back in the second quarter.
We maintain our view that economic growth in 2016 will be slightly above 2.0% with inflation beneath 1.5%. The surprise will be that corporate profits will beat prior expectations with S&P earnings nearing $125 per share in 2016. While the stock market remains statistically undervalued, the pause button has been hit until after the Brexit vote.
Bond yields fell to record lows in most countries as exampled by the 10-year bund falling beneath 0.06% and the 10-year gilt beneath1.25%. Risk off trades led to major declines in most European stock markets. There has been a slowdown in economic growth throughout the Eurozone in the second quarter after a surprising strong 0.6% gain in the first quarter. Yes that was 0.6%! I still believe that the ECB forecast of 1.6% growth in 2016 and 1.7% in 2017 will be revised downward. Inflation remains non-existent.
Even though China will most likely grow in excess of 6.5% in 2016, which is above our internal forecasts, it is clear that the government is not moving fast enough to reduce the number of zombie companies, reduced inefficient capacity and bring down debt levels to more manageable levels. German Chancellor Angela Merkel said this past weekend in Beijing that no one wants trade wars and that China needs to follow through on its promises as well as reduce overall debt levels. David Lipton, IMF first minister, also urged China to reduce overall and corporate debt meaningfully from 225% and 145% of GNP before it becomes an insurmountable problem. China's government has the will and means to complete its transition to a consumer based economy from production based but its timeline may differ with the West. It certainly does not help China or any major industrialized nation that global demand and trade has slowed dramatically.
Japan and India had better than expected first quarter growth of 7.4% and 1.9% respectively. India will clearly be one of the major engine's for global growth in the future will Japan has to face many challenges that limits future prospects.
I want to reiterate the oil prices are most likely range bound between $40-$55 per barrel. It is interesting to note that there was a slight increase in U.S oil production last week and the number of U.S. drilling rigs has stabilized as oil prices have approached $50 per barrel. A combination of increased production in Iran, a reduction in supply disruptions and the threat of increased shale production should cap oil prices at these levels.
So where does all of this leave us?
The political battle for President is clearly between Hillary Clinton and Donald Trump. It will be interesting to see if some Bernie Sander's supporters shift to Trump or not. I still believe that the odds favor a Trump victory which is really the outsider beating the establishment. Watch very closely who Trump picks as his running mate. John Kasich would be a wise choice. The call for change won't be limited to the United States.
The United States remains the market of choice as we are in better economic and financial shape than other major industrialized countries despite the many problems that need to be tackled. Our corporations are also ahead of their competitors abroad making the needed changes to their overall corporate strategies so needed to compete and enhance future returns.
While I still believe that the market is statistically undervalued, this really is a market of stocks where each and every one needs to be analyzed looking for either positive, negative or no change.
My portfolio is comprised of companies with earnings, cash flow, free cash flow and dividend growth in 2016 and beyond. Each investment has increasing returns on investment and current yields over 3.0%. That's pretty good in a world of virtually 0% short-term rates.
So remember to review all the facts, consider the proper asset allocation and risk controls, consider how mindset changes impact consumers and corporations, do in-depth research on each investment and ...
Invest Accordingly!
William A. Ehrman is managing partner at Paix et Prosperite LLC.