Note July 23,2019: Renewed Ease, Renewed Market Subsidy- Prolonged state ownership of capital assets peaked in the late 1970s, to be unwound on efficiency grounds over the subsequent two decades. Freer market proponents need to consider efficiency risks as another arm of government now again expands in effect the prolonged subsidy of capital assets. From negative yield bonds to equities, markets appear once more to be opting for momentum from new quantitative ease led by Federal Reserve rate cuts.
In an environment of slowing growth and heightened trade tensions, currency volatility risk seems a reason to favor precious metals for diversification. Elevated geopolitical tensions appear from South Asia, the Korean peninsula and Levant violence now including the Persian Gulf. The U.S. debt ceiling extension and other fiscal developments worldwide still leave capital markets flows unsettled.
We see Real Estate exposure as underweight due to its already elevated status in response to quantitative ease. Equity markets appear sustaining index levels but punishing of individual companies demonstrating weakness. Response differences need watching on merely meeting very low consensus. We believe volatility is likely to be elevated. We espouse quality as well as diversification for instance by favoring leading financials, energy, precious metals and delivery information technology, rather than being concept/social media oriented. We also underweight consumer areas on traditional business cycle features (its present length notwithstanding) and new operating business challenges which are likely to make them early in feeling any downturn.
Prolonged state ownership of capital assets peaked in the late 1970s. Over the subsequent two decades, many such holdings were unwound on efficiency grounds. Freer market proponents need to consider the risks as another arm of government now in effect expands prolonged subsidy of capital assets by new quantitative ease. Massive quantitative ease has already been in place for a decade and in cases like Japan for much longer. In turn currently, markets appear once more to be opting for momentum based on renewed quantitative ease.
Capital market participants appearing willing to extend exposure based on central bank positioning is demonstrated by recent action from lower quality corporate bonds to emerging market bond yields being closer to twelve month lows to German and Dutch government bond yields being more negative even than those of Japan. The U.S. administration and Congress may have agreed on a two year debt ceiling extension but the size of its deficit buildup and its implications for capital markets flows remain unsettled. The same is true of fiscal developments worldwide.
Meanwhile, political angst appears moving upwards. Within the United States and over fifteen months ahead of an election, emotions run high on societal issues like immigration. For Europe, a new set of European Union leadership still needs to coalesce on policy. Institutions like the IMF also singularly stress that the Brexit issues in Britain have global cross border trade impact in Europe and globally as well. The tensions between China and the United States remain elevated, including the issues of tariffs and trade. As the past demonstrates and not just in the 1930s, trade risks becoming an even more stressful broad relationship issue were global growth to slow. Geopolitical tensions appear being elevated as shown in events linked to South Asia, the Korean peninsula and the violent Levant now including pressure point retaliation in the Persian Gulf.
Since the July 10, 2019 Federal Reserve Semi-annual Testimony to Congress, expanded in official Federal Reserve circles appears gelling onto a Fed Funds rate reduction. In their pronouncements, other central banks appear to have commenced before such as the ECB in its pronouncements, with others following suit and the IMF seemingly supportive. In many cases, central banks also seem obscuring clarity of purpose by referring to weakening global growth forecasts for immediate policy support but still opting not to give equivalent prominence to longer term factors like deficit and debt control.
To us, it is hard to define a whole decade and in some cases more, such as Japan, of quantitative ease as merely involving short term measures of limited long term risk. The late 1960s/early 1970s demonstrated that inflation pressures can seem latent but then flare rapidly. Many cases of corporate finance excess by companies individually show that a failure to harbor cash reserves can result in extreme corporate duress, whether taking place in expansive or in tighter business environments. The Federal Reserve is likely to reduce interest rates but unlike the conventional wisdom of today, we would be watchful of the potential for currency volatility. In an environment fearful of slowing growth and certainly amid heightened trade tensions, currency volatility risk seems to us to be a reason to favor precious metals for portfolio diversification. We see Real Estate exposure as an underweight due to its already elevated status in response to quantitative ease.
In its latest projections, the IMF has reduced anticipated annual GDP global growth towards 3 ¼ to 3 ½ % over 2019/20. Advanced country and major emerging country growth rates such as for China and India appear slower. Across continents and stages of development, there appears deeper stress for countries like Italy, Turkey, Venezuela and several others. At the same time and led by U.S. based companies, quarterly corporate results are starting to pour out. Earlier in this earnings cycle, reduced earnings delivery compared to initial expectations appeared to be regarded as secondary when compared to the importance of beating the immediate consensus. At the time, the earnings growth recovery metric was still strong. As most central banks remained in the mode of quantitative expansion, it was followed by valuation expansion. With the central banks again appearing now to re-emphasize ease led by the Federal Reserve, albeit at lower tranches than before and valuation elevated, we would be watchful on the type of market reaction to the meeting of consensus at a much reduced base, for example at under 1% year-over-year earnings growth for the S&P 500.
So far, the capital markets appear again focused on quantitative ease as contributing to maintaining index levels but also being very punishing of individual companies that demonstrate weakness and/or who appear to being left behind their sector compatriots in terms of business delivery. We believe equity volatility has the potential to be elevated and so espouse quality as well as diversification for instance by favoring leading financials, energy, precious metals and delivery in information technology rather than concept/social media oriented segments in that sector. We also underweight consumer areas on the basis that were economies to weaken even more than current indications, traditional business cycle features (length notwithstanding) and new operating business challenges would likely make them early in feeling the pain of downturn. StrategeInvest’s independent consultancy operates as Subodh Kumar & Associates. The views represented are those of the analyst at the date noted. They do not represent investment advice for which the reader should consult their investment and/or tax advisers. Any hyperlinks are for information only and not represented as accurate. E.o.e.