WHATEVER IT TAKES
For central bankers in the major economies around the world, the above has been their credo – is their credo and seemingly, will be their credo for some time to come. Whether it be Ben Bernanke of the U.S. Fed or his successor Janet Yellen or Mario Draghi (President of the European Central Bank) or Mark Carney (the former head of the Canadian Central Bank and now chief of the Bank of England ) or BOJ Govenor Kuroda (head of the Japanese Central Bank) the message to the world’s markets is the same – there will be enough liquidity to prevent deflation and to spur economic growth from its present lethargic state. There is an old market saying that investors should never “bet against the Fed”. In other words, if the central bank is going to provide the marketplace with lots of “cheap money” via low interest rates, then the smart bet would be to be “long the markets” – i.e. be invested in bonds and stocks, but do not hold cash. For investors with a “long view” who have successfully overlooked the numerous fears of the “market” which have appeared over the past several years and focused on the actions of the central bankers around the world, they have been nicely rewarded. The “fearful” have been left behind.
Very recently, President Draghi took an extraordinary step in his fight against a perceived threat of European deflation by cutting interest rates to a negative number. In other words, it will now cost banks to keep deposits at the ECB. Banks will no longer earn interest on their deposits – but pay interest on their deposits. OUCH!!! This should hopefully spur some lending in the Eurozone, which should augment European growth. In the U.S. Fed Chair Janet Yellen acknowledges that economic progress has been made. Unemployment is down pretty significantly to 6.3% from around 10% a few years ago and below the original target of 6.5% that Chairman Bernanke set as a decision point with regard to action on interest rates. But for Chair Yellen no single data point is going to be determinative. The unemployment rate alone is not sufficient reason to move rates. Rather, there will be a collection of data which will guide her course. So far, she has indicated that the overwhelming evidence suggests that interest rates need to stay low for quite some time still. In Japan, the message to investors is much the same. In China monetary policy is also quite relaxed. So from this important perspective (i.e. that of monetary policy around the globe) we would suggest that investors should “go with the flow” and stay invested.
POLITICS: THE GOOD, THE BAD AND THE UGLY
The world is nothing if not complicated. In India, the BJP (a conservative and considered business friendly party) won a resounding result in the national elections just held last month. The markets in India took off. With complete control of the executive and legislative branches of government, it is hoped (and expected) that the BJP will be able to successfully enact laws which will streamline the economy and enable the economy to perform as many have hoped for years, but who have been disappointed for years. In Indonesia, the first rounds of elections have been held and it looks as though the “market” favorite will eventually succeed. The final result will be known in July. These are the GOOD politics. Brazil is in the midst of World Cup play and so the focus is not politics per se – but futbol. President Rouseff has lost a lot of popularity recently and political “clout”. Recent opinion polls show her losing significant voter support and the markets in Sao Paulo have rallied on the news. We do not think she will lose the election this fall. If she does markets will rally strongly. If she wins, perhaps her “margin of victory” will chasten her to alter her behavior and become less “interventionist” in Brazilian business. Egypt just put General Sisi into the Presidency. Hopefully now some stability will come to the “Land of the Pharaohs”. Egypt has the potential to be one of the fastest growing economies in the Middle East – but only if it can stay “on track”. These are the BAD politics. Ukraine, Russia, Iraq, Afghanistan and Thailand – these are the UGLY ones. Gunshots and missiles fired to move political “chess pieces” around a board and silence dissent. In reaction, currencies devalue, bond and stock markets decline, people flee across borders. The UGLY places are the ones that provide the “scares” for investors. A bomb explodes in Baghdad and some start to wonder about the effect on oil prices. People are shot in Ukraine and pundits start to think of another “Cold War” and markets from the U.S. to Tokyo react. The UGLY ones keep people up at night worrying.
We do think that the BJP win in India was consequential. We believe that India might achieve its economic promise and investors should “own India”. Indonesia could also improve its lot with better political leadership. While not a big market, with better stewardship, people should be exposed here. If Rouseff loses, investors will cheer. While we think that happy outcome unlikely, a significantly reduced plurality might spark some much needed behavior change by the President. This would be helpful to the markets. Fortunately, most of the UGLY ones are states of no particular economic significance. Even Russia, a former Superpower, only has one important product for sale – energy. Happily for the world, Russia needs its customers and their revenues as badly as its customers need the energy. So we would not expect any sort of “Doomsday” scenario where energy supplies to the West are cut off. Otherwise Ukraine, Iraq, Afghanistan and Thailand can provide reasons for investors to worry. But Wall Street loves “to climb a wall of worry” as it has for several years.
VALUATION
Since our last note, equity markets around the world have advanced. Rallies have been strong in some of the emerging markets (like India) and some of the European indices (like Italy, Spain and Sweden). Bond markets have also rallied because interest rates have gone down and not up. Nevertheless, we continue to think that bond markets around the globe are expensive. First quarter earnings were generally better than expected by analysts. Second quarter profit reports are on tap. We suspect that again companies will positively surprise. Economic growth around the globe is getting stronger as 2014 gets older. The second half of the year should also be stronger for corporate earnings. All this is to say that equity valuations are still well underpinned by company profits or cash flow. Certain stock markets are cheap (the “Emergings”, certain bourses in Europe) while others (i.e. the U.S.) are fairly valued. Corporations continue to buy back lots of stock and raise dividends. These actions further lend support to the equity market valuations.
SO WHAT DOES ALL THIS MEAN?
- The Central Bankers of the world are on the side of the investor for the forseeable future. Money will be cheap. Safety (i.e. cash) is expensive because you get no return on it. Risk in comparison (i.e. stocks and bonds, but especially stocks vs. cash) is cheap because you can get a return on it.
- Some countries (think India and Indonesia) are getting better leadership and should be improving places to invest. Some places (think Iraq and Russia) will keep you awake at night.
- Valuations are still generally supportive of equity prices. Stocks are not wildly overvalued.
PREDICTIONS FOR 2014
- Housing will be an engine of growth for the U.S. economy. – Still believe but harsh winter held back builder plans
- Employment will improve throughout the year. – Yes
- Businesses will invest more money. – Still Believe
- Companies will raise dividends & buyback stock. – Yes
- The Fed will complete its tapering late in 2014, but will not increase short-term interest rates. – Yes
- Economic growth in China will pick up speed, as will growth in Emerging economies. – China is planning on 7.5% v. 7.7% growth – others a “Mixed Bag.”
- Asian consumer spending will grow. – Still Believe
- The Eurozone will do better economically – as will Japan. – Yes
- The U.S. bond market will have another bad year. – Still Believe
- The U.S. stock market will have another good year. So too will Eurozone & Emerging markets. – Still Believe – OK so far
The opinions expressed in this Commentary are those of Baldwin Investment Management, LLC. These views are subject to change at any time based on market and other conditions, and no forecasts can be guaranteed.
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