Note February 26,2019: Considering The Tides of March – Since 2009 with fleeting deviations, capital markets have come to be fixated on central bank policy, especially from the Federal Reserve. Its Semi-Annual Testimony to Congress of February 26, 2019, signals interregnum in rate increases and balance sheet reduction. Central banks may be anxious to not prematurely raise rates as happened in the longest standing quantitative ease program of Japan. Prolonged ease there coincided with a decline in its world beating status in myriad industries, governance scandals and the tarnishing of quality standards, admittedly for many reasons.
In the tides of March 2019, capital markets may have a much less robust favorable response to lessened progress towards containing credit than in earlier in this cycle. After all, global growth appears slowing, within and as a whole. Furthermore, trade and geopolitical tensions as well as terrorism responses are not issues with solutions in a month but instead, are a process.
There can be little doubt that yields are extremely low in many benchmark sovereign issues. Phraseology such as equities not being extremely expensive may offer solace to the momentum participant but not so to the value investor. Much less commented upon for instance, is the appropriate stratification of equity valuation versus the long term delivery of growth. Even in ostensibly defensive consumer staples (and globally elsewhere), business imperatives loom as being brand and business pruning.
In asset and equity mix, being overweight benchmark seems appropriate in cash and alternate hedging via precious metals. For markets overall, we espouse focus on quality and of Financials as being crucial in leadership.
Since 2009, large portions of capital markets have come to be fixated on central bank policy, especially as it relates to the Federal Reserve. Any deviations have appeared fleeting but it is appropriate in markets to be considering the tides of March 2019. After several quarters of signaling change towards a more neutral policy stance, in the January 29- 30, 2019 FOMC minutes as well as now in the Semi-Annual Testimony to Congress of February 26, 2019, the Federal Reserve has appeared to signal postponement of Fed Funds rate increases and an interregnum in balance sheet reduction for 2019. Our Fed Funds target of 3.50% at peak may not be that different from the Federal Reserve target of 3.1% in 2020/21. Still, these nearer term aspects of interregnum have not developed in isolation are more controversial.
Global growth in GDP has shown signs of slowing towards 3 ½-4% annually in aggregate, with slowing also sector wise from China to Japan to Europe with several countries flirting with recession and not least within the United States. Central banks ranged from the ECB to the Peoples’ Bank of China to the Bank of Japan to the Reserve Bank of India have also indicated pause or even policy reversal of varied degrees in response perhaps credit and/or political pressures. Central banks may be anxious not to repeat prematurely raising rates as happened in the longest standing quantitative ease program of Japan. Market participants need also to recognize that the prolonged massive quantitative ease in Japan has also coincided with a marked decline in world beating status in a number of its industries as well as emergence of governance scandals and the tarnishing of quality standards, admittedly for many other reasons as well.
Unlike the physical sciences when it comes to understanding long term impact, laboratory testing is unavailable for financial policies like quantitative ease and artificially changed cost of capital for prolonged periods. However, salient real time examples do exist. We maintain that Federal Reserve policy in enforcing elevated risk premiums played a major role in divorcing markets from incorporating inflation well into the 1980s and contributed to the global benefits of restructuring based on efficiency, not expediency, in country after country and in industry after industry. Around the end of the 1980s, massive quantitative ease was initiated in Japan ostensibly to cushion exit from excess credit and financial engineering thereof. Such ease still continues in Japan with debt ratios also having increased. Whether by cause and effect is immaterial but for Japan, this period has also coincided with both a decline in global beating industries and the emergence in individual companies in many diverse industries of governance and quality control scandals.
We believe capital markets should be watchful in the tides of March 2019 for a much less robust favorable response to indications of lessened progress towards containing credit. In fact from the BIS to the IMF in recent commentary to the Congressional Budget Office in January 2019 and the Federal Reserve Semi-Annual Statement to Congress just released in February 2019, have come overt warnings on debt leverage and public sector deficits. Since 2009, central banks have been encouragingly instrumental in stress testing in banking using a variety of scenarios and in several cases enforcing capitalization change. Still, they have appeared less keen to even comment likewise on broader industry practices like financial engineering that have emerged in conjunction with prolonged quantitative ease.
Furthermore, trade and geopolitical tensions as well as terrorism responses are not issues solved in a flash or a month but instead are a process. Into March 2019, there loom trade tensions between China and the United States with more than superficial parallels of the same in the 1980s between Japan as largest net surplus holder and the United States as the largest net importer and which involved protracted change. In Europe and despite timelines well known for two years, the Brexit negotiations over the initial departure of Britain from the European Union appears convoluted at best, not least over trade. On terrorism and response, the reality appears to be one of conflagration from South Asia to the LeVant to North Africa and well beyond, despite the claims of the defeat of radicalisms. U.S. and North Korean negotiations are also likely, despite the hoopla, to be of long term duration.
The currently liberal use of phraseology such as equities not being extremely expensive may offer solace to the momentum participant but not so to the value investor. There can be little doubt that yields are extremely low in benchmark sovereign areas like U.S. Treasuries. Commentary abounds about equities appearing comfortably priced against the current rate of fixed income yields. Much less is commented upon for instance about the appropriate stratification of equity valuation versus the long term delivery of growth.
Yet, global growth appears far from robust and slowing. In several industries, companies in their recent releases have appeared cautioning on growth, not least in the consumer sector. Marquee industrial companies in several countries have been forced into divestment. Even in the ostensibly defensive segment of consumer staples, the business imperatives have expanded from scoffing about private equity attacks and into painful recognition of the necessity of brand and business pruning. For that matter, the same could be said about business prospects worldwide from Healthcare to Information Technology to the Financials especially in Europe and in Materials, including precious metals.
We believe that at the asset mix and equity mix levels, being overweight benchmark seems appropriate in cash and alternate hedging via precious metals. We suggest an underweight in long duration fixed income. Taking into account recent developments from economic growth to company releases to central bank positioning, we espouse in equities and capital markets at large, focus on quality of business delivery and balance sheet structure, notwithstanding prevailing low administered rates. Despite the tribulations on their role in this cycle, we envisage the performance of Financials as being crucial in leadership. 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.