Note Précis September 26,2018 – Search Beyond QE For More Solid Ground: After a decade of basking in quantitative ease that in equities included massive mainly U.S. share buy backs, capital markets will likely search for different solid ground. Capital markets will potentially be more volatile. Common for more mature phase capital markets, fraying in 2018 can be seen for example in fixed income, in emerging market equities and in a narrower composition of the stocks driving up U.S. equities. We expect another 25 basis point increase in Fed Funds in December 2018 as well as 3.50% rate by September 2019, just above but earlier than the Fed FOMC forecast of a potential cycle peak. Performance and valuation risk appears in fixed income for a variety of reasons but is more classical than many appear willing to countenance.
Even as some espouse high valuation as appropriate amid quantitative ease, we hold two equity episodes to be historically instructive namely that neither prebubble 1980s Japan suppositions of superior management and low interest rates driving valuation held nor did the prebubble 1990s NASDAQ suppositions of valuations being irrelevant for secular growth. Reformulation of sector composition seems more of an ETF and leadership composition issue. Differentially, potential for U.S. 10 year Treasury yields to rise to 4.50% into late 2019 would likely constrain both valuation and share buybacks. The next phase of earnings and corporate performance will start soon. Our favor is for quality.