Note Précis October 29,2018: Alternate Universe – Recurring vs. Amplitude of Delivery. Over the decade of massive quantitative ease, the generally accepted universe has been one of ample liquidity and of low interest rate policies including the suppression of fixed income yields. Progress has been uneven and the efficacy of prolonging quantitative ease has become questionable. In policy and market response, issues set aside have included the levels of deficits and debt incurred by governments and quasi government organizations. Not to be outdone, private companies engineered massive equity buybacks. Complacency about this universe persists, illustrated by discussions about a flattening yield curve. There is an alternate universe to consider.
The political environment seems one of populism from Germany to Brazil. Violence is acute in the Levant but is not limited to it as seen in pre-election United States. Politically palatable appears to be spending increases. In an oblique stance designed to raise the costs of fiscal profligacy with global growth slower but still positive at a 3 ½% annual GDP rate, the central banks in effect could be accepting of the entire yield curve in major economies rising. After many months of 10 year U.S. T-Note, BBB corporate and emerging market yields closer to twelve month highs, signs of change now include rising yields in CCC corporate fixed income and suggest an alternate universe to that of 2008-18.
Equity risk premiums and valuations do change with fixed income yields. We expect Fed Funds to be close to 3.50% and 10 Year Treasury Note yields to be closer to 4.50% as ongoing growth moderates and deficits interplay with markets. Also, focus on recurring earnings is perforce necessary for sustaining equity valuation. The focus of momentum can often be and until recently has been on the amplitude of near term earnings change. In 2018 so far and despite U.S. tax cuts, equity indices have globally turned lower. Individual equity prices seemingly appear less receptive to earnings amplitude alone. Stronger than global economic growth has been no panacea even in larger emerging economies whether more domestically oriented like India or China with its export strategy facing a tariff war with the United States. Amid recent reporting worldwide, focus on revenue shortfalls appears more intense. Bifurcation abounds across sectors. In equities also, expanding appears an alternate universe focused more on recurring strength and less on the momentum of amplitude. It would favor quality even as global growth continues.
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.