What’s Ahead for the Global Economy and Financial Markets?

Last week, the Federal Reserve raised rates- the third increase since the financial crisis.  Yet, despite world economic growth and the stock markets surging since President Trump’s election (until yesterday), the Fed is still cautious about the future.

The world economy has been picking up.  The Economist reported last week that “today, almost ten years after the most severe financial crisis since the Depression, a broad-based economic upswing is at last underway.”  This is a big change from the early months of 2016 when stocks were down 10% or more due in part to anxiety about China’s economy and related plunging raw material prices.  Fortunately, China, through controls and stimuli, turned things around and by the end of 2016, China’s nominal GDP was growing again.

At the same time, global manufacturing has gotten stronger.  Factories are much busier in the U.S., Europe and Asia.  Taiwan and South Korea are rocking.  Worldwide equipment spending is up; growing at an estimated annualized rate of 5.5% in 4Q16.  American companies, excluding farms, added 235,000 workers in February.  The European Commission’s economic-sentiment index is at its highest since 2011.  Japan, whose growth has been anemic, has revised their 2017 forecast from 1% to 1.4%.

The stock markets have, until yesterday, risen dramatically based on both current economic growth stats and expectations about the future.  With Mr. Trump’s election, there has been hope that taxes and regulations will be reduced which would help businesses and increase corporate profits.  Further, the expected return of $1 trillion of untaxed cash held overseas by American companies could be coming back (repatriated) at new low tax rates.  These funds could produce a big boom in business investment.  And, then add to this the possibility of a $1 trillion private-public infrastructure push for America. Mr. Trump has been talking about growth of 3.5-4%.  There’s been lots of optimism.

Yet, Fed officials forecast growth of only 2.1% this year; about where it has been for 8 years.  So, what’s their cause for relative skepticism?

The list of concerns includes fears about protectionism stifling trade, political disruption in Europe, China’s ability to sustain strong growth, and closer to home, whether or not the White House and Congress can work together to get legislation passed.  If the repeal of Obamacare gets sidetracked, there is concern that tax reform and infrastructure will endure the same fate.  And, of course, we haven’t even talked about a black swan- an unexpected event of large magnitude and consequence.  All bets are off in the case of major problems such as war, terrorism or some other major catastrophe.

We could be on the precipice of a new era with the cutting of taxes and regulations and a huge infrastructure boom creating a turbocharged economy.   Or, we could have a repeat of the many times in the past decade when optimism at the start of the year faded as the year progressed.  No one knows what the future holds.

Yesterday’s stock market declines of roughly 1% were, in large part, a concern about the ability of the White House and Congress to enact their legislative agenda, starting with the repeal of Obamacare.  People are nervous that if the health-care bill doesn’t pass or gets delayed, what will that mean for other policies.    Tax cuts could be delayed and even face a tougher fight in Congress.  Treasury Secretary Steven Mnuchin had earlier thought that tax reform would pass Congress by August and now he is hoping for early next year.  And, infrastructure would come after that.

With all of that in mind, the Fed understandably is cautious and we at DWM are as well.


brexitJune 23rd is a big day.  Brits, including all members of the Commonwealth, will be voting on leaving or remaining in the European Union (“EU”).  It’s a big deal.  And, it’s only the tip of the iceberg regarding the future of the UK and Europe.  At this point, the expected result of the possible British exit from the EU (called Brexit) is too close to call.  Here are some of the key points:

The Ayes.  Those who favor leaving argue that the EU has changed substantially since the UK joined it in 1973 with regard to size, reach of bureaucracy, diminishing influence and sovereignty.  They also point to the failure of the euro as a common currency and recent migration debacle across Europe.   Vocal supporters of the Brexit movement are the U.K. Independence Party, half the Conservative members of Parliament, Boris Johnson, former mayor of London, a group of “Economists for Brexit” and even Marine Le Pen, president of France’s National Front party.

The Nays.  Those who favor staying believe there would be huge economic losses, particularly in London’s financial sector, as well as the need to be part of larger block of like-minded companies to have real influence and security in the world.  British Prime Minister David Cameron leads the “remain” camp; his Labour Party, the Liberal Democrats and the Scottish National Party are all on board.  President Obama, Angela Merkel and President Xi Jinping of China also want Britain to stay in.

History.  In 1957, the Treaty of Rome created the European Economic Community or Common Market.  Britain tried to join in the 60s, but its applications were vetoed by Charles De Gaulle.  De Gaulle died in 1970 and Britain finally joined in 1973.

The debate is more than Brexit.  It really is a question of more European unity or less.  While some see “more Europe” as the solution to all of Europe’s problems, others see “less Europe” as the answer. Back in 1992, Margaret Thatcher proposed an “a la carte” system which would allow governments to be able to select the quality and degree of their participation in the EU as the best strategy for the future. Many EU member countries support that view today.

The EU institutions have failed in a number of key areas. First, the euro, established without a solid program of discipline or transfer payments, has led to stagnation, high unemployment and political instability in much of Europe. Second, migrants surged across Europe last year because the EU had abolished internal borders before strengthening external ones.  Creditor nations like Germany want “more Europe” and more discipline.  Mediterrean Europe would like “Europe lite” with more help on bailouts, sharing of debt, etc.

Potential Economic Impact of Brexit.  Two weeks ago, “Economists for Brexit” published a report that Brexit would be good for Britain– estimating in 10 to 15 years that its economy would be 4% larger than if it had remained. This group of academics likened the EU to a “walled garden” that imposes punitive tariffs and regulatory barriers on goods and services produced outside its 28 member state and that leaving the EU would enable the UK to unilaterally lower trade barriers.

On the other hand, last week the Bank of England warned that a vote for Brexit would be likely to cost jobs, raise prices and see the pound sterling plummet. The financial services industry centered in London could be one of the biggest losers.   On April 30th, the Economist opined that the EU would suffer from Brexit and therefore would not be kind to Britain afterwards during the ensuing two-year period of “divorce” negotiations.

Conclusion.  There’s a lot at stake in the June 23rd referendum for both Britain and Europe.  And, for many, it’s not just economics. It’s a part of a broader movement we’re seeing across the world- the election to president last week of a brash non-establishment politician in the Philippines, the huge popularity of “Hamilton” based on the centuries old, but still omnipresent, conflict of federalism vs. states’ rights, and, certainly, the presidential primaries here in America.  Angry voters across the world are not happy with the status quo and want a change to bring their country back to the “good old days.”  Anti-Europe parties across the continent are supporting and campaigning for Brexit.  Three days after the Brexit vote, Spain will be holding its general election.  In 2017, France and Germany and likely Italy will hold national elections. No wonder this referendum is too close to call and a potential harbinger of things to come in Europe and, perhaps, the world.

Time for a Stock Market Correction?

bullsvsbearThe overall calm, positive performance of financial markets in 2014 took a hit on July 31st when stocks declined 2-3% and fixed income and alternatives lost about 1%. Markets have been about flat since then, yet talk about a stock market correction of 10% or more has escalated.

There’s lots of reasons why some believe a correction could happen:

  • Valuations of stocks are high. The current P/E ratio of the S&P 500 is 15.7- higher than the 10-year average of 14.1
  • Improving U.S. economic conditions have brought concerns about the Fed raising rates quicker than many investors anticipated
  • Europe’s prolonged economic slump is making deflation a concern
  • Economic sanctions against Russia could negatively impact consumer demand in many countries
  • Geopolitical unrest in Iraq, Gaza, Syria, Ukraine, etc. could explode

Yet, at the same time, there are many reasons why some believe the bull market should continue:

  • The U.S. economy is the best in years: new jobs are up, unemployment is at 6.1%, job openings are at a seven-year high, housing is up again after a slow start in 2014, car sales are at post-crisis high, and consumer sentiment is up
  • There has been a huge recovery in American corporate revenue and profits since the 2008-2009 crisis. Yes, lower borrowing costs helped. Second quarter earnings, with nearly 90% of S&P 500 companies having reported, are on track to grow 8.4% this year
  • For a variety of reasons, companies are continuing to buy back large quantities of stock
  • Market peaks have occurred historically when P/E ratios are 25 times earnings or more
  • Geopolitical worries have boosted the allure of “safe” bonds. With U.S. 10-yr bonds at 2.4% and German 10-yr bonds at 1%, stocks continue to be very attractive

Overall, it has been suggested that we are in a “Goldilocks” economy. One that is “not too hot, not too cold.” Stimulative policies, created by Fed Chairman Ben Bernanke and now Janet Yellen have created a great environment for stock growth. However, when investors get nervous about the Fed’s ability to keep the “temperature just right” we have seen big swings. May and June 2013 saw 5-6% drops when the Fed first started talking about “tapering” the QE program. Now, with the economy doing better and inflation nearing 2% targets, investors are concerned that the Fed will start to raise interest rates and change our “just right” conditions. That’s a huge challenge for the Fed. A perceived major misstep or miscommunication by the Fed could again shake the markets.

Yes, at some point we will have a correction in the stock market. History tells us they come along regularly (27 corrections of 10% or more since 1945). Yet, a priori, the reasons were enigmatic. Hence, trying to time the start and finish of such events is useless.

We have a saying at DWM: “There are many variables you cannot control. Long-term success, on the other hand, relies on managing the variables you can control, including reviewing your risk profile and asset allocation, reducing expenses, diversifying portfolios, minimizing taxes, and staying invested.”

Five Years Later: “Advantage America” by Dr. Gary Shilling

Lehman collapseLehman Brothers collapsed September 15, 2008. Five years later, the world is still struggling to recover from the most serious crisis since the Great Depression. Our government seems to be in perpetual dysfunction. The media seems intent on focusing on real and potential problems. It is easy for Americans to feel pessimistic about the future.

There is another side to the story. It is presented by Dr. Gary Shilling who has become quite bullish about the future prospects of the U.S. This is particularly interesting, since Dr. Shilling has been a “confirmed bear” and may be best known as the author of The Age of Deleveraging- Investment Strategies for a Decade of Slow Growth and Deflation, originally published in late 2010.

Dr. Shilling, in his July 2013 issue of Insight, wrote that prospects are bright for a return to rapid U.S. economic growth and a resulting decline in the federal debt-to-GDP. He outlined six key areas where the U.S. is better positioned for the future than any other country- developed or developing. These include:

1.  Demographics. The U.S. fertility rate is currently 2.06 to 1. That is close to the 2.1 rate needed to sustain the population in the long run. All of Europe, and even Canada and Australia, are below the reproduction level. Japan is at 1.30 and China at 1.55. In the long run, this means our population should stay roughly constant and there should continue to be a large percentage of younger workers. This is critical for future economic growth. No other developed country has these characteristics.

2.  Entrepreneurial Spirit. “Despite perceptions of an erosion of U.S. economic vigor, America still seems way ahead of whoever is in second place,” wrote Dr. Shilling. Our educational systems encourage free inquiry and challenging the accepted doctrine. Japan and China discourage individuality and education typically is based on rote memorization and lack of inquiry. In addition, U.S. manufacturing has regained its spot as the most favorable spot for foreign direct investment, pushing China into second place.

3.  Labor Flexibility. In the last 40 years, union membership in the private sector has been reduced from 40% to 6% of the workforce. In the last five years, Americans that are out of work have accepted new jobs, many at lower pay. In the auto industry, for example, the average pay of autoworkers is now less in the U.S. than in Germany or Japan. As a result, American made vehicles are beginning to be shipped abroad in significant numbers.

4.  Declining Need for Foreign Financing. Americans are saving more. Most recognize that you cannot count on double-digit returns every year from your investment portfolio. In addition, you cannot plan on your home equity providing the funds you need for retirement. Therefore, Americans need to save more and they are doing that.

More savings means consumption will grow more slowly. In addition, when spending growth is retarded, this means buying fewer imports. The result will be, in Dr. Shilling’s estimate, a reduction in the U.S. trade and account deficits. This will put fewer U.S. dollars in foreign hands. And, it would mean that America could meet more of its financing needs internally.

5.  Strong Dollar. Despite all of the issues here in America, the U.S. dollar is not even close to being unseated as the world’s primary reserve and trading currency. We have the largest economy, deep and broad financial markets, free and open financial markets and economy, lack of substitutes and credibility in the value of the currency. No other country can boast these attributes. Hence, the U.S. dollar is the only safe haven of any size in a persistently uncertain world.

6.  Energy Independence. America is on the way to self-sufficiency in energy. There are predictions that the U.S. could be relatively free from foreign oil dependency as early as 2020.

Certainly, no one can predict the future. However, Dr. Shilling’s remarks do unmistakably outline the reasons why America is better positioned for the future than any other country in the world. With all the negative media we see, hear, and read daily, it is nice to be reminded and encouraged by positive facts foretelling a brighter future.

What’s Next for the Economy and Markets?

crystal-ballTough question. A more relevant question would be: “How do I obtain long-term investment success?” We’ll discuss both today.

First, the economy and the markets are not correlated over the short-term. Last week’s overall market selloff again demonstrates this. Yes, over the long-run, there is a correlation between GDP growth and corporate earnings. But data demonstrates that over the short-term, there is no correlation.

Second, it is imperative to filter the noise of the media and put the current situation in broader context, than to guess about the future. Our economy is still recovering from the 2008 credit crisis. Similar crises were followed by weak GDP and job growth. The Fed confirmed last week that we are following this historical pattern. Since September 2012, when the latest QE program started, the unemployment rate has fallen from 7.8% to 7.6%. The Fed expects GDP to increase 2.3-2.6% this year. Inflation is up only 1.05% year over year.

Of course, these results, and the stock markets, have been influenced by easy money policies. Since 2008, the fed funds rate has been near zero. Hence, the Fed has employed additional policies to boost the economy. The most significant has been QE. The Economist on Friday described Chairman Bernanke’s tough assignment: “In a zero-interest rate environment, the central bank can influence monetary conditions more through words than through actions.” Mr. Bernanke’s comments last week, which pointed to the path that actions were “data dependent” were interpreted (perhaps incorrectly) by many investors to mean greater “hawkishness” (tapering was about to start). Virtually all markets tumbled.

The economic data doesn’t support a change in the bond-buying policy. Unemployment is still at 7.6%, labor participation rates are near 29 year lows, inflation expectation are falling, and perhaps, most importantly, there has been no substantial improvement in job growth:


Yet, despite the weak pace of overall growth, the recovery in the last four years seems to be getting smoother. The housing market is up, the energy sector is booming, auto sales are improving, household finances are looking healthier and consumer confidence is at a five-year high. The Fed has increased its 2014 growth forecasts to 3% to 3.5%, from a March forecast of 2.9% to 3.4%. So, we’re making progress, but will it continue? And, if so, when will tapering start?

We agree with Yogi Berra, who said: “It’s tough to make predictions, especially about the future.” We humans are not so good with making accurate predictions. However, these days, you can generally find an opinion to confirm almost any point of view. In fact, studies have shown that the most confident, specific forecasts are a) most likely believed by readers and viewers, and b) least likely to be correct.

We prefer to focus on the long-term. People seem to lose sight of their financial future in the midst of all the noise. Most of us have a long-term investment horizon- perhaps 20, 30 years or more. During that time, we can expect bull and bear markets, volatility and short-term market swings. Emotional reactions to short-term events and media noise can cause you to miss market rallies and doom you to long-term investment failure.

You need a disciplined investment strategy and perhaps a full-time professional investment adviser to help you with it. Your asset allocation needs to represent the three asset classes; stocks, bonds and alternatives, with further diversification within each asset class. Your portfolio needs to be reviewed continually and rebalanced regularly. You need to make your capital work for you all the time, and not leave money sitting in cash. Over time, asset allocation, diversification, rebalancing and mean reversion will all work in your favor.

So, we won’t focus on predictions. Instead, what we will do is to help you establish and maintain a long-term probability-based investment approach that should reap dividends and investment success for you for years to come. Give us a call. We’d be happy to chat.

Economy: Private Sector Leading the Recovery

Yes, there has been good economic news since the first of the year; stronger-than-expected employment figures and upticks in manufacturing and services data. Stock markets worldwide have responded. Most bond yields, even in Europe, are down. The Federal Reserve has made it clear that low interest rates will continue for three more years.

Will it continue? Housing seems to have hit a bottom and many households have reduced their debt. However, personal consumption continues to lag and Europe not only has its debt problems, but also many of its economies are in recession. Here in the U.S., we have a budget debacle ahead of us and tax cuts expiring at year-end. And, of course, we need to watch out for black swans that may come from places like Iran. Time will tell what the remainder of 2012 will bring.

In the meantime, it’s valuable to put our current recovery in perspective. The New York Times ran a series of great charts this weekend comparing this recovery to those started in 1991 and 2001. It’s easy to see that private enterprise is providing the bounce. Government spending and hiring is down.

Private investment, not including housing, is now 17% higher that it was at the end of the downturn. But government spending, adjusted for inflation, is nearly 3 percent smaller than it was when the economy hit bottom. Residential investment, which really boosted the two earlier recoveries, is now substantially unchanged. While the housing industry is no longer a drag, it is also not a contributor to the recovery.

Gross Domestic Product (GDP)

For more information: click here http://www.nytimes.com/interactive/2012/02/10/business/economy/off-the-charts-private-sector-leads-recovery.html