We write mostly to tell you that we have examined all of the recent economic and company specific evidence that we can find and see nothing that changes our views or themes. Tensions in the Ukraine and the Middle East have obviously elevated the geopolitical risk factors of investment decision making. Nonetheless, we have made no major shifts because of these events as we were already quite cautious.
The most critical point we can make at this juncture is that it seems clear to us that the Fed is set to end QE in October at a point when sustainable growth is no more assured than when it commenced this latest ill-conceived scheme. In addition, Japan’s mammoth money printing effort looks to have been a failed policy as well given poor economic data from that nation.
We put forth two more thoughts. First, though we wish it were otherwise, under the adage of “give a man (or woman) a hammer…” we would not be surprised to see more QE in the next year if equity markets correct substantially or economic growth becomes even more disappointing. Second, we would suggest that if the end of QE causes treasury rates to rise meaningfully, which we doubt, then it just might be riskier markets like equities, high yield bonds, and European sovereign debt including that of Italy and Spain which run into major trouble. After all, we do know that those asset classes stand out as the most expensive that they have ever been on the misguided belief that QE has somehow removed company specific and default risks across the board.
With so many stocks already down 15-20% from their highs, we would suggest that investors are beginning to wake up to the fact that the central planners are unable to insure against each and every case of earnings disappointment, though they speak as if they can. In addition, rapidly falling European financials stocks indicate risks are mounting in another region declared “fixed.” Italy is now officially back in recession and its equity market has cracked 15%. Furthermore, credit ratios do not look to have turned the corner in a positive way across the EU.
The central bankers have been backed into a corner because they have been left with only one tool and it has failed to produce the authentic recovery they and their text books promised. Having made no moves to tighten policy after so many years since the last official recession in the U.S. and constantly cheering for equities even at these multi-year highs, we wonder what is really left to placate markets let alone alleviate economic dysfunction. The big question is what happens when those still fawning over the Fed realize that earnings have not remotely kept pace with stock prices.
The views expressed on this blog are the opinions of the authors. This information is not intended as investment advice or to recommend the purchase or sale of securities. More information on Strategic Balance, LLC may be obtained by contacting investor relations.