Don't miss our newsletter. Please confirm your subscription now at the top of this email.
PATH FINANCIAL LLC
Registered Investment Advisor
1990 Main Street #750
Sarasota, FL 34236
941-350-7904
Raul Elizalde - Friday, September 2 2011
The latest economic indicators, regional and national, paint a picture of a stalling economy. This picture does not have much room for interpretation, so the general view now is that economic growth will be very slow for the rest of the year, keeping monetary policy loose. As a result, interest rates are falling and bond prices are going up.
Those monetarists who fret about the potential inflationary effects of loose monetary policy choose to buy gold instead. Combined, both camps pushed gold and bonds to new heights during August.
Equities at first moved predictably. Since a weakening economy deflates prospects for future earnings, stocks tanked.
But soon stocks recovered a lot of ground, going up seven out of eight sessions, and gaining back about 10% from their lows. Why did this happen?
It doesn’t seem that investors changed their minds about the weak economic outlook. Had that been the case, bonds and gold would have retraced a big portion of their gains as equities rallied, but they didn’t.
The reason why stocks recovered and bonds stayed high may simply be that the market concluded that with economic prospects so weak, policymakers have no other option than to inject a massive new dose of stimulus to prop up the economy and lifting stock prices in the process. But this conclusion might be wrong.
The idea that new monetary stimulus could come courtesy of the Fed is based on a speech that Federal Reserve Chairman Ben Bernanke made two weeks ago. Then he made three points: that the Fed still had numerous ways to help the economy; that, notwithstanding that, there were limits to what monetary policy alone could do without help from fiscal policy; and that the next FOMC meeting will last two days instead of one.
This last point really captured the market’s imagination. It was generally taken to mean that the Fed would spend two full days to choose carefully their best course of action. But it could also mean that the Chairman needs two full days to work out heavy internal dissent.
At the last meeting, when the Fed announced that rates will remain at zero for two more years, three board members disagreed. This casts reasonable doubt that more drastic measures could come from the next meeting, even if the Chairman spends two days beating down on the dissenters.
And what could he possibly feel so strongly about? The most aggressive action would be another round of asset purchases (“QE3”) focused on long-term bonds or mortgage-back securities. But, since the economy actually slowed after deploying $600bn on the previous round, the success of a similar program is doubtful. With interest rates at zero and a ballooning money supply appearing to have little effect on economic activity, Bernanke was quite right in pointing out that the Fed cannot save the day alone.
So the market also hopes that President Obama will come up with something fiscal when he speaks to the nation on September 7. He is widely expected to unveil new economic proposals to boost growth and jobs. But the market may be over-optimistic on what the President seems likely to offer – namely, infrastructure construction spending and tax breaks linked to job creation.
Government-sponsored “shovel-ready” construction projects have little effect other than picking up the slack from private employment while the economy gets back on track. And tax breaks to encourage hiring of new workers do little to spur economic activity, since private employment grows in response to growing demand, not in response to tax policy. More aggressive fiscal stimulus would face severe opposition from those in Congress determined to reduce debt and spending at all costs. The likelihood that the President will put forth a game-changer, then, is slim.
Ultimately, both the President and the Fed Chairman know that there is no single policy or condition that can magically make the US or the global economy grow. Many factors interplay to keep the global engines running. While fouling up this mechanism is easy, tuning it up successfully is exceedingly complex.
In the past, when one region faltered another one picked up the slack. The US, for example, was the “consumer of last resort” for many years, providing external demand for emerging countries that lacked internal sources of growth. In the wake of the 2008 financial crisis, China massively stimulated its economy and in so doing it helped the rest of the world, especially the West, from sinking further.
But today all major regions are bogged down under the weight of their own problems. The US is running out of monetary options to prod its economy back to life, and took virtually all fiscal options off the table. China is winding down its stimulus program and curbing lending. And Europe is fighting to rebuild its banks and peripheral economies, in great measure by taking a path of severe austerity that is not conducive to growth.
This unfortunate synchrony of negative conditions is a big impediment to a faster global recovery. It seems reasonable that, with all the needles pointing red at the same time, chances that equities will resume the strong rally of the last couple of years are not great, considering what policymakers can realistically deliver. Therefore, investing in stocks now on the basis of upcoming stimulus may well turn out to be the wrong bet.
Upcoming economic indicators will have a large impact on investors’ attitude towards equities and other risky assets in the weeks and months to come. Until something meaningful happens to spur economic activity or change sentiment in a positive way, investors may find that bonds are far more likely than stocks to perform well, as inflationary pressures fail to materialize, growth remains elusive, and investors seek the safety of low but stable investment yields.
-----------------------------------
We use quantitative measures to build and maintain portfolios for our clients, which we rebalance every quarter. We described our investment process in previous newsletters. If you would like to know more about how Path Financial’s investment process works, call us or send us an e-mail at the address below. We’ll be happy to set up a confidential meeting to discuss new paths to financial success.
Raul Elizalde | raul@pathfinancial.net | 941-350-7904
Don't miss our newsletter. Please confirm your subscription now at the top of this email.
