Investment View Q3 2016
It has been very easy to be negative this year given the constant bombardment of bad news. But important economic indicators in the U.S. and the relative strength of the U.S. and Asian stock markets are telling us that pessimism is not going to pay off. Even in Europe and despite the immigration and political turmoil, there are indications that the economies of the union are slowly getting back on their feet.
Protective assets posted stellar returns over the first half of 2016 as a whole, with Gold returning 24.4% and 30-year U.S. and German bonds returning 16.3% and 29.6%, respectively.
The rally in the stock markets over the past few weeks – after the Brexit accident – has continued and broadened; the S&P500 index is making all-time highs, volatility has been falling and bonds and other safe haven strategies have started to sell-off. Cyclical stocks such as mining and steel manufacturers have outperformed defensive stocks.
Monetary stimulus by central banks globally, with the exception of the U.S. Fed which has stopped QE, has never been higher since 2009. The marginal impact of these monetary measures has become less significant, however. The opposition to negative interest rates is also growing.
Monetary policies are expected to be gradually replaced by fiscal stimulus. This would imply a slow return to higher bond yields. A dramatic sell-off of fixed income assets and other safe haven assets can be expected at some time in the near future.
By re-introducing fiscal stimulus, the classic Keynesian measure, governments would focus less on debt reduction or austerity, but more on growth. Infrastructure projects and generally the construction sector would benefit from this shift.
Although equities are generally expensive and earnings growth has been poor, we cannot ignore the fact that the most watched equity index in the world, the S&P500, has broken out to the upside of a two-year consolidation. Meanwhile many emerging markets are showing similar trends and so are a number of small capitalization stocks. This technical picture suggests an upside for the S&P500 index of 10-15% from current levels in the next twelve months.
Such an outcome is supported by some excellent economic data in the U.S. as recent strong employment numbers showed. It is worth monitoring however slowing consumer income growth, declining U.S. productivity and tightening lending standards at banks.
But the U.S. stock markets have mostly been driven by money leaving a disappointing Europe and very low borrowing costs. Fundamentally, the U.S. stock market is expensive considering low head line sales and earnings growth of most U.S. companies. The U.S. labor market is practically at full capacity, even the participation rate has been growing. There are some signs of wage pressures returning. And will the Fed act regarding interest rates this year?