US Stock Market
David R. Kotok
Cumberland Advisors
For a while we said the US was the “least worst” investment alternative in the world. And that used to be hotly disputed. The present global outlook may require the most strenuous doubters to reconsider.
Sure, we have a lot of work to do. And the fiscal, energy, tax, geopolitical, and social policies of our country are debated vigorously. But a quick global inventory puts the US at the top of the list, not only in size but also in outlook.
In Asia, we see the world’s second-largest economy, China, with low inflation and growth that is slower than previously projected. Meanwhile, the third-largest economy, Japan, has made remarkable changes in policy. Imagine a 400-stock ETF as a tool of monetary policy. Be sure, this is a buy-and-hold strategy for the Bank of Japan. And the BoJ will absorb the reallocation out of government bonds and preserve that very low interest rate. In financial terms, Asia is in massive adjustment, and realignment is underway. Most other countries in Asia are impacted by the behaviors of the two giants.
In Europe, the world’s fourth-largest economy, Germany, sees its 10-year benchmark government bond trading to yield 0.8%. Germany watches the Europe-wide recession broaden. The German view of central bank policy is not aligned with the other views within the European Central Bank, so the ECB has been unable to make a credible policy shift. Who can blame them? Would anyone reasonably want to use a central bank’s policy of money creation to finance the small business loans of a Greek or Cypriot bank? One can only speculate about the Japanese policy that has replaced sovereign debt instruments with baskets of stocks. Maybe the ECB needs to think about that structure with a basket of Eurozone stocks.
We also note how Switzerland faces inflows in the franc with a policy of pegging its currency to the euro. That makes the Swiss National Bank a partner with the ECB. The Swiss have to buy incoming euros to maintain the peg. Thus their reserves of euros grow. On November 30, a Swiss referendum will determine if the SNB has to take its reserves to 20% gold holdings. Hmmm?
Gold price? Who knows? The swing may be large in either direction.
Meanwhile, Russia, a large reserve holder of gold, finds that gold cannot be used to defend the currency exchange rate. The plummeting ruble and its impact on trade require the Central Bank of Russia to use liquid securities among its currency holdings. Gold does not make that cut. Neither do higher interest rates, which only impose a cost on the Russian economy on top of all its other problems. A positive vote by the Swiss may change the gold equation. So could there be a Japanese decision to add gold to their reserve holdings? That would be a market-moving surprise.
The world’s fifth-largest economy is France, which is quickly becoming a basket case in economic terms. “Will there be a “triple dip” recession?” asks Chen Zhao of BCA Research. Zhao notes how the French growth rate has slowed from 5% in the 1950s and 1960s to 1% over the last two decades. Right now it is zero. Productivity growth is dismal. Remember, France is the second-largest country in the Eurozone. Italy is third. Nothing more need be said about that debt-laden basket case. And Spain makes economic headlines with unemployment rates at extraordinary levels (youth unemployment at 50%).
The conclusion about interest rates is easy. The Eurozone and Japanese short-term rates are at zero for years to come. Their highest-grade 10-year yields (bund or JGB) are under 1%.
The world is trying to get to 3.5% real growth next year and needs the emerging Asian countries in order to do it. A little help may come from small South American economies like Peru or Columbia. So the United States really looks good, comparatively speaking, if it can get close to 3% real growth.
All this means inflows into the US in both stocks and bonds. The dollar is destined to get stronger, maybe a lot stronger. Other asset classes will rally, too, as foreign buyers seek safety for money invested in real estate or businesses. Just add to that a possible repatriation-tax-code change, and the US markets could soar.
At Cumberland, we remain fully invested. And our bond portfolios continue to reflect this outlook with barbell structures and hedges.
A final note. Norbert Gaillard has released his second book on sovereign debt, When Sovereigns Go Bankrupt, A Study on Sovereign Risk. Like his first book, this one is a “SpringerBrief” in economics. It is short, crisp, and very helpful to anyone who cares about sovereign debt and whether or not they will get paid. Norbert’s first book, A Century of Sovereign Ratings, was helpful to this writer. This Princeton grad is sharp. We recommend the new book with high confidence in his work. David R. Kotok, Chairman and Chief Investment Officer
