Category Archives: US Economy

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Are You An Investing Optimist? Check Your Portfolio


  • Investors are very optimistic in bull markets and allocate much of their portfolio to stocks, increasing their risk.
  • Analysts and economists expect more spending which will consequently push GDP and inflation up, but low rates push people to save more for their retirement.
  • If the GDP and earnings don’t grow as expected, we could see a bear market in 2017.

Introduction

Stock markets keep going up while fundamentals keep going down and the economic situation isn’t that great either. The S&P 500 is dancing around new highs despite corporate earnings for Q2 falling by 3.6%, and the economy only growing by 1.2% on an annualized basis. Economic growth for the whole of 2016 is only at 1%.

So, what is pushing stocks higher? The simple answer is optimism. It is assumed that next quarter’s earnings will be exceptional and economic growth will blow off the charts. In this article we are going to elaborate on the forecasts and assess their probability in order to take a look at what optimism can do to investors.

About Optimism

Being an optimist is nice. Optimists are happier, have a more positive view of the world, are ready to take risks in life and optimism helps one to cope with life’s uncertainties. We can say that in life, it pays to be an optimist. On the stock market it also pays to be an optimist but it pays even more to be a rationalist.

An old research project (1999) by behavioral scientists Benartzi, Kahneman (Nobel prize) and Thaler explains perfectly how investors approach stock markets after a few years in a bull market. Based on 1,053 Morningstar subscribers of which 84% were male with annual household income averages of $93,000, they found that investors had an average allocation to stocks of 79%, and 95% of their pension contributions were directly allocated to stocks. This bullishness derives from investors’ optimism. When asked what they focused on when thinking about financial decisions, a staggering 74% of investors focused on positive returns.

figure 1 optimism survey
Figure 1: Thinking about potential return or potential loss. Source: Behavioral Finance.

By being an optimist, you make bold investment decisions, but investors should also think about risks. Don’t forget, one of the most quoted of Buffett’s pearls of wisdom is: “Rule No. 1: Never lose money. Rule No. 2: Don’t forget rule No. 1.” The reason behind this rule is that if you lose 50% of your investment, it takes a 100% return just to get you even.

Optimistic Forecasts

Yes, earnings have declined and the economy isn’t growing fast at the moment, but analysts are highly optimistic that in the next quarter or the one after that, everything will grow. On June 30, most analysts expected earnings to return to growth in Q3 2016.  Now analysts expect a 2% earnings decline in Q3 2016 and don’t expect earnings to return to growth until Q4 2016.

figure 2 earnings
Figure 2: Forecasted earnings growth for Q3 2016. Source: FACTSET.

The same analysts that consistently revise their estimations downwards as actual earnings results are released expect S&P 500 earnings to grow 13.3% in 2017. At the end of June, the expectation was at 13.5%.

figure 3 earnings growth 2017
Figure 3: Forecasted earnings growth for 2017. Source: FACTSET.

The expected increase in earnings comes from an expectation that oil and other commodity prices will inevitably increase and push earnings higher, and that no sector will see earnings decline.

Additionally, GDP is expected to grow at a rate above 2% from this quarter onwards. The current 1.1% yearly growth is just a temporary slowdown according to interviewed economists.

figure 4 wsj gdp
Figure 4: Forecasted GDP growth. Source: Wall Street Journal.

But not all economists agree on that rosy view. Economist Stephanie Pomboy stated that analysts and economists are wrong because they use pre-financial crisis frameworks to make their estimations and the world has changed a lot since then. Despite the fact that interest rates have severely declined, people spend less and save more. Less spending means inevitable declines or slower GDP growth.

figure 5 savings
Figure 5: Total saving U.S. deposits. Source: FRED.

Why are people saving more? Well, with lower interest rates you need to save more to reach a satisfying level of income for retirement. As the population is getting older, they will save more and more. This speaks to how low interest rates have been beneficial for businesses but very detrimental for savers and an aging population.

In such an environment we cannot expect GDP growth and earnings to increase just because interest rates are low as it is clear that low interest rates have not worked thus far to stimulate economic growth.

If the GDP does not reach the expected 2% growth rate and corporate earnings continue with their decline, Pomboy sees a bear market in 2017, especially in discretionary stocks.

Discretionary stocks have really high PE ratios and, yes, if the growth from the past 5 years continues, those ratios might be justified, but any kind of bad news could quickly send those stocks down. Amazon (AMZN) has a PE ratio of 188.4, Home Depot (HD) 23.8, Starbucks (SBUX) 30.9, and Nike’s (NKE) is at 27.3. All these stocks could easily fall more than 50% if a recession comes along or people spend less because of their high valuations based on optimistic future projections.

Conclusion

It is good to be an optimist, but in investing it is also good to be a realist, or a diversified optimist. A diversified optimist is an investor that is positive about his returns, fully invested but well diversified among various uncorrelated assets and prepared for any economic environment.

The main point of this article is for you to assess your optimism and look at the risks in your portfolio. When you look at each component of your portfolio, ask yourself how much you can lose. Write that number down and then go through the list again and ask yourself how much you can gain. Where the potential risk is much higher than the gain you might want to look for other assets.

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The U.S. Dollar: Should You Stick To It Or Diversify Now?


  • The dollar has been positively correlated with stocks for the last 4 years which is unusual.
  • Potential FED interest rate increases don’t make international diversification a great idea right now.
  • Any sign of a U.S. recession should be a good time to think about international diversification with emerging markets.

Introduction

On big news sites like Bloomberg you often come across headlines related to the movement of the U.S. dollar. The headline below is a good example.

figure 1 bloomberg news

Such headlines relay what has been going on in the few hours before publication but are completely irrelevant for investors that aren’t trading pips on forex. This article is going to investigate the longer term relationship between the dollar and stocks, and discuss the best option for maximum return with minimal risk.

Recent Dollar & Stocks Movements

Before 2012, as the dollar strengthened, stocks went down and vice versa. The reason was simple, a strong dollar meant U.S. exports were less competitive and businesses suffered, while a weak dollar made U.S. goods cheaper across the world and increased corporate earnings. Since 2012, however, the story has been a little bit different. The dollar has gotten stronger and stocks have gone higher.

figure 2 fred dollar stocks
Figure 2: U.S. dollar vs. S&P 500. Source: FRED.

The reason behind this is the fact that no matter what we think of the FED, it is the most globally coherent financial institution. In an environment where the European central bank is continuing with stimulus and the Japanese think about printing money for direct spending, the FED is the only institution that contemplates raising interest rates. So the positive correlation between the U.S. dollar and the S&P 500 comes from the relative success of the U.S. economy and the global faith in the U.S. dollar as the only safe currency.

On one hand, the strong dollar lowers corporate revenue. But on the other hand, it also lowers corporate costs, something CEOs never talk about when reporting earnings. As the U.S. has a net trade deficit, the strong U.S. dollar makes everything around the world cheaper and therefore expenses should also be much lower. Don’t forget this in the next earnings season.

Long Term Dollar Strength

The long term perspective is a little bit different than the above. Since 1975, the dollar has slowly but consistently weakened in relation to foreign currencies.

figure 3 long term dollar
Figure 3: Dollar index since 1975. Source: FRED.

The slow decline of the dollar means that global trends are shifting, which is also normal given the development in China and other countries. As the rest of the world is expected to grow at a faster rate than the U.S., the long term trend for the dollar is clearly and slowly downwards. This point is essential for international diversification. We have discussed many times how ChinaIndia and other fast growing emerging markets are essential for healthy diversification.

Forecasts & Economic Factors

In the short to medium term, it looks like the dollar is going to continue to strengthen. If the FED increases interest rates and others continue with their stimulus, the dollar will surge even higher. The most recent FOMC minutes clearly indicate that we could see a rate hike by the end of the year. But, eventually the strength of the dollar will kick back as exports will be more expensive and the trend will turn and continue to follow the declining line seen in figure 3 above.

What To Do

There are two options with currencies. They go up or down and do so for longer periods until the structural influences rebalance on a global scale. With interest rates low and good news from the U.S. economy, the FED will eventually raise interest rates and send the dollar higher. The moment of maximum strength of the U.S. economy and the dollar will be the time to diversify to other currencies but until then, sticking to the dollar is not a bad idea, especially for the majority of our readers who are living in the U.S. If the U.S. economy slows down and the dollar weakens, you will still have most of your assets in your home currency which will not represent a real change to your portfolio. But if you are exposed to other currencies and the dollar gets stronger, you will have to look at losses, which is never pretty.

Conclusion

U.S. investors have the benefit that if the dollar gets weaker, international diversification is just a missed opportunity while if the dollar gets stronger, it was a good idea to stay at home. International investors have to play it differently. With the FED eventually increasing rates, the dollar has no other direction to go than up which is a great diversification play when looking at the stimulus in Europe and Japan which weakens their currencies.

In the long term, it pays to be exposed to the currencies of the countries that are going to grow at a faster pace than the U.S. economy, i.e. emerging markets. We have seen the Chinese Yuan get weaker in the past two years due to some fears about China slowing down, but the longer term trend is clear.

figure 4 cny usd
Figure 4: Chinese Yuan per 1 USD. Source: XE.

With the economy expected to grow at a pace of above 6% in the next 10 years and the Chinese getting richer, there is only one way for their currency, up. Think about international diversification, but only when the dollar strength reaches its structural limits and the U.S. is close to a recession.

 

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Signs of Fragility in the Economy Point to an Impending Bear Market. What To Do Now To Protect Yourself.


  • The last jobs report was good news but it also indicates higher costs and full employment.
  • An “easy to hire, easy to fire” mentality is in the air.
  • Healthcare, cash or short term trades should be the best options in this situation.

Introduction

Last week the Nasdaq and S&P 500 reached yet another record high. Aggressive central bank stimulation pushes investors to disregard risks and look for any kind of yield or growth. Not looking at risk is the worst thing an investor can do, but they also shouldn’t fight the trend.

Even from a long term perspective the market is irrationally valued, and no one can know how long it will stay that way. Being in cash might seem logical but a 0.1% return looks much worse than the S&P 500’s 8.9% year-to-date return.

Today, we are going to analyze earnings as 86% of S&P 500 companies have reported them, but first take a look at Friday’s jobs report which sent mixed signals.

The Jobs Report

On Friday, the U.S. Bureau of Labor Statistics reported an increase in total non-farm payroll employment of 255,000 in July. The unemployment rate was unchanged at 4.9 percent which is great news for the economy but not so much for investors because it indicates that we are close to full employment. The unemployment rate has stabilized at 4.9% and wages have started to increase (2.6% over the year). Higher wages mean higher costs which have a negative effect on margins and earnings.

figure 1 unemployment rate
Figure 1: Unemployment rate. Source: Bureau of Labor Statistics.

Apart from the reach of full employment and higher wages, the fact that businesses prefer to hire more than to invest in equipment signals that corporations are not so optimistic about the future. They easily hire but know that they can fire with the same ease, if necessary. If you buy equipment, you are stuck with it in most cases.

figure 2 employment equipment
Figure 2: Lower equipment spending in favor of labor. Source: Bloomberg.

The “easy to hire and fire” effect is even more pronounced by the increase in the number of people forced to work part-time for economic reasons, which rose from 5.84 million to 5.94 million.

All of the above means that job numbers are fragile and can quickly shift in the opposite direction. This, along with slow GDP growth, will probably keep the FED on hold or result in minimally increased rates to hold off inflation.

S&P 500 Earnings

The second quarter of 2016 is the fifth consecutive quarter with a decline in earnings.

figure 3 earnings growth
Figure 3: S&P 500 earnings growth rate. Source: FACTSET.

The S&P 500 reported sales were flat in comparison to Q2 2015 which means that the increased hiring does not create growth but is necessary to merely keep up with the competition.

Analysts have postponed expected earnings growth to Q4 2016, which doesn’t mean much as they had expected earnings growth for this and for the next quarter. So, as always, analysts’ expectations have to be taken with a grain of salt.

From a sector perspective, consumer discretionary was the best performer with earnings growth of 10.7% which is logical seeing that consumer spending is the only growth segment of the U.S. GDP. But as consumer discretionary is not essential, any kind of bad news or tightening credit might quickly turn this trend around.

For investors interested in not taking on much risk if a bear market hits us, the healthcare sector continued its good news. Healthcare earnings grew 4.9% and revenue grew 9%. As we know that the global population is getting older, especially in the developed world we can expect demand for healthcare to stay stable, or fall the least in a recession or bear market. Therefore, finding good healthcare investments is essential for a defensive portfolio that is still open to growth in this bull market but limits the potential downside if things take a turn for the worse.

figure 4 sector
Figure 4: S&P 500 Earnings growth by sector. Source: FACTSET.

All other sectors are exposed to negative volatility because consumers are going to save on all things except for food and healthcare. With oil prices around $40 we cannot expect an earnings pickup in the energy sector.

The most important factor for long term investors is valuation. Lower earnings and higher prices have brought the current S&P 500 PE ratio to 25.25. If the FED is forced to increase rates due to high employment rates, corporate earnings will be further pressured downwards by the high debt levels and tightening credit will lower consumer spending.

figure 5 multpl
Figure 5: S&P 500 PE ratio continues to grow. Source: Multpl.

Conclusion

We are in a situation where the S&P 500 is consistently breaking new highs while there have been 5 consecutive quarters of declining earnings, slow GDP growth, lower productivity and where bank credit, the main factor for GDP growth, is about to tighten due to increased interest rates and full consumer indebtedness.

We cannot know for how long such a surreal situation will last, but as smart investors we have to be prepared for the worst and still try to grasp the benefits of the upside. As Warren Buffett has $66 billion in cash on his balance sheet, we might to also want think about having cash on hand just in case a bear market comes that will enable us to buy the bargains. As earnings yields are at 4%, that would be the opportunity cost for holding cash but we can hold cash for 5 years and still break even if a bear market comes along. It is difficult to mentally accept such a strategy as we are in the 7th year of this bull market, but some returns have to be sacrificed in order to lower risks.

Another option for diversification is to use a part of your portfolio for well-placed short term trades. The S&P grew minimally in the last two years but in the meantime it gave great trading opportunities. With stop losses and by knowing what you are doing, you can limit the time you are invested, thus lower the risk of being caught in a bear market while still creating healthy returns on the liquid part of your portfolio.

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Where The Risks Are: It’s Not Where You Might Think…


  • Car sales are in a downtrend and PMI is falling, which ties the FED’s hands.
  • Japan has just entered into direct economic stimulus with $273 billion.
  • The Bank of England behaves like the economy is in a depression, cutting rates and printing money.

Introduction

Yesterday we discussed how China isn’t as big of a risk as many would like to make it out to be. Today, we are going to go through the latest data from the U.S., Japan and Europe in order to assess their riskiness.

The U.S. 

We already discussed on Tuesday how the GDP has grown at a slower rate than expected and the actual growth is fueled by increased consumer debt, which isn’t a sustainable long term situation. Going into more detail will enable us to better forecast what will happen in the short to midterm.

One area of consumer spending that is currently essential for U.S. GDP is car sales. In the first 7 months of 2016 car sales have hit a plateau, which means there is more downside than upside. Car sales peaked in October 2015 and it looks like a downtrend is forming. The peak reached in sales is especially worrisome as car loan rates have hit historical lows and are currently around an average of 4%.

figure 1 car sales and rate
Figure 1: U.S. Total vehicle sales and car loan interest rates. Source: FRED.

This explains why the FED’s hands are tied when it comes to interest rate increases. Increased rates would increase the costs for consumer debt and therefore immediately lower consumption, sending the U.S. into a recession.

If you are overweight car stocks, be careful and watch what is going on because the low valuations are there for a reason and any kind of economic turmoil might be very negative on stock prices.

Continuing on the state of the U.S. economy, the Institute for Supply Management’s (ISM) Purchasing Managers Index (PMI), which measures factory activity, came in positive but below expectations on Wednesday. The PMI declined from 53.2 in June to 52.6. Any reading above 50 signals activity is expanding which is a good sign, but a downward trend isn’t ideal to see as most indicators were slower than in the previous month.

figure 2 manufacturing
Figure 2: U.S. manufacturing. Source: ISM.

Apart from the decline in activity, it is also important to note how the PMI reacted to the FED increasing interest rates in December 2015. The expectation of an interest rate increase alone decreased the PMI, and only with the later change in the FED’s rhetoric did the PMI return back into positive territory.

figure 3 the fed and PMI
Figure 3: PMI index in the last 12 months. Source: ISM.

This is yet another indication of how difficult it will be for the FED to increase rates as businesses and people have gotten used to low rates and any increase would immediately lower economic activity, pushing the FED to step backwards.

Japan’s Easing

On Tuesday Japan’s prime minister, Shinzo Abe, approved a $274 billion stimulus package aimed to help the Japanese economy and to help ensure his political survival. The package includes $173 billion of fiscal measures, $73 billion of government spending and $59 billion in low cost loans.

As this is a step beyond monetary easing, we will see what the impact will be on the Japanese economy. Analysts expect added economic growth of 0.4%.

The conclusion is that, if everybody is easing, it doesn’t make much of a difference and forces other central banks to do the same. This is the third reason in this article that makes it difficult for the FED to increase rates.

UK

The situation isn’t better in the UK.

While the major economic impact of BREXIT won’t be seen for two to four years, the first signs of a slowdown can be seen from the weaker sentiment. The UK Manufacturing PMI came in at its lowest level since 2013, which was a recession year in Europe. What is also important is the sharp decline, the PMI index fell to 48.2 in July from 52.4 in June which confirms BREXIT related uncertainty.

figure 4 uk pmi index
Figure 4: UK manufacturing PMI index. Source: Markit Economics.

On top of the negative PMI, the Bank of England has slashed its growth forecast to 0.8% from 2.3% for 2017, lowered interest rates to a record low, and announced increased lending of 100 billion pounds to banks. It will also increase bond purchases by 60 billion pounds. The Bank’s actions portend an outright depression in the UK rather than a possible future economic slowdown, but this is what central banks do these days.

Europe

A positive note comes from Europe which saw its PMI grow in July to 53.2.

figure 5 gdp pmi europe
Figure 5: Europe PMI. Source: Business Insider.

But the negative news is that GDP growth in Europe is expected to only be 0.3% in Q3 2016, further emphasizing the already bad decline to the 1.2% annualized growth rate in Q2 2016. All eyes are on the ECB which has stated many times that it will do whatever it takes to keep things stable and growing, thus, more stimulus.

Conclusion

The main question is: how long will central banks be able to keep things stable and markets high, and when will monetary and fiscal stimulus become inefficient and spur inflation? All factors indicate that the markets are overvalued, the economies are stretched and monetary stimulus is reaching its limits. As soon as signs of a normal economic cyclical downturn emerge, central banks step on the gas and print more money.

On one hand, investing logic would indicate that investors stay in cash as a bear market is imminent, but the fact that central banks keep printing money and saving markets, or not even allowing markets to decline, indicates that stocks and bonds will be artificially propelled even higher and investors might want to stay long these markets for the time being rather than fight the trend.  However, having well thought out stop loss orders in place is a must, and raising some cash would be prudent too because at some point things will turn.

It is important to keep an eye on inflation because low or no inflation is what is enabling central banks to continue with easing. As soon as inflation increases, central banks will have to start tightening.  Consumer price inflation is still at only 1%.

figure 6 inflation rate
Figure 6: U.S. inflation annual inflation rate per month. Source: Trading Economics.

As we discussed yesterday, China is growing at 6.7% per year, has low debt when compared to developed countries yet and is considered a risk. While developed countries use desperate measures to keep things as they are, fight deflation and spur some economic growth. Logic suggests that the risks lie in the developed world and China is a much safer bet.

 

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Euphoria & Denial Point to the Last Days of the Bull Market


  • Risks are cumulating and getting bigger.
  • U.S. GDP growth is slower than expected, earnings and oil prices continue to decline.
  • Japan is unable to grow while BREXIT risks are still unfolding.

Introduction

It is difficult to find good news lately. The last really good news was the June jobs report when 287,000 jobs were added. Since then, most of the news seems dismal, however, it has yet to have a negative impact on financial markets. It’s as though investors are just hoping for something good to happen in the future. As hopes are an immaterial human feeling, they should not be the base for investment decisions.

In this article we are going to analyze what’s pushing the S&P 500 to new highs. Are we in a state of euphoria about stocks or are the valuations and price increases rational?

GDP News

The U.S. economy was expected to grow 2.5% in Q2 2016, but it only grew 1.2% (seasonally adjusted). U.S. economic growth for 2016 is currently at 1% which is the weakest start of a year since 2011. Saving the economy from a recession is consumer spending which increased by 4.2%.

Low interest rates create cheap money which fuels two trends, growth in both consumer spending and the S&P 500. Consumer loans have increased at a faster pace than consumer spending which makes it clear that spending growth is fueled by debt.

figure 1 consumer loans
Figure 1: Consumer loans at all commercial banks (blue) and consumer spending (green). Source: FRED.

Anyone who has studied economics will tell you that the economy works in credit cycles, when money is cheap and prospects good, people take on credit and spend it. But one can only take on so much credit, and all banks want their money back sooner or later. When sentiment shifts, a credit contraction arises and consumer spending falls. As this is inevitable, the only justification for the current hope of increased GDP growth can be explained with the most dangerous words for investors: “this time is different.”

figure 2 credit cycle
Figure 2: Credit cycle. Source: Loomis Sayles.

As we are in the expansion part of the credit cycle, a recession is going to hit us as soon as we reach the downturn part of the credit cycle because consumer loans are the only thing still boosting growth.

figure 3 gdp contributors
Figure 3: Contributions to Q2 economic growth. Source: Wall Street Journal.

If it wasn’t for consumer spending fueled by cheap loans, the U.S. economy would most likely already be in a recession.

The S&P 500

With economic growth largely missing expectations you would assume the S&P 500 would tank, but that’s not what happened Friday when the economic data was released. On the contrary, the S&P 500 reached a new intraday high at 2177 points. The main reason for the new S&P 500 high is hope of future economic growth, the same economic growth that didn’t realize itself in this quarter.

Another reason stocks have continued to rise has been the Q3 2016 expected corporate earnings growth, but that also vanished like the above described economic growth. As most companies have issued negative guidance we cannot expect higher earnings in Q3 2016.

figure 4 positive guidance
Figure 4: Q3 2016 earnings guidance for the S&P 500. Source: FACTSET.

The FED

It would appear the FED is also somewhat in denial about the true state of the U.S. economy and S&P 500 earnings, and is holding on to the hope of increasing interest rates as soon as the economy shows signs of strength, be we’ve been hearing the same story for a while now.

Last week the FED left the door open for interest rate increases as the economy seemed to be improving, but this was before Friday’s GDP debacle. With growth being lower than expected, the FED will probably continue with its status quo policy. As we now know that the only thing pushing the economy higher is consumer spending fueled by consumer debt, any interest rate increases would be detrimental for the economy and push it into the downturn part of the cycle because higher interest rates would increase the cost of debt.

Data on jobs, consumer spending and inflation will be available before the FED’s next meeting in September so we will closely watch that in order to see if the FED will eventually move, highly unlikely after the latest GDP debacle.

Global Situation

The BREXIT had only a short-term effect on markets as investors soon focused on other things and hoped that it would not have any long term effects. But any BREXIT effects won’t be seen in economic data for a few years as it will take the UK at least two years to exit the EU, if not four.

figure 5 brexit
Figure 5: Soon forgotten BREXIT. Source: Google.

News from Japan was also not that good. As economic targets have not been reached, the Bank of Japan decided to double the annual amount it uses to buy exchange traded funds, from ¥3 trillion to ¥6 trillion ($57 billion). This is only a modest increase to Japan’s easing policy, measured in hundreds of trillions, and brings us to the conclusion that Japan is out of monetary policy ammo. Even with constant increases in monetary easing, Japan has experienced a 0.5% deflation in June and slower consumer spending. This should be a warning sign for the U.S. as it is clear that easing has its limits.

Conclusion

All the above indicates that we are currently in the denial phase of a stock market cycle. We have had a bull market for 7 years now and no one wants to look at the above data as it indicates a turn in the credit cycle, lower business spending and earnings, a strong dollar and global uncertainties with the UK, Japan and China. We will analyze the situation in China soon as it requires a special article.

figure 6 stock market cycle
Figure 6: Stock market cycle. Source: The Gold and Oil Guy.

Not to mention oil prices coming close to $40 dollars per barrel, which will push energy earnings down, again.

All of the cumulating risks we’ve discussed send a strong message. Investors have to start thinking about risks and rewards. In the late stage of a bull market, many are overweight stocks, which means they can expect a beating if any of the above mentioned risks trigger a bear market. The options are to increase one’s cash in order to have liquidity when a market decline comes, or to own more uncorrelated asset classes. I’ve written more on this in our recent article on Ray Dalio’s strategy.

For stocks, simply ask yourself, how much are you willing to risk for a 4% long term expected yield?

 

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The Economic News is Very Good, But Keep An Eye On the FED and GDP This Week


  • Housing is showing inflationary signs but still offers an opportunity to profit from the rising trend as a downturn is unlikely and not expected in the short term.
  • Amidst all the positive news, manufacturing turned negative. Yet despite this, stock valuations keep going up, increasing the risk.
  • In the week ahead: the FED’s decision and GDP data. It looks like stable weather in the near future.

Introduction

The last sequence of economic data was very positive. In this article we are going to discuss the important data coming out this week and analyze the information released last week. Then we’ll combine it with the current situation on the market and, as always, analyze the risks and rewards.

Housing

Existing home sales came in at 5.5 million which is the highest in the last 10 years. This is great news and indicates a continuation of the positive trend in the real estate market. Distressed sales from foreclosures are at 6%; down from last year’s 8%.

figure 1 home sales
Figure 1: Existing home sales since 2013. Source: FRED.

Some might think that a new housing bubble is being created. Unfortunately, a clear answer to that can only be given in hindsight. There are several worrying factors, but every bull market climbs the wall of worry. The most alarming factor is that the number of people renting is growing which may indicate that many are already priced out of the market.

In support of a continued uptrend is that fact that home inventory is low as housing starts are at 1.18 million, which is still subdued when compared to the historical average of around 1.5 million, but much higher than it has been over the last 7 years.

figure 2 housing starts
Figure 2: Housing starts. Source: FRED.

According to Bloomberg, another worry is that many homes are being purchased by “mom and pop” investors with less experience, while institutional investors are ducking out of the market. Institutional investors used to account for 50% of investor foreclosure purchases, but in June that number fell to 38%. More troublesome is institutional investors now only make up 2.5% of the market, down from 9.8% in 2013.

Similarly to the situation we had in 2007, more and more foreclosed homes are bought by amateur speculators, which may be over-inflating the market.

figure 3 third party investors
Figure 3: Third-party investors auction home purchases. Source: Bloomberg.

Housing is cyclical and at some point in the future we will see another down market, but the above mentioned worries do not indicate an immediate decline, which means there is still money to be made in the uptrend. Investors might want to look at building and building materials companies that are trading below their real values and still feeling the consequences of the great recession. But beware of the risks, the downturn will eventually arrive. It might be a soft landing as more new homes are built which smooths out the price increases, or a hard landing similar to the one we saw in 2009.

The S&P/Case Shiller home price index will be published today, and prices are still expected to grow at 5.5% year over year which is very high for housing markets, but if low interest rates continue we might see a few more years of such increases.

The S&P 500

The recent S&P 500 breakout is strengthening on the positive housing data and jobless claims at 43 year lows.

figure 4 jobless claims
Figure 4: Jobless claims. Source: FRED.

So far, 25% of S&P 500 companies have reported positive earnings surprises, further fueling the stock market. Earnings are not growing, but 68% of companies have reported earnings above estimates. As of this weekend, the S&P 500 earnings decline for Q2 2016 was expected to be at -3.7%, and unfortunately, expectations for earnings in Q3 2016 have been constantly falling over the last several months.

According to Factset, Q3 2016 will be the sixth consecutive quarter with declining earnings (-0.1%). Positive analysts don’t expect a return to earnings growth until Q4 2016, but the below figure shows how quickly analysts’ forecasts can change.

figure 5 expected earning growth rate
Figure 5: Expected S&P 500 Q3 2016 earnings growth rate. Source: Factset.

With positive economic news and declining earnings, it is difficult to know where the market goes from here. From a fundamental perspective, the market is getting riskier and investors are paying more for lower returns. The current S&P 500 price earnings ratio has now surpassed 25, indicating that in the long term you should not expect stock returns to be higher than 4%.

figure 6 multpl
Figure 6: S&P 500 PE ratio. Source: Multpl.

Reaching full employment means that companies will have to pay more for employees, and thus have higher costs, which should put more pressure on earnings. This should spur inflation, but we will know more on Wednesday when the FED issues its Monetary policy statement.

The Real Economy

As always, life for the FED will be difficult. Low jobless claims, higher house prices and a higher S&P 500 are all good, but there is always the fear that those are just asset inflation repercussions.

The Philly Fed Manufacturing business outlook survey has turned negative again. As manufacturing is the basis of a healthy and sustainable economy, this might push the FED to postpone rate increases, but we might hear a more positive tone.

figure 6 diffusion index
Figure 7: Current and future general activity indexes. Source: Philadelphia FED.

No matter what the FED says, the week will be overshadowed by Friday’s publication of the preliminary data on GDP. A big rebound is expected given the positive economic activities happening in the last few months. GDP is forecasted to grow at 2.5% in Q2 2016.

figure 7 forecasted gdp
Figure 8: Forecasted GDP. Source: Wall Street Journal.

Conclusion

The current environment is one full of positive news and positive expectations which is very good, but as savvy investors we must always look at ways to protect ourselves. More and more indicators are signaling that we are getting closer to the end of the real economic growth period and entering a bubble period.

House flippers are inflating house prices, stocks are reaching new highs even as earnings are declining—and still expected to decline further—while the real manufacturing economy is not growing. All this mixed data indicates that we are close to a recession and a bear market, but the good times could still last for a while as the FED continues to keep interest rates low. We will watch this week’s news releases and earnings carefully and update you on the new developments. Stay tuned.

 

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As The S&P 500 Reaches New Highs, Asset Inflation Continues


  • All factors are indicating an artificially created asset inflation.
  • Earnings are expected to decline with economic outlook being constantly revised downwards.
  • Gold is gaining alongside stocks which confirms that all assets are inflated.

Introduction

Amidst all the turmoil from BREXIT, negative interest rates and global downward economic growth forecasts, the S&P 500 has reached a new high. On Monday it closed at 2,137.16 points, overtaking the previous high of 2,130.82 from May 21, 2015. The Monday record was surpassed again on Tuesday and Wednesday, with Wednesday closing at 2,152.43.

figure 1 s and p 500
Figure 1: S&P 500 in the last 5 years. Source: Bloomberg.

This new high isn’t significant in terms of real returns as the market hasn’t really gone anywhere in the last 14 months, but it is significant from a psychological and confidence perspective. In this article we are going to look for the breakout reasons and fundamentals, and analyze potential risks.

Fundamentals

It’s pretty straightforward: if earnings grow then the S&P 500 is also supposed to grow, if earnings decline and the S&P 500 grows we can assume we are in a bubble. At the moment, earnings are not growing and this earnings season will probably be the fifth consecutive quarterly earnings decline. In total, net income is down 18% since its 2014 high.

figure 2 earnigs
Figure 2: S&P 500 index and earnings. Source: Bloomberg.

The 18% decline isn’t that bad when compared to the average 36% earnings decline in recessions since 1936, but currently we are not even close to being in a recession.

Investors seem optimistic and willing to pay a hefty premium for stocks. The current S&P 500 PE ratio is approaching 25 and it has been higher than 25 on only two occasions in the last 100 years, in the dotcom bubble and in the midst of the Great Recession when earnings plunged.

figure 3 S&P 500 pe ratio
Figure 3: S&P 500 PE ratio. Source: Multpl.

As earnings are not growing and fundamentals are deteriorating, there must be something else that creates investor optimism.

Economic Data

As stock prices reflect future expectations, a look at GDP forecasts will give a good perspective on the rationality of the above valuations. In June, well before the BREXIT vote, the World Bank lowered its global growth forecast from 2.9% to 2.4% indicating more trouble for corporations. The International Monetary Fund has cut its forecast for the U.S. from 2.4% to 2.2% for 2016 but expects a pickup to 2.5% in 2017, while the FED expects moderate and stable economic growth at 2% for the next few years. In greater detail, the media highly promoted the 287,000 new jobs added recently but failed to focus on the increased unemployment rate from 4.7% to 4.9%.

One might wonder if the above mentioned data is enough to sustain a PE ratio of 25 as historically the economy has grown faster than 2% and the S&P 500 has had lower PE ratios, again an indication that asset prices are inflated.

Low Bond Yields 

The inflation in asset prices is especially visible in fixed income investments. With 30% of global sovereign debt charging a negative yield, investors push bond prices higher and higher in a desperate search for positive yields. This is further enhanced by the central banks of Europe and Japan actively buying corporate bonds on the market, and even stocks for the latter. As long as central banks relentlessly continue buying securities, it is very difficult for stock markets to experience substantial declines which means that small risks are being smoothed out by monetary policies while the big black looming risk grows bigger and bigger.

Not only that, but capital flows toward fixed income funds are reaching record highs.

figure 4 etf flows
Figure 4: Cumulative fixed income ETP flows in billions. Source: Bloomberg.

S&P 500 Sector Performance

One could argue that the above mentioned corporate earnings decline is mostly the result of lower commodity prices and declining earnings in the energy sector, but only 4 of 10 sectors will see earnings growth in the coming earnings season.

figure 4 earnings per sector
Figure 5: S&P 500 expected earnings growth per sector. Source: FACTSET.

Despite that the energy sector is expecting the worst decline in earnings, its performance in the last 6 months has been the best as things have stabilized a bit. On the other hand, the fact that utilities, energy and materials were the best performing sectors in the last 3 months shows that investors are looking for investments that protect against inflation and have constant, recession-proof yields.

figure 5 sector spdr
Figure 6: S&P 500 sector performance in the last 6 months. Source: Sector SPDR.

The same conclusion related to the search for inflation protective assets can be reached by the looking at the continuing surge in gold prices.

figure 6 gold prices
Figure 7: Gold prices in the last 12 months. Source: Bloomberg.

Gold is usually not correlated with stocks, but from the chart above we can see that both gold and stocks are increasing which again leads toward the conclusion that all asset prices are inflated.

What To Do

It is difficult to be smart in such an artificially created situation, but stock picking and “stick to what you know” might be the best option. You must evaluate the companies in your portfolio and identify how they will perform in the uncertain times that are ahead as asset inflation, possible real inflation in the future, and higher rates will wreak havoc among securities.

Now is the time to be smart. Investors should grasp the opportunities given by the high liquidity but at the same time think of the potential risks if anything changes in the current financial monetary easing system.

 

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Negative Yielding Debt: A Party for Investors or Pure Stupidity?


  • Almost 30% of global sovereign debt comes with a negative yield.
  • The situation is much worse in Japan and Europe than it is in the U.S.
  • Investors should enjoy the asset inflation party while it lasts but also be prepared for the worst.

Introduction

Negative yielding debt seemed impossible and illogical for a long time, but it suddenly became a reality a few years ago and now we are seeing it slowly become the new normal.

This isn’t just strange, it’s dangerous as risk averse investors—like pension funds and insurance companies—are forced to invest in assets that have traditionally been considered safe but that have now become risky, and their returns minimal. Those low returns will result in lower pensions and lower savings which will create new troubles in the future.

This article will analyze how we arrived negative interest rates, what the current situation is globally, and what the long term implications will be for your portfolio.

History and the Current Situation

Negative interest rates started with a few European central banks cutting their interest rates below zero in 2014 (Switzerland and Sweden), followed by Japan in 2016. The EU is not far behind with its 0% interest rate. Apart from central banks’ negative interest rates, high demand for bonds also pushes the yields below zero. With the European Central Bank buying 169 billion of bonds per month with its asset purchase program, it also distorts the markets, and pushes bond prices up, creating negative yields.

It is now estimated that 30% of global sovereign debt has a negative yield.

figure 1 negative yielding debt
Figure 1: Global debt by yield. Source: Wall Street Journal.

Per country, the worst situation is in Switzerland where the complete yield curve is negative, even for bonds maturing in 2049. Germany and Japan have negative yields on debt maturing in 10 years with yields of -0.17% and -0.28% respectively, while The Netherlands and France are not far away with yields at 0.02% and 0.12% respectively. The situation is much worse for debts with shorter maturities.

figure 2 euro yield curve
Figure 2: Euro yield curve. Source: Financial Times.

For perspective, it is wise to compare this to how the U.S. nominal yield curve looks as it is much healthier. If economic news from the U.S. continues to be similar to the latest job news, we could expect an interest rate rise in one of the next FED meetings, which should normalize the U.S. yield curve even more.

figure 3 us curve
Figure 3: U.S. yield curve. Source: U.S. Department of the Treasury.

With longer term yield being above inflation, the U.S. debt market looks much healthier and more rational than the EU or Japanese markets.

Economic Reasons and Implications

Many of the World’s most renowned investors have warned that this negative interest rate experiment in Europe and Japan will backfire. Pimco’s Bill Gross stated that a new supernova is being created and BlackRock’s Larry Fink has warned that it will have huge repercussions on the ability investors have to save and plan for the future.

The main goal central banks had in mind by lowering interest rates was to stabilize the economy and increase employment. However, given the length of time yields have been at zero, or even negative, without the accompanying benefits to the economy, one could conclude that the experiment has not worked. In fact, the World Bank has now trimmed global economic growth prospects from 2.9% to 2.4%.

One of the reasons why it may not have worked, is because the whole world is pushing for liquidity by lowering yields, and the positive effect low yields should have on an economy has been diluted and the only thing that has been inflated are asset prices, which isn’t bad if you are fully invested.

Since central banks were unable to create a healthy inflation rate of 2% with what they deemed the appropriate amount of liquidity, they then flooded the global economy with too much liquidity. And instead of having the desired effect of raising prices, it has actually increased competition with more goods and services being offered, which has lowered prices.

We might now start to see some inflation in the U.S. as the unemployment rate is getting close to the natural unemployment rate but Europe is still far from it with unemployment at 10.1%. Until consumers increase spending and create inflation this negative interest environment will persist and we cannot know when it will change, what we can is prepare for when it will change and analyze the current risks.

Implications for Investors

The most painful consequence of negative yields is that savers are penalized and that investors desperate for any kind of yield pay a high risk premium for low yields. A global snap back in interest rates, or a fall in credit quality, would put the financial world under extreme pressure as investments that are usually considered the safest could lose a substantial amount of value depending on how high interest rates rise, since bond prices move inversely to yields. Goldman Sachs estimates that an unexpected 1% increase in U.S. treasury yields would trigger $1 trillion of losses. If you are highly invested in bonds please be aware of the risks you are running if interest rates rise and ask yourself if the low yield is worth the risk.

Inflation would put pressure on interest rates and companies which cannot transfer increased financing costs onto customers would have huge difficulties in refinancing their debt. The current S&P 500 debt pile is the largest in history and companies are taking advantage of the low interest rates in order to borrow as much as they can.

figure 4 net debt
Figure 4: Net debt issuance/reduction. Source: FACTSET.

Investors should take advantage of the situation as most of the corporate debt is used for repurchases that further inflate asset prices but be careful for the moment when the party stops. At some point, the party has to come to an end someday because corporations are not using the fresh capital to invest but instead are only using it mostly for repurchases and dividends, thus not thinking that much about the future.

Conclusion 

As there is no historical precedent to the current situation, all that one can do is make an educated guess as to when it will end. We all know that this situation is artificial and we also know that it has not been that beneficial to the global economy in the last few years.

As the more mature investors reading this will know, the economy works in cycles and we will see this asset inflation end but we cannot know when. When it does turn, it will certainly be an ugly scenario as investors will sell inflated assets in panic, corporations will find it difficult to refinance debt and central banks will not have maneuvering options with interest rates already negative.

But, as central banks continue to hope that more of the same—which is clearly not working—will eventually work, and which according to Albert Einstein is the exact definition of stupidity, let us enjoy the party while it lasts, hope that it will last for a long time, and always stay prepared for an eventual change.

 

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Could the Economic Climate in Europe Be Contagious?


  • The first hard data after the BREXIT won’t be available until October, but property funds are already frozen.
  • The decline of the pound will lower UK GDP and will spill over into Europe.
  • Italian banks are in trouble as 25% of GDP are nonperforming loans.

Introduction

As two weeks have passed since the BREXIT debacle, most heads have cooled off and we can calmly look at the current situation in Europe, the repercussions of BREXIT and contagion risks. It is important to analyze the full potential impact of the BREXIT by analyzing the stability of the European financial system, business investments, hiring and the political risk premium.

As BREXIT was popular primarily amongst the older population, politicians campaigned on a platform that promised that the money currently being spent on the EU would be diverted into the UK’s national healthcare system, the economic implications of which could be huge.

Situation in Europe

Europe could have done without this BREXIT vote as the last recession just ended in 2013 and the economic consequences will certainly have a detrimental effect on the growth experienced in the last two years.

figure 1 europe
Figure 1: European Union GDP annual growth rate. Source: Trading Economics.

We shouldn’t forget that the UK is still part of the EU and will remain so until all the administrative issues are resolved, presumably for the next two years or possibly even for the next four years. As GDP is always measured in dollars and the pound fell by about 10% in the last quarter in relation to the dollar, we can expect a decline in UK GDP (measured in dollars) similar to what was experienced when the UK left the European Exchange Rate Mechanism in 1992.

figure 2 UK gdp 1980s, 90s
Figure 2: UK GDP in the 1980, 90s. Source: Economics Help.

What saved the UK economy back then was a cut in interest rates, but as the current interest rate is 0.5%, not much can be done there. As the UK’s GDP is $2.8 trillion, it makes up about 15% of the EU economy, so a decline in the UK’s GDP will certainly have a detrimental effect on the EU GDP. An economic slowdown would make credit agencies downgrade the UK or possibly other countries in Europe and thus would create a domino effect of bad news. Moody’s has already expressed concerns about the BREXIT and stated that it will probably change its outlook for the UK from “stable” to “negative,” and Fitch predicts 2017 to be a record year for sovereign downgrades.

In addition to the impact on its currency, the UK economy will be hit by changes in the employment market as well. Some businesses will be forced to move their London branches to elsewhere in Europe. HSBC bank has announced that it will move 1,000 trading jobs to Paris, the same is true for Morgan Stanley, and let’s not forget that London is the European center for financial start-ups which will also have to be moved to somewhere in the EU to serve their primary markets.

The first impact the BREXIT has had is on UK real estate. $23 billion worth of assets in property funds have been frozen for withdrawals. Aberdeen Asset Management marked down the value of its UK property fund by 17% and suspended redemptions with an explanation that this will give time for investors to reconsider. The reality behind this funny explanation is that there is simply not enough liquidity behind the assets for redemptions. A halt in liquidity is also one thing to worry about in Europe.

We won’t know the full impact of the BREXIT for some time as most of the data won’t be published until after Q3 2016 is over. As the BEXIT repercussions become more clear throughout this year, some other risks will emerge as investors become more risk averse in this uncertain European political and economic time.

Italy and Its Banks

In uncertain times, investors look for safety and are much more risk averse. Some assets that were once not considered risky suddenly become risky. As investors withdraw their funds from the riskier assets, those assets consequently become even more risky as there is a lack of liquidity.

This is the situation with Italian banks. Not that Italian banks were ever considered that safe, but at this moment they might tip the stability of the European financial system. It is assumed that Italian banks sit on $401 billion of bad debt, equivalent to a quarter of the country’s GDP. For comparison, the percentage of U.S. nonperforming loans is 1.15% which is around $103 billion or 0.6% of U.S. GDP, thus 42 times less than in Italy which clearly implies that Italy is about to implode if the ECB does not intervene.

On top of Italy’s banking troubles, the country’s own prime minister certainly doesn’t know how to put a fire out. Instead of keeping things as calm as possible he immaturely attacks other EU banks stating that their derivatives exposure is a hundred times bigger problem than the Italian debt issue.

With the BREXIT and other populist leanings—including in Italy as evidenced by the statements by its Prime Minister mentioned above—the European markets should be terrible. In such a climate you’d think there would be plenty of bargains around, but the opposite is true.

Valuation

All of the above may settle down, but the stock market in Europe is highly overvalued for such a political and financial mess. If you look at the iShares MSCI Italy Capped ETF (NYSEArca: EWI) it has a PE ratio of 12.79 but the biggest holdings are oil ENI which is losing money, highly indebted utilities ENEL and the biggest Italian bank Intesa San Paolo which will be in for a wild ride if a banking crisis hits Italy. Therefore, Italy and all other European companies are far overvalued for the potential risks.

figure 3 Europe PE
Figure 3: European PE ratios. Source: Star Capital.

It wouldn’t be a surprise if the above PE ratios are more than halved in the next year or two as a consequence of the BREXIT, which is just a symptom, and debt which is the real disease. As the ECB is buying corporate bonds on the open markets, even the ECB might be in trouble as there is nobody who can bail the ECB out.

Conclusion

The expected sovereign downgrades will push the dollar higher as global investors will seek safety which should negatively impact U.S. exports. Any kind of potential European crisis will bring turmoil to U.S. markets but investors can prepare for that by carefully assessing the situation in Europe.

Traders may want to seize the swings between bad news and ECB interventions, and long term traders might just want to short Europe as a weaker euro will make it easier to cover in dollars.

In general, we can expect uncertain times ahead of us. The last European financial crisis in 2012 with Greece as a culprit resulted in a European recession. The current situation doesn’t look much different, only this time Italy and the BREXIT will probably be the culprits.

 

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Watch Out: The FOMC’s Current Stance Could Impact Your Portfolio in the Long Term


  • Bonds are becoming riskier as yields are falling.
  • Inflation is at 1.2% and very likely to get higher as full employment is approached.
  • The FOMC predicts stability which could create a great environment for traders.

Introduction

On July 6 the Federal Open Market Committee (FOMC) June meeting minutes were released. As they give clear insight into how the controllers of our monetary policy think, it is very important to analyze the minutes in order to better position one’s portfolio and also execute short- and medium-term trades. The FOMC gave a clear indication of their expectations in relation to future GDP growth, unemployment, inflation and its federal funds rate. All of the mentioned indicators will have different effects on various investments.

Summary & Indications for Investors

“Prudent to wait” are three words that summarize the FOMC meeting. For investors this means that you should prepare for anything as the FOMC doesn’t know what will happen.

Yields

In more detail, the low treasury yields is what worries the FOMC. As investors shun foreign sovereign debt and repatriate their cash, U.S. yields go down. This decline in U.S. yields is not only caused by global political and economic turmoil—think Europe with BREXIT and Italian banks, and Brazil—but also by the FOMC’s indecision.

Yields went up when the FOMC increased interest rates back in December and forecasted three more increases during 2016, which obviously will not happen. This change in policy has pushed yields down again.

figure 1 u.s. yield
Figure 1: U.S. treasury 10-year yield. Source: Bloomberg.

With consumer price inflation at 1.2% with projections at around 2% in 2017 and a yield of 1.36% on the 10-year note, buying 10-year treasuries doesn’t protect your capital. Such an artificially created situation by the FED is unfair towards savers.

As the price of a bond moves inversely to its yield, the current low yield means that investors have to pay a lot for little. For example, if you invest $100,000 now in 10-year U.S. treasuries and next year the yield climbs up to 2.3% where it was a year ago, your $100,000 investment will become $59,130, which is not a great way to protect your capital, especially if you don’t plan to keep the debt until expiration.

Astute traders might want to grasp the opportunity given by the clear indications of higher inflation which should produce higher interest rates and consequently lower bond values in the medium term by shorting bonds.

On the labor side, the FOMC is worried about the low number of new payrolls added in May as the fall from 5% to the 4.7% unemployment rate was mostly influenced by a large number of people exiting the labor force. The FOMC estimates unemployment to stay in the 4.5% to 5% range in the next three years and in the longer run. This stable forecast is very strange as the unemployment rate has historically never been stable.

figure 2 unemployment rate
Figure 2: Unemployment rate from 1948. Source: FRED.

As the figure above demonstrates, since unemployment has been measured there has never been a period of stable unemployment for a longer period of time except for a one-year period in 1955 and a two-year period in 1965. Perhaps the FOMC is forgetting that the economy works in cycles. Investors should understand that the reach of full employment increases costs for corporations which should finally spur inflation. This again reinforces the above described risk of holding treasury notes and also indicates that investors should look for stocks that will perform well in an environment with higher inflation and higher interest rates. One example is energy stocks as they can raise their prices pretty quickly in relation to inflation and if they have their debt maturing in the distant future with fixed interest rates, even better.

The FOMC’s view on economic growth is a mixed one, again reinforcing the sit and wait strategy. Weakness in the mining sector is continuing, declining corporate earnings and high inventory levels lower business investments that “could portend a broader economic slowdown” according to the FOMC.

On the other hand, the committee is also optimistic due to a turnaround in energy prices and greater optimism in business surveys. So, for the FOMC, pessimism from actual figures like lower business investments, higher inventories and lower corporate earnings is equalized by survey optimism and a turnaround in energy prices. Such statements indicate high risks because even if there was a recession looming, the FOMC isn’t allowed to tell us that because such an admission has the power to influence markets. If the FOMC said that a recession would come in the next year, that recession would begin the same day of the statement and not next year.

Fed governor Daniel Tarullo stated that “This is not an economy that is running hot” and that the Fed has limited tools if the economy slows down as the interest rates are already at their minimum which increases the risks for investors.

To sum it up, the figures below are the FOMC’s forecasts and forecasted ranges for GDP, inflation and unemployment:

figure 3 fomc forecasts
Figure 3: FOMC’s forecasts. Source: FED.

Conclusion

As the FOMC forecasts stability on all levels, investors can expect sideways market movements because as soon as negative news like the BREXIT lowers market values, positive news like monetary interventions will push the markets higher again. If things will be as the FOMC forecasts, it will be a heaven for traders. Long term investors will see their current low yields eaten up by inflation, so a portfolio should be rebalanced accordingly.