Narrower Market, Narrower Path
At their December meeting the Federal Reserve Open Market Committee, after almost seven years, finally began to raise short-term interest rates from nearly zero to a little more than nearly zero. This trivial rise in rates is not a trivial event in our view. It signals the desired end of the extraordinary measures employed by the central bank to prop up the economy in the wake of the global financial crisis. This “normalization” of policy does not, in our view, presage a return to a status quo ante of conditions existing prior to the debt fueled mortgage debt bacchanal. Too much time has passed and new secular trends are driving the global economy as well as the rewards and risks offered by the securities markets. We believe by discussing three long-term factors we can plausibly sum up these challenges to “normal.”
First is the end of the beginning of China’s rise as an economic superpower. For over a decade one assumption underlying investors’ view of the markets was the insatiable appetite a rising China would have for the world’s resources in the form of coal, iron, steel, oil, grain, protein and industrial goods. What we have discovered over the past couple of years is that China’s rise, while profound and important, is fundamentally no different than the path trod by other Asian “growth miracles” like Japan and South Korea. After an initial build out and a couple of decades of double digit GDP growth, these economies downshifted as they turned toward a consumer oriented growth path of mid-single digit growth. This shift has been swift in China and not all of the fallout has taken place. This has profound implications for exporters of value added goods like Germany and commodity based economies like Brazil, Canada and Australia.
The second trend affecting the investor’s calculus is the aging of the population and the concomitant pressure this places on the developed nations’ finances as social promises made come due and the labor force changes. This will foment political change and limit governments’ options as a fiscal counterweight to flagging global demand.
The third factor we believe is important to respect as we commence 2016 is the hangover markets will experience due to the end of seven years of historically easy money. The U.S. stock market is either overvalued or fully valued after the better part of a decade as the Fed’s beneficiary and so the future returns on the indices will be more modest than in the past. Long-term interest rates will likely remain low as the markets come off a Fed induced “boil” to a “simmer.”
Despite this sober sounding outlook, we believe this all adds up to a reasonable medium term outlook for the U.S. Only about 20% of our economy is dependent on global trade. We are aging slower than almost all of our economic competitors (including China) and our institutions, while somewhat hapless, have proven to be considerably more adroit than those of Europe and Japan.
Because we are dealing with a fundamentally better economic environment, our securities look attractive to a global investment community. This places a bit of support under the elevated prices of our bonds and blue-chip stocks. While our economy is growing anemically, the consumer who accounts for around 70% of economic activity is in better shape as wages have begun to rise albeit modestly.
We certainly do not discount the short term risk to investors and a bit of caution is still warranted but after the turbulence that we think will inevitably accompany the Fed’s policy shift, the outlook for investors will improve.
The Altavista Investment Team – Winter 2016