August 2019 Commentary
July saw the Federal Reserve complete another highly signaled rate cut. Our previous commentary presented our concerns over the Feds ability to have true lasting economic impact when interest levels are as low as they are currently. It seems a losing proposition to us that the Fed has become the ultimate savior to the capital market psychology. We wouldn’t be surprised if they return to a zero-target rate over the coming months. While this may not have a meaningful long-term macroeconomic impact, it does offer tactical opportunities within our portfolios.
Brief Market Recap for July
Most of the capital markets were relatively docile in July despite the anticipated Fed move. Equity markets grinded slightly higher and intermediate and long-term interest rates moved mostly sideways. Shorter term (< 1 year) interest rates were impacted by the Fed decision and experienced a general downward trend. Precious metals were the most active exposure in the commodity space experiencing meaningful gains; other commodities were generally down slightly for the month. In other words, a typical summer month.
Geopolitics, Twitter, Policy and the Capital Markets
The rhetoric coming out of our nation’s capital has become overly toxic and counterproductive. Trade policy shouldn’t be executed on Twitter but it seems that contemporary leadership believes otherwise. Twitter has become the platform for sharing every meandering thought traveling through the cranium of anyone with a device. The potential impact of trying to interpret these character limited posts has added a level of anxiety to both the performance of the capital markets as well as monetary policy. It’s seems a dangerous game to be so capricious with the global economy. The Fed responded with a rate cut and we expect risk to increase throughout the equity markets as a result.
The increase in jitteriness will push the Treasury curve down and offer opportunity in the fixed income market. We have lightened up our equity exposures and increased our duration exposures in order to better manage risk and capture some return. We don’t see the trade issues with China being resolved in the short term. President Trump is unlikely to backtrack substantially on tariffs in the short term and China is hardening its stance as well. Further devaluations of the Chinese renminbi will most likely be on the horizon in an attempt to mitigate or offset the effect of the tariff increases by the US government. What is most likely to happen is that we will have literal quiet periods where the rhetoric will decline and the markets will react favorably; it will be a period of fits and starts in the markets. During this period general volatility will increase and the economy will trend lower. The Fed will attempt to assuage the markets and boost the economy with more rate cuts. These will have minimal impact but will offer tactical exposures along the way. Generally, risk management will return to the fore of the investment process. To what extent the Fed is still independent from the executive branch is an open question.
Global consideration to keep an eye on include Brexit, the German economy, Hong Kong, Japan-South Korea, and Iran among others. All of these will have varying impact on capital market performance. Most of these areas are rarely a source for good news currently and it is unclear whether this will change in the short to medium term. The UK government wants a quick resolution on Brexit which, in principle, should be welcomed by everyone. However, there is very little evidence that the UK government has a proper Brexit plan in place (not even after all these years!) and has taken precautions to safeguard its economy which is likely to weaken considerably unless a smooth path to Brexit will be found. If the protests in Hong Kong continue and potentially become more violent, then sooner or later the Chinese military is going to intervene forcefully. While Hong Kong is an important trade hub for the country, its share if Chinese GDP has steadily decreased over time. Therefore, the Chinese government could easily lose its patience at some point. Moreover, it seems very unlikely that the Chinese leader Xi Jinping will be willing to be humiliated on two fronts at the same time for long, namely on the US trade front and on the Hong Kong protest front. We are focusing on any triggering event that can impactfully alter investor confidence. Currently confidence in policy makers is waning and this happens the markets will be challenged to retain current levels.
The Fed (we are compelled to address!)
Additional theories abound in an effort explain why the Fed lowered rates again. Some suggest that the Fed is more interested in weakening the greenback in a race to the bottom and have the most devalued fiat currency. This is a zero-sum game, but central bankers do seem intent on weakening their currencies to boost their respective economies. This is pure madness but at this point given the evidence it’s worth considering. Others argue it is a coordinated effort with the White House to balance recent tariff threats. This is what we reason above as the arguably most viable rationale of the latest rate cut. We’d also suggest that in the long run it may be simply an effort to manage the cost of the fiscal profligacy implemented by our Federal government intermixed with an occasional Pavlovian snack for the markets. Any or all of these may contribute to monetary policy but the bottom line for us as investment managers is that the general suppression of Treasury yields and increased equity volatility will bring with it investment opportunity. Moreover, the markets will eventually need to incorporate the possibility that current market levels can’t be artificially sustained forever by at most marginal policy decisions.
The Fed’s Insertion into Private Banking – Beware
The Fed is now considering competing directly with the very industry they are supposedly overseeing. It is planning to move in on the real-time payments business which is the business of speeding up financial transactions between people and financial institutions. The overreach into the private sector can only have deleterious long-term consequences on both the banking industry and the way our economy operates. We are not fans of government insertion into competitive markets. History has taught us that society suffers whenever elected officials involved themselves in anything where they don’t have any expertise whatsoever. Given this and our current political environment we should all remember Margaret Thatcher’s famous line about Socialism (“The problem with socialism is that you eventually run out of other people’s money.”)
Though we are amidst the dog days of summer, we expect increased volatility throughout the capital markets. Treasury rates will trend lower and equity volatility will increase. These offer investment opportunities. An eye on the long term will be essential in positioning our exposures. Being nimble and deploying transactionally efficient product structures will prove important in the coming months. Risk management will again be the most important aspect of portfolio and wealth management Strategies.