Despite what is likely to be continued pressure on inflation, we would expect the Fed to remove its emergency monetary accommodation at some point this year. For us, the implication is simple – a more volatile risk-free rate is likely to lead to more volatile risk assets. If there is good news in this, we believe dispersions between both stocks and asset classes should rise this year, benefitting the active manager.
We have not found a previous period in modern financial history in which a sovereign economy (or, regional or global, for that matter) underwent the full impact of deleveraging in a single cycle. Rather, deleveraging appears, always and everywhere, to be a multi-cycle phenomenon.
Like it or not, it is conceivable that M&A activity, despite its already-frenetic pace, could expand further for several reasons: (1) Interest rates remain low; (2) Many companies are, arguably over-capitalized; (3) AUM of activist investment firms has skyrocketed; (4) On average companies announcing acquisitions are going-up immediately on the news.
The Fed’s QE3 program has reached the point of diminishing returns, and is set to end. There is – of course – some chance the FOMC votes to slow down the QE taper, but our base case remains an end to QE. In any case, the dollar amount of Fed purchases has already fallen to such a small number that it’s hard to see the operations themselves mattering much. It’s the signaling that’s key. Given the improvement in labor market conditions, the signal has been clear: the Fed wants out of their increasing bond purchases, soon. (The Fed will still re-invest principal payments). Market volatility around this event is probably not over, and there are still risks abroad. But monetary policy cannot address all economic/political issues, and while there’s a good case for waiting until mid-2015 on Fed rate increases, the U.S. – in our opinion – is likely to continue to move away from “emergency” monetary policy. Fed credibility is beginning to demand it.
With the market hitting fresh highs, the chorus of those warning about valuations is getting louder. Warren Buffett’s favorite market valuation indicator (market cap as a pct. of GDP) is approaching levels last seen in the late 1990s and Professor Shiller’s Cyclically Adjusted PE suggests that long-term returns may be harder to come by. Of course, in the money management business when you start counting is a critical factor in determining performance. With sovereign bond yields near all-time lows in much of the developed world, the long-term prospects for bond returns are even more discouraging.
These four charts say that U.S. growth looks stronger and more sustainable. Surges like these are enough to keep monetary policy makers awake at night. It's simply a question of whether "emergency" monetary policy is still needed. Policy accommodation could be removed, and if it is done slowly policy would still be accommodative for quite some time.
For the past few years, the slow pace of recovery has garnered much attention. The depth of the recession and subsequent rise in numerous key macro-indicators have lagged well behind previous recoveries. Non-farm payroll employment just recently surpassed the level reached at the business cycle peak in December 2007. The other indicators...
With the FOMC voting to continue tapering assets purchases down to $35 billion per month in its latest meeting, our base case remains that the Fed will continue reducing purchases by $10 billion per meeting, and eliminating the remaining $15 billion in October's meeting.
U.S. real Gross Domestic Product (GDP) contracted at a -1.0% quarter/quarter annual rate in the first quarter (1Q). While it was clearly a bad quarter, this revision into negative territory was widely expected, and the size of the revision was not abnormal. We always hesitate to call a blowout negative report 'old news,' but that is indeed what this number appears to be.
The housing recovery has been slow but steady throughout the U.S. There have been some concerns on weather disrupting activity in 1Q (eg. the Fed's Beige Book). But housing has been in an uptrend around the country in a longer-term view.
Examining the VIX data over the past 20 years suggests that volatility tends to move in secular fashion -- i.e. the relatively high level of volatility from 1998 to 2003 was bookended by relatively low levels of volatility in the mid-1990s and the mid-2000s. While this is undoubtedly less fun, such markets tend to give truly active managers a leg up.