Note: This article is part of the ETF Trends Strategist Channel
After its March meeting, the Fed announced that it would slow the likely pace of short-term interest rate hikes considerably. This announcement eased our chief concern for the global economy.
Three things that history suggests are (1) major stock price declines in the U.S. are usually associated with recessions, (2) all but one recession over the last 100 years was associated with the Fed over-tightening monetary conditions via interest rate hikes or other policy tools, and (3) when the U.S. sneezes, the rest of the world catches a cold.
Those points explain why we have positioned our strategies relatively conservatively over the past year. With the primary risk to global financial markets (Fed interest rate increases, in our view) seemingly abated, we are now becoming more interested in taking advantage of opportunistic investment ideas, as opposed to several months ago when our portfolio management conversations were more focused on asset protection.
With the Fed backing off, our favorite labor market measure, prime age unemployment, should continue to improve, along with the more widely followed measures of headline underemployment (the U-6 rate). We are by no means out of the woods, but cautious optimism has taken over our discussions.
With the Fed slowing the pace of short-term interest rate increases, the U.S. dollar has softened versus other currencies. Most importantly, the U.S. dollar softening has eased pressure on China, who had been spending down its foreign currency reserves at a rapid pace to keep its unofficial currency peg to the U.S. dollar in place.
This unofficial policy cost China about $800 billion over the last several months. If that course were to continue, risks would have grown substantially as China would either have to let its currency devalue or chance running too low on reserves. The current situation is much improved in our opinion.
We think that China’s economy has stabilized recently, and the easing of currency pressure reduces our second key risk to the global economy. Still, we expect choppy markets ahead due to slowing growth rates worldwide, along with government interventions designed to offset the impacts of slowing growth.
Potential near-term market volatility notwithstanding, we are optimistic about the U.S. economy over the long-term given the strength of the U.S. consumer and positive demographic trends, combined with an economy that can make the most of the creative strengths of the U.S. labor force. We are not as optimistic regarding foreign economies and markets in general, though there are exceptions.
The recent rallies in global equities, high yield bonds and commodities are neither a head-fake, nor a signal that the road ahead is clear in our view. While the markets have gained and underlying fundamentals have improved, we think risk management is still very important in this type of environment. Defensive equity and investment grade bonds look to us as areas to potentially protect principal in the near-term. We are not overly concerned with interest rate risk at this time. We think that market forces will keep long-term interest rates grounded for the time being.
Although inflationary pressures may be building, we think that the recovery in survey-based inflation, is fragile.
Any additional Fed rate hikes can quickly tame inflation pressure, while sluggish nominal GDP growth will provide an additional cap to inflation expectations and long-term interest rates. We think this weakness in potential inflation is better captured by market-based measures of inflation expectations, such as the 10-Year Treasury Inflation-Protected Securities (TIPS) breakeven spreads, which suggest that inflation risk is receding and not likely to meet the Fed’s target for core inflation.
With the pace of Fed interest rate hikes slowing, which has resulted in softening of the U.S. dollar and China seemingly stabilizing, commodity prices may have formed a bottom during the first quarter. We think there is a long-term relationship between the price of oil and industrial metals.
Oil fell so fast that it went from being expensive relative to industrial metals to overly cheap, in our view. As a result, the decline in oil may have been overdone. We think oil needs to appreciate to roughly $50 a barrel to return to its normal price relationship with industrial metals. We also continue to be skeptical about the investment potential of gold. Gold may represent trading opportunities from time to time, but we think the long downtrend in the price of gold will continue.
Any forecasts, figures, opinions or investment techniques and strategies explained are Stringer Asset Management LLC’s as of the date of publication. They are considered to be accurate at the time of writing, but no warranty of accuracy is given and no liability in respect to error or omission is accepted. They are subject to change without reference or notification. The views contained herein are not be taken as an advice or a recommendation to buy or sell any investment and the material should not be relied upon as containing sufficient information to support an investment decision. It should be noted that the value of investments and the income from them may fluctuate in accordance with market conditions and taxation agreements and investors may not get back the full amount invested. Past performance and yield may not be a reliable guide to future performance. Current performance may be higher or lower than the performance quoted.
Data is provided by various sources and prepared by Stringer Asset Management LLC and has not been verified or audited by an independent accountant.