Last week's major events support the view that globalization is a fact of life, influencing economies, financial markets and government policies everywhere to a greater extent every day.
The two key news items last week dealt with the Fed meeting, Janet Yellen's follow-up press conference and, of course, Greece. The financial markets got a lift from Yellen's and the Fed's dovish comments, only to be drawn back by the Greek tragedy.
Surprisingly, I expect a patchwork deal to surface as the clock strikes twelve to extend ECB and IMF support a little longer. The drama will continue. The winner is Germany, whose influence and dominance over the Eurozone grows daily.
Let's review the events of the week and see how they compare against our core beliefs. Finally, we will discuss any change in our asset allocation and investment profile.
1. I want to say at the outset how much Yellen impresses me with her depth of knowledge and perspective on economic policy. She appears less dogmatic than I initially feared. The key takeaways from both the Fed meeting and her press conference call are that the Fed lowered its growth forecast for this year; lowered its forecast and trajectory for the Fed Funds rate not only for this year, but for the next two years as well; maintained both its employment and inflation forecasts; and targeted long-term growth at 2.0 percent to 2.3 percent. The Fed projects that the Fed funds rate ends this year at 0.625 percent, ends 2016 at 1.625 percent and ends 2017 at 2.875 percent. Do you want to own bonds in this environment? It was clear that the Fed will maintain an overly easy monetary policy after its first rate hike. We will discuss asset allocation later. Basically, nothing here surprised us, but the keys are the future data points both here and abroad and how they compare to what we believe.
Other key data points included inflation adjusted hourly earnings have fallen for four straight months; the House passed a fast-track trade bill (good news); leading indicators rose 0.7 percent in May; the CPI rose 0.4 percent in May, but only 0.1 percent excluding food and energy; the consumer comfort index finally rose; consumer and business confidence is improving; housing starts fell more than expected in May, however, construction rose more than expected and building permits increased to an eight-year high; and finally industrial production and capacity utilization fell in May, which is surprising, as both hiring and consumer spending are rising. Net net, the U.S economy remains a mixed bag, but it is improving ever so slowly.
2. Greece's on-again, off-again negotiations with the ECB, IMF and Germany remain the daily highlight in the Eurozone. Enough! Germany should declare victory and Greece should tweak its package to adhere to the most recent moderate demands from the ECB and IMF. How hard could it be to reach a 1 percent surplus before debt expense anyway? Imagine the budget surplus the U.S would report before interest costs! It's time for Prime Minister Tsipras to stop the blame game and recognize that his country owes 279 billion euros to others and made commitments that have not been adhered too. Should the ECB and IMF continue to send bad money after good? The ECB, IMF and Germany realize that prior agreements cannot be broken for any one country, as it could have a domino effect with other countries. Unfortunately for Greece, it came up to bat first. Remember that the vast majority of Greek obligations are owed to the ECB and IMF rather than governments or financial institutions. Therefore, I continue to believe that a Greek default will be manageable and not lead to contagion elsewhere. Will there be a hiccup and a temporary flight to safety? For sure. But, in the end, it will work out with minimal impact on the banks, the European economy and, most of all, the global economy. Greece is a small player on the global economic scene. It's time for Tsipras and his government to stand up and do the right thing for all concerned rather than be concerned about politics. Admit defeat and move on for everyone'ssake.
The Greek drama has negatively impacted the European economy. Any resolution will lift the cloud and I believe that growth will reaccelerate. If Greece remains in the euro, the currency may weaken, and if Greece exits the euro, it will strengthen. European interest rates have rallied recently with a flight to safety, so with any resolution with Greece, interest rates will eventually rise again and the yield curve will steepen.
3. The Chinese market fell by nearly 10 percent last week and the pundits are asking if the bubble has burst. I doubt it and believe that a correction does not alter China's internal dynamics, which we have discussed for the last year. Dramatic change is neither easy nor smooth and the government continues to reduce past excesses while building a stronger foundation for the future. Remember, too, that the Chinese market has advanced more than any other major market over the last year.
4. Bank of Japan Governor Kuroda basically reversed what he had said last week about the yen having depreciated enough and that it should now stabilize, if not rise. The Bank of Japan announced that it would maintain its monetary stimulus at an annual pace of $650 billion dollars. I expect consumer demand boosted by higher wages and increased exports to lead to a further acceleration in growth over the next 18 months. Watch closely as Japan and the United States build a stronger bond to counter Chinese global expansion and influence.
While a certain calm came across the financial markets after the Fed meeting and Yellen's follow-up press conference, it reversed course on Friday, as fears of an imminent Greek default grew louder and louder. Stock markets fell and there was a flight to safety in bonds. This is transitory in our opinion. The markets hate uncertainty and once the cloud surrounding Greece is lifted, I expect the financial markets to reflect the improving underlying fundamentals both here and abroad.
The key takeaway for me this week is that virtually all of my core beliefs are intact: Monetary policy here and abroad will remain easy; the supply of funds will exceed the demand for funds; the global economies are improving, albeit slowly; the dollar will remain the currency of choice; inflation is contained as global supply exceeds demand and globalization means pricing competition at the margin; conservatism permeates every corner of the globe, from governments to corporations to individuals; Greece exiting the euro won't lead to contagion; M&A activity will remain strong; and, finally, change is in the air, and if you fail to recognize it, you will not succeed.
I suggest reading the transcript of GE Chairman Jeff Immelt's interview with Charlie Rose last week. It is about the necessity to change, to innovate, to invest and to have a global footprint in order to thrive today. He said it better than I could.
The bottom line is that this is a time to reallocate your capital away from bonds into other financial instruments that will benefit from an improving global economy. Risk must be controlled at all times, as we live in an unpredictable world. Maintain excess liquidity and own companies that will succeed in a globally competitive world by making the needed strategic moves that may mean jettisoning some of the older businesses and investing in newer ones—such as GE. Focus on long-term gains that will be tax efficient, but be willing to change course regardless of taxes. We cannot all be Warren Buffett, but we can watch and learn from his rules for successful investing.
