Easy money policies from central banks around the world and the lack of political unrest in the developed world helped support stock prices during the first quarter of 2015 as several indexes moved to new highs in the US, England, and Germany. The Standard & Poor’s 500 rose 4/10 of 1% during the first three months of 2015 while the Dow Jones Industrial Average was slightly negative, down 3/10 of 1%. Investors continue to be driven into stocks by low interest rates.
The Dow Jones Transportation Average has declined 4.4% since the start of the year and the utilities index is down 5%. Technology companies continue to gain as investors clamor for the latest cloud-based and social media technology. The NASDAQ 100 gained 2.3% while small-company stocks gained 4%. Biotech companies in particular lit up the scoreboard, rising almost 16%. On the other end of the spectrum, oil companies and oil service providers declined 10% as energy prices continue to decline. Natural gas was down 8.6% while gold stabilized during the first quarter of 2015.
International markets overall gained 3.1% due to the accommodative policies noted above. Europe’s stock market was up an astounding 16% as investors seem willing to ignore the specter of political unrest in the Ukraine or the fiscal dangers presented by Greece’s impending bankruptcy. The German stock market was the biggest winner, up 22% year to date. China’s stock market gained almost 16% while Japan, enjoying the warm glow of the Bank of Japan’s pedal to the metal approach to printing money, gained 10% to its highest level in 15 years.
The search for returns is forcing many people into riskier investments than they would otherwise choose. Interest rates are expected to rise slightly this year but will remain at depressed levels so that bond investors will continue feeling the pain of a near zero global interest rate environment. In Japan and Europe, central banks have let off a barrage of economic stimulus efforts by cutting interest rates to negative levels and wholesale buying of their constituent banks’ bonds. This serves to buttress local stock markets and at least keeps up the appearance of a slightly growing economy. If you’re looking for a job or trying to start a business, things don’t feel so positive.
If you are a conservative investor and are looking at CDs, the average five-year CD in the US is paying about 1 ½% while money market rates are below one half of 1%. The broad aggregate of US bonds gained 1.6% during the first quarter. High-yield bonds, also known as junk bonds, were up 2.6% while municipal or tax-free bonds were up 9/10 of 1%. This is the ninth consecutive quarter of positive return for bonds. For all the hand ringing and teeth gnashing in the media, interest rates have not yet begun to move up but when they do, many investors who own medium and long term maturities of bonds will suffer.
Due to the European Central Banks unprecedented pumping of sizable quantities of money into their system, there is a strong likelihood that the Eurozone will see some nominal growth in their economy. Unfortunately for individuals in Europe, excessive amounts of government and bank borrowing have created structural obstacles to business growth. Unemployment remains high with France and Italy stuck in recession.
U.S. Consumers are feeling confident, the most so in almost 8 years, as a stronger US dollar makes imported merchandise cheaper and low gasoline prices lift discretionary income levels. Confidence among all American age groups is on the rise because, other than the increased portion of paychecks going to healthcare, costs are coming down for food and fuel. The beneficial effects of lower oil prices is one of the few income flattening factors of the last decade as middle and lower wage earners spend a proportionately larger amount of their income on gasoline and food and so they directly benefit from these lower prices.
China may turn out to be the main reason that global growth turns out to be constrained over the next few years. Economic activity there has fallen sharply and all kinds of debt levels continue to be built up to very alarming levels. China is making a play to become an alternative trading currency to the US dollar and so it has initiated an exchange in Canada as a first step to becoming an alternative master of the international trade stage. Americans presently enjoy substantial financial advantages with the US currency being the dominant force and main medium of exchange for the last several decades. We have effectively received a subsidies of our national debt by being able to print more dollars at will as other nations have had no choice but to use dollars to settle their accounts. Should China and Korea join the currency wars started by Japan and the European Union, global economic policymakers are in for trouble. Competitive devaluations have a “beggar thy neighbor” effect, resulting in reduced global growth which eventually hurts everyone. China is lowering its interest rates and bank reserve requirements in order to support its economy and to aid its ailing and inefficient industries. For now, they continue to tie their currency to the US dollar which aids the country in avoiding volatility. If China were to allow its currency to float freely, it would create great uncertainty and political unrest.
Notwithstanding a slowing economy, Chinese stock markets are going crazy on the upside. It reminds me of the roaring 1920’s in the US as stock purchases on margin (based on borrowed money) have increased tenfold over the past two years. Many Chinese companies are zombies; mere shells created to provide employment but providing no productive benefit to the economy. Chinese technology stocks in particular are prone to rampant speculation. As world trade is declining, Chinese juggernaut manufacturers face huge hurdles as government economic planners are trying to turn its economy into a consumer driven, as opposed to an export led, economy.
Foreign investors are taking advantage of relatively high interest rates in the US. This helps buttress the US dollars dominant position which in turn keeps US Treasury yields down, below 2%. With the European bank flooding their market with euros, investors are creating dollar shortages and this exacerbates foreign commercial banks problems as they need to borrow more and more money from their governments in order to buy US dollars which their local customers want. Investment funds continue to enter the US from overseas as people want to invest here at higher rates and in safer conditions. Capital is leaving fragile emerging markets such as Brazil, Turkey, and Greece. Emerging-market central banks are in a pickle in that they rely on the US dollar to provide stability but as the US dollar appreciates, it gets more expensive for them to service their debt. Many home buyers in Eastern Europe are caught in this bind because as their local currencies depreciate against the dollar, they end up falling further behind in their payments. We expect the dollar to continue rising and this will increase deflationary pressure, which has a dampening effect on real economic activity worldwide.
Conventional wisdom says that the Federal Reserve will be raising interest rates in 2015. Because the U.S. economy is performing weaker than predicted, it is likely the Fed will be forced to adopt a more relaxed attitude and keep interest rates low for longer than is now expected. The US labor market is weak, not just because of the recent jobs report, but it looks like US gross domestic product output is languishing. As the dollar’s strength allows US consumers to buy goods from overseas, we have not yet really experienced the downsides of deflation yet but it is actually curtailing real economic activity.
Global economic growth is projected to decline in 2015 for the first time since 2009 as emerging markets struggle against a super strong US dollar. With politicians lacking the willpower to implement labor or tax reforms, central banks have had to step into the breach and act as de facto fiscal policy makers. Very low interest rates are, in effect, a tax on savers, pension funds and insurance companies. Despite the ultra-loose monetary policies of the past several years, incomes adjusted for inflation have fallen for most families. Continued monetary easing, while providing stabilization to the financial markets, results in a sub optimal allocation of capital into low or non-productive activities. This means that the next several generations of workers will experience falling real income levels. These problems are now masked by rising stock and bond markets. Those who benefit the most from appreciating securities markets often do not end up spending money in local stores or in creating new businesses/jobs.
The US bond markets have held up remarkably well as commodity prices have fallen along with new orders and production on the part of regional companies. There is often a substantial lag time between what happens in the real economy and when it gets reported in the media. There is little margin of safety today in current stock price levels and our sense is that investors in common stock should have a long time horizon and the patience to ride out expected volatility. While the stock market can remain overvalued for years, the implication we take away is that returns over the next 5 to 10 year period will likely be below normal, around 4% per year after inflation. For this reason, we don’t advise jumping into stocks in a big way now, except in well financed companies that pay good dividends.
Greece will be back in the headlines soon as its economy is in a depression and there is no way out of their predicament other than through debt forgiveness. This is politically unfeasible because other European countries that lack discipline and productivity will require the same. Our feeling is that over the next five years, the European Union will transmute itself into a free trade zone without a common currency. The system as it is now set up doesn’t work.
France in particular has huge amounts of debt and while the French enjoy a highly refined lifestyle, they can only live beyond their means for so long. The “neutralization “ of Europe, which means taking all of the weaker countries unsustainable loans and having the economically stronger nations pay off those debts, is the only possible way that the European Union can survive. This is similar to the situation that American banks found themselves in during the 2007-2008 great financial crisis. Their survival was totally dependent on the US government and central bank interceding to absorb the risks taken on by highly leveraged companies.
It looks as if things are going along well because there is no current crises in confidence, either in Europe or in the US. Whether that is due to the highly controlled nature of the media and or the lack of long-range economic debate, everyone is acting like things are in good shape. As long as this general benevolent attitude persists, we ought to do just fine. This is not an overwhelmingly convincing reason to be optimistic but we have to invest our money somewhere, don’t we?
Upcoming Events and Personnel News
Rob: My daughter Robyn recently returned from Thailand, Cambodia, and Indonesia with a new perspective, aided by spending nine days in a retreat with an international community of meditators and breathatarians. She is headed for Central and South America next and hopefully will be back in the States before the snow flies. Hannah was pleased with her grades at Portland Community College and is impressed with the quality of education in Oregon. She continues on with calculus and chemistry this spring and is looking at the School for Naturopathy in Portland or Mills College in Oakland, California for pre-med studies. I have settled back into a routine here in Santa Fe, after visiting both coasts and picking up a short lived bug during my airplane travels. We are looking forward to planting a garden and I hope to be doing some painting outdoors this summer.
Juliana: After many years at the Rikoon Group, I am moving on due to my desire to be closer to my mother in central North Carolina. I will continue be available to help with any transition issues. Please keep in touch as I would love to hear how everyone is doing.
Jeff: Our daughter, Stephanie, is now 19 and she recently got her own little apartment. I think that her mom and dad might be enjoying that as much as she is! I learned that I have a bone spur and a rotator cuff tear in my right shoulder and I am scheduled for surgery the first week of May. I have been told that I will have to wear an arm sling for about 6 weeks as a part of the recovery. I am right handed and so to prepare myself for after the surgery, I have started to practice using my left hand for lots and lots of things now.
Patricia: Happy Spring everyone. I have just completed my classes in the Bernalillo County Master Gardeners Program….although still far from a Master Gardener. This experience has allowed me to see what an ignorantly blissful gardener I had been for all these years. I learned about pests, diseases, noxious weeds of New Mexico, trees and so much more. Now on to volunteer work so I can earn my nifty Master Gardener pin. As spring winds down I am planning a nice trip at the end of May to Victoria BC by way of Seattle to visit with a few friends.
Lauren: After being in California and Washington State for much of March, I was surprised to return to a surprisingly warm spring in Santa Fe. I have been spending the last couple of weeks getting my garden ready for planting and working on some commissioned furniture projects.
Kyle: In March, my family and I traveled to Arizona for Major League Baseball’s spring training. We had the opportunity to attend several baseball games and even got a behind the scenes tour of the Oakland A’s training facility. Hopefully the boys caught on to some of the game to help when they start t-ball later this spring. Over the next few months, I will be working to clean up the yard at our new home in El Dorado and get our spring planting done before it gets too hot.
Local tea and conference call in dates.
The next Rikoon group gathering will take place at our office at 2218 Old Arroyo Chamiso on Wednesday, May 20 at 3:30 PM. Feel free to bring a friend, relative, or anyone needing some afternoon shut eye! On Thursday, May 21, we will host our quarterly phone and conference call at 3:30 PM Mountain Daylight Time. The call-in number is 1– 626 – 677 – 3000, access code: 425993. Please let us know if you have any topics that you would like Rob to cover during either session.