Happy 4th of July!
To Infinity and Beyond! The Federal Reserve has increased the size of its balance sheet from $773 billion in to $2.5 trillion over the past three years through QE I and QE II. The multi-trillion dollar question is whether Bernanke literally shoots money from his helicopter as he has stated in the past in order to avert another Great Depression. Along the way, large holders of Treasury bonds have made enormous profits as the 30 year Treasury bond trades at 2.74% yield with a very large price appreciation. In theory, the banking system should be lending money to stimulate economic growth which has occurred modestly. The recent commodity price decline is pushing the economy to the precipice between deflation and inflation. Deflation is worse than inflation.
Market Elixir. The stage is now set for QE III. The most recent Operation Twist has bid the longer term Treasury bonds up in price. The jury is still out on the effects of Twist. Alongside the Open Market Committee Operations is the complication of Dodd Frank legislation that has added numerous financial institution regulations that has impaired banks from lending money. The Volker rule is supposed to limit banks from trading its bank capital in exotic trading vehicles. Recent revelations that super-bank J.P. Morgan lost $2.5 billion through its London subsidiary indicates that the large banks are still involved in proprietary trading. Under the Volker rule, these banks are not supposed to be involved in these activities. They are supposed to be commercial banks and not investment banks.
Borrowed Time. As select European countries struggle, interest rates for borrowing in the capital markets are increasing for those cash strapped countries including Greece, Italy and Spain. Should the U.S. ever become “cash-strapped”, then our interest rates for Treasury will rise. Henceforth, our U.S. Treasury bonds are trading in their own financial bubble. The large bond holder such as China, Japan, and Pimco Investments will ultimately unload these bonds. We do not know what will trigger this. As our U.S. government continues to issue paper at $1trillion per year, we believe the bond market will be saturated and begin to sell-off. We believe our 30 year bond is overvalued by 30%. Buyer beware!
Safe to Get in the Water. The recent Facebook initial public offering debacle is just another damaging event for confidence in the stock market. We do remind our clients the U.S. stock market has doubled in value since the March 9, 2009 Dow Jones Industrial Average low of 6400. We remain positive on the stock market for the next eighteen months as enormous cash balances remain high. Money market assets still remain close to $3 trillion. These assets are making virtually 0%. In fact, we believe many money market accounts may be losing money. We believe ultimately these assets will flow back into stocks. The recent market volatility is keeping the retail investor away and recent data suggests that money continues to flow out of stock funds. We believe that current stock prices are attractive and recommend investors keep a portion of their assets in good common stocks.
Blue Light Specials. The low Treasury bond yields are supposed to make it easier for home owners to purchase homes. We know that housing is a small percentage of the country’s GDP. We do believe that housing will improve in the coming months should jobs start being created in the private sector. Our government has eased some mortgage standards recently but more will be done as we head into the Presidential election in the fall. The quandary between housing and employment is the proverbial chicken and egg issue which excessive federal budget deficits have not cured. We know that housing is improving, but the problems have yet to go away.
Broken Record. The current U.S. Treasury yield curve continues to forecast economic growth in the U.S. We do believe the commodity price decline will reverse its course and that over the next three years commodity prices will rise. With history on our side, we believe the economy will improve and not slip into another recession. The Federal Reserve continues to print money and provide liquidity in the financial system. Patient investors will be rewarded over the next several years.
Sweet Spot. Our current investment strategy continues to favor stocks over bonds. The stock groups we favor continue to be pharmaceuticals, telecommunications, energy, paper, chemicals and rails. The lower price earnings and higher dividend paying stocks are attractive for fixed income investors to obtain higher income than the bond market. Commodity based industries and companies will do better after the election. We believe the world economy will improve in the coming months that should stoke commodity prices. In spite of all the recent world troubles, we believe the economic data will improve as the wealthy countries come to the aid to the struggling countries.
That 70’s Show. Additionally, we believe that a coming inflationary environment will help small and mid-capitalization companies balance sheets. Worldwide central banks are printing enormous amounts of fresh new cash. Eventually the economy will have many dollars, euros and yuans chasing too few goods. The recent forces of deflation have certainly made our inflation argument less credible. Historically, governments have cheapened their currencies as the economic tool of desperation. The problems in Europe hinge because of the 20 some odd countries that do not have the authority to monetize their deficits as the U.S. Europe has 20 separate governments, 20 separate Treasury departments, and 20 separate tax codes. The survival of the Euro must align these functions in order to succeed.
Tea Time. Ironically, as we celebrate the nation’s independence from England in 1776, the government that appears stronger in promoting free markets is England. The decision not to enter the Euro in 1998 looks pretty smart as the 20 or so countries struggle with a regional currency. David Cameron quietly could be the strongest leader in the world, and an ally that the U.S. needs. Food for thought.
We continue to consider it an honor to manage your assets even during challenging times. We welcome meetings and conversation on how we can better manage your money.
Robinson Investment Group
5301 Virginia Way, Suite 150
Brentwood, Tennessee 37027