The U.S.
U.S. markets are entering a typically volatile and unproductive seasonal period, marked in this case by the emergence of new political drama surrounding potential impeachment proceedings against President Donald Trump. Tactical traders may seek to take advantage of seasonal weakness. For our part, we continue to remain longer-term bullish on U.S. stocks. As we have frequently noted, the present market cycle is, like the previous several cycles, fundamentally credit-driven, and we see no signs of imminent deterioration in U.S. credit conditions. On the contrary, the U.S. continues to remain an economic and financial bright spot in the global economy. When the next earnings season gets underway in a few weeks, we will get a clearer view of the effect of global conditions on U.S. earnings.
The recent funding stresses that drove U.S. overnight repo rates to spike point out actions that the U.S. Federal Reserve will need to take over the coming year to ensure liquidity. Accounting for organic growth in liquidity needs, the need to re-establish a larger liquidity buffer, and the rollover of maturing mortgage-backed securities into Treasuries, all imply that over the next year, the Fed will need to purchase a significant quantity of Treasury paper, perhaps $500–$600 billion. Whether or not they are called “QE,” these purchases — “permanent open market operations,” or POMOs — are the same basic type of action as QE. The liquidity crunch and the Fed’s response highlight that ending extraordinary post-crisis measures may well be more difficult than it was to start them. Still, we do not view current events as an immediate harbinger of financial turmoil.
Europe
Some analysts have observed that outgoing ECB chief Mario Draghi’s swan song included a remarkable policy: dual rates, whereby the ECB lends via TLTROs (“targeted longer-term refinancing operations”) at a –0.5% interest rate — but banks get a 0% interest rate on most of their excess reserves parked at the central bank, rather than being penalized. If this analysis is accurate, the ECB is essentially transferring money to banks, and if the process is linked to a requirement that banks extend loans to the private sector, the effect will be magnified. This would be an extraordinary attempt both to bypass the apparently immovable fiscal conservatism of Europe’s surplus economies, and to throw a lifeline to European banks staggering under the effects of negative interest rates. This is quite a baton to pass to his successor, Christine Lagarde, who while she is a consummate politician, has not yet shown herself to be as astute a financier as Draghi. Whether the policy shows genius or desperation (or both), we do not know.
Emerging Markets
Indian markets responded strongly to Prime Minister Narendra Modi’s dramatic corporate tax cuts. Ultimately, although India will need to adjust fiscal policy moving forward, we continue to believe that Modi is slowly setting the stage for India’s movement towards center stage as a global economy. We view India as a long-term opportunity. The same may be true for Brazil, but the changes being put into place by President Jair Bolsonaro are more recent, and to us it is unclear whether they will have staying power. If they do, Brazil could also represent a long-term opportunity.
Gold
Gold will certainly fluctuate with stock market trends and sentiment, but we remain bullish for reasons enumerated in all our recent letters, and regard weakness as a buying opportunity. We believe gold will move higher longer-term, and there are many potential events that could cause it to move significantly higher.
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