VOL. 129 | NO. 70 | Thursday, April 10, 2014
The Worldly Investor
Renewing Our Vows
By David Waddell
Last week, U.S. indices ascended briefly back into record territory on supportive comments from global powerbrokers.
In Europe, Mario Draghi, the head of the European Central Bank, initiated a bold conversation on monetary stimulus measures. Reality has set in across the Eurozone that the euro is too strong and inflation too weak for enduring economic expansion.
Japan decided to take on these dynamics in 2013 by printing enormous amounts of money. The yen weakened immediately, the stock market rallied substantially and the Japanese economy ended 2013 at a 2.6 percent annualized growth rate and a 1.5 percent inflation rate. The Europeans must have noticed as they struggle with the same disinflationary disease. European monetary policy may soon be turning Japanese.
In the U.S., Janet Yellen gave perhaps the most emotional and empathetic speech ever delivered by a Fed chairman on the plight of the unemployed. As if correcting her more austere commentary from her recent congressional debut, Janet reassured investors that she will keep the monetary hoses open until everyone has a job.
With Japan, the U.S. and Europe renewing their simulative vows, the downside insurance policy on global asset policies remains in force.
Why Do We Need Insurance?
As you know, the global economy binged on credit and poor underwriting standards for the decade prior to the financial crisis. This massive run up led to overleverage, overinvestment and overemployment. The economic oversupply must either be absorbed through dramatic reductions in supply (i.e., close plants, fire workers, scrap inventory) or dramatic increases in demand (i.e., new innovations, new incentives, new customers).
Unfortunately for us, in this case, the natural pathway is reduction. Reductions, otherwise known as recessions, exist to purge excesses from economies. To combat this natural tendency, global insurance providers (politicians and central banks) have intervened with policies designed to stoke demand and offset naturally contracting supply.
So we have a natural deflationary process (reduction of supply) competing with an unnatural inflationary process (subsidized demand). Maintaining balance between these two is pretty tricky business for even the most adept bureaucrats. Periodically, the reductions will prevail and reinvigorate stimulus policies, while at other times the stimulus will prevail, leading to restraint.
The point is that we are going to be in this economic wrestling match for some time. Eventually, natural supply and demand will regain equilibrium, removing the case for intervention. Until then, expect this stimulus-on, stimulus-off confusion to continue.
For investors, reminders of the underperforming economics evoke selling behavior, while reminders of stimulus commitment evoke buying behavior. On balance, with the markets setting fresh highs, stimulus has held the upper hand … to date.
The U.S. economy added 192,000 jobs in March. For the trailing twelve months, the U.S. economy has added an average of 180,000 monthly jobs. This pace has lowered the overall employment rate to 6.7 percent, and private sector employment has now recaptured its pre-recession high. While this is good news, the labor market is still sluggish and disappointing 5+ years after the financial crisis. Why you ask? Re-read the paragraph above.
David Waddell, who is regularly featured in the Wall Street Journal, USA Today and Forbes, as well as on Fox Business News and CNBC, is president and CEO of Memphis-based Waddell & Associates.