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PCM 130/30 July 2015 Commentary
Major equity markets have been moving sideways…a
“dull” market as opposed to a “bull” market. We have
to admit to some jealousy for not thinking of that
moniker first. But just because the market action has
been dull, it does not follow that events have been
equally dull. That is especially true if you live in or
have lent money to the nation of Greece or the
commonwealth of Puerto Rico.
ECONOMIC STATISTICS
S&P 500 Index
10 Year Treasury Yield
Gold Spot ($ / oz)
WTI Crude Oil (next future)
GDP Qtr / Qtr
2nd Qtr
(6/30/15)
1st Qtr
(3/31/15)
%
Change
1 Yr Ago
(6/30/14)
%
Change
2,063.11
2,067.90
-0.2%
1,960.23
5.2%
2.35%
2.17%
$1,172.42
$1,183.68
-1.0%
$1,327.32
-11.7%
$59.47
$47.60
24.9%
$105.37
-43.6%
N/A
-0.2%
2.53%
4.6%
Among the many similarities between those two is
CPI Y / Y
0.1%
-0.1%
2.1%
that they have borrowed money to fund current
Unemployment Rate
5.3%
5.5%
6.1%
standards of living utilizing currencies for which they
have no control. Neither can pay back what they
owe. Perhaps the most significant difference is that
Greece, notwithstanding recent negotiations with the European Union, is now facing a cash crunch. As a result, the government has
put controls on currency movements, severely limiting withdrawals from banks. Businesses are having difficulty paying for
inventory, and goods are disappearing from retail shelves. Likewise, individuals are having difficulty paying for basic necessities. The
dilemma is that if the government lifts the cash withdrawal restrictions, there is likely to be a run on the banks. The situation is
somewhat less severe in Puerto Rico in that there will likely remain some access to cash. But overall, the government is broke and
unemployment is high. We sincerely wish the best for citizens of those two entities. We also hope that in this country, along with
the rest of the world, the appropriate lessons are fathomed.
Among other news, the Federal Reserve continues to threaten to raise interest rates. The markets have anticipated such a move,
with the general level of interest rates rising during the quarter. Still the Fed hasn’t yet moved due to concern about the potential
impact of an increase in interest rates. The absolute fear astounds us. Ironically, the more they fear such a move and the longer it is
put off, the larger the market impacts (at least in the near term) are likely to be. Let us put the Fed’s fear in perspective. Currently
the Federal Reserve has a target Fed Funds rate of 0.25%. It has stood there since late 2008. By contrast, the lowest level of the Fed
Funds rate during the 2000 – 2001 recession was 1.00%. By late 2005 the targeted Fed Funds rate exceeded 4%, eventually peaking
at 5.25% in 2007. Yet six years after the end of the last recession, the Fed thinks the economy is so fragile that a quarter point
increase risks derailing the economy.
What’s going on here? We think there are a few factors. First, we don’t doubt that there is a general fear. No one wants to be
responsible for doing the wrong thing and causing a repeat of 2007 – 2008. But as so often is the case, we believe the Fed is still
fighting the last war. Meanwhile the level of investment and savings is distorted as a result of artificially low rates. We, on the other
hand, are of the opinion that the economy isn’t that fragile. We think a more appropriate level of savings and investment would
serve to further strengthen the overall economy.
Second, the Fed has too much of a focus (in our opinion) on the near term movements of the equity markets. The markets might in
fact react negatively to an interest rate increase. But markets adjust, and we think the longer term impacts from a return to
normalcy will ultimately lead to even higher stock prices. Contrary to popular opinion, we think Fed policy is now a negative for
investment success.
Finally, and this is the most sinister of our theories, the Fed may be very complicit in a transfer of wealth from savers to borrowers.
And who are the largest borrowers? They are the government entities at the federal, state, and municipal levels. If interest rates
go up, the cost of borrowing will lead to worsening budget deficits. With rates at artificially low levels, government entities can
avoid making hard decisions. Meanwhile, those most dependent on their savings, primarily retirees, have seen their investment
earnings fall. They have in many instances taken on inappropriate risks to maintain their income. As we said above regarding the
circumstances in Greece and Puerto Rico, we hope the appropriate lessons have been fathomed.
While we have focused on this country and the problems in Greece, we’ve neglected to discuss the situation in China. That country
is facing problems of its own. In a nutshell, it is easier to control a low wage, production oriented, export economy, than it is to
control a middle class, demand oriented economy. As a result of missteps as the nation undergoes such a transition, security
markets are experiencing wider swings. We still think the rising middle class will keep the economy moving forward. But given the
size of the Chinese economy and that country’s impact on currency markets, it will be necessary for us to keep our attention on
developments there.
Before concluding this commentary, we do want to offer our prognostications about the future. We continue to expect the U.S.
economy to chug along at a modest, positive clip. Meanwhile, the U.S. dollar should remain strong, especially as a result of the
fallout in Greece. We also expect that the Fed will finally raise interest rates. This will likely occur in September or October. We
wouldn’t be surprised if there were a negative reaction in the equity markets to this. If that does occur – we want to emphasize
such a reaction is not a prediction – we would most likely view it as a buying opportunity. We still think the equity markets are
attractive, though corrections and volatility will remain a reality.
After the initial rate hike, we would expect the Fed to pause to determine if the world subsequently ends. Assuming it does not,
sometime in 2016 there will be additional rate increases. But then again, presidential politics have a way of interfering with events.
At this point, however, it is way too early for us to discuss the still distant election. We’ll save that for some future edition of our
Commentary.
-PCM Portfolio Management Team