The Breadth Is yet to Come
Global capital markets continued to perform well in the third quarter despite periodic disconcerting political headlines emanating from both Washington and London. Financial assets (fixed income and equity) have been the primary beneficiaries of universal accommodative monetary policy. Ultralow and negative interest rates have driven investors to seek “risk assets”.
The world’s central banks will continue to pursue accommodative monetary policy until inflation is meaningfully above the median of their target ranges. The fact remains, inflation is nowhere to be found… anywhere in the world… save and except for maybe a few shadows in the US. In the absence of inflation, anytime economic growth rolls-over, the respective central bank in charge will prime the pump. Fixed income markets are very fluid – truly global. Until we see inflation appear in a majority of the developed world (look to Europe) rates will continue to be low globally. We see no end to this positive, liquidity-induced investment environment.
Thus far, most of the action has been in US mega cap stocks, especially those in the technology, utility and real estate sectors. Definitive steps towards gradually resolving the current US-China trade stand-off, however, should set the stage for a much broader rally. A rally that would include US small cap stocks as well as international developed and emerging market equities. We believe that the US and China will reach a resolution. And will likely do so sooner rather than later. For both countries, their respective domestic political situations make it an imperative. A further faltering of export fueled China presents President Xi with the potential for social unrest. For President Trump, a strong US economy, while not sufficient, is almost certainly necessary to winning a second term.
Beyond a near term trade-induced market rally, a switch in focus from monetary to fiscal policy (in the form of infrastructure spending) could give new sustainable legs to global equity markets. We think there is reason to believe this could happen in the US and even in fiscally paranoid Europe! The incoming President of the European Central Bank, Christine Lagarde, has been socializing the idea with some verve. We think Ms. Lagarde has the creativity to find a structural solution to achieve buy-in (from Germany in particular). Fiscal policy unlike monetary policy benefits all sectors of the economy and further supports our view that there will be breath to any future rally in equities.
Much has weighed on the mind of the market in recent weeks – China-US trade, global slowdown, Brexit, Middle East geopolitics, and pretty much all things Trumpian. Market participants, we believe, are far too negative. A positive surprise or two could completely reverse this sentiment. We continue to believe that the greatest investment risk today is being on the sidelines in cash.