Markets, Fed And The Election
Cumberland Advisors | Nov 07, 2016 08:00AM ET
I was honored to participate this past week in discussions on the Fed, markets, and politics. The rationale for our views at Cumberland is argued here.h3 An Overview/h3
• The market now anticipates a high probability of a Fed hike in December. The Fed has been prepping market agents for months. The major risk is that they don’t hike, which would be a negative surprise for markets and for the economy.
• Japanese policy is now clear: Anchor the yield on government bonds at zero for both short and long maturities. Note how the anchoring of two points on the yield curve really anchors the entire curve by using forward rates. Japan is clear: No negative rates. Many more years at zero. And the Japanese are beefing up defense expenditures with the ability to finance them at zero interest.
• See the Alix Steel chart , showing post-Brexit low yields in the US term structure. Notice the red circle. We believe it identifies the 35-year secular low in US interest rates. Our bond management favors shortening duration.
• Politically induced market volatility is an expected outcome of a closely contested and viciously acrimonious election cycle. Pre-election uncertainty is high. And it will be replaced by an outcome that we may or may not like, depending on our views. But certainly, an outcome will allow shrinkage of the high uncertainty premium. We believe that while markets can handle good news or bad news, it is the uncertainty of no news that creates the greatest volatility.
• Markets are ignoring earnings reports, while 75% of reporting companies are exceeding estimates. Earnings drive stock prices, and we think the markets will rise as an earnings growth trend replaces several flat years. We are fully invested in US ETF accounts.
• Additional discussions were held on Bloomberg Radio and with Barron’s. Several speeches and Q&A sessions have rounded out my pre-election personal dialogue.
Our final takeaway before Tuesday is as follows. American political dysfunction and gridlock will continue regardless of a Trump or Clinton victory. American institutional strength will be tested again. The country remains resilient but has gradually weakened. Our two-party system is failing. We are the only G7 country left with just two major political parties. Hat tip to Jeff Kleintop.
Last, the outlook for stock markets remains dependent on low interest rates and monetary policy as the Fed eases its way out of QE. For now these are not threatening markets but risk is rising.
The biggest risk is acceleration of the general price level as asset inflation morphs into broader prices. That hasn't happened yet, but we are closer to higher inflation than we have been in eight years. That is why the Fed must hike in December and do so a couple more times in 2017.
Get The News You Want
As election returns are arriving on Tuesday night, you might consider following global market reaction to the election results. Futures on American markets and global debt markets will be indicators of US market volatility on Wednesday. The worst outcome would be continued uncertainty, as we saw in the infamous "hanging chad" affair in 2000.
by Cumberland Advisors
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