Here’s the news of the week – and how we see it here at McAlvany Wealth Management:
Draghi May Be Behind the Curve
Markets overseas were overjoyed when central banks engaged in more doing than talking with regard to stimulus this week. In China, government officials prepared a budgetary increase to defense spending as the Japanese had done a few months before. In Japan, Shinzo Abe placed Japan’s $1.2 trillion government pension investment fund under review – after which the fund may be required to divest a portion of its $600.0 billion allocation to Japanese government bonds in favor of equities. Japan’s finance minister, Taro Aso, also stated that the Bank of Japan was prepared to boost stimulus (again) to offset the negative impact of the 10.0% increase in the sales tax. And in Europe, Mario Draghi outshone them all with a surprise cut to three of the European Central Bank’s benchmark rates, in addition to a $906.0 billion bond buying program (QE) that will target higher quality ABSs within the next month. Needless to say, stocks and bonds in both Asian and European markets fared well on the back of these announcements.
In contrast, US markets struggled a bit – due in part to Apple’s cloud blunder and the Ukrainian/Russian ceasefire now in effect. The latter produced what appeared to be a repatriation of assets away from US safe havens to European and Eastern Bloc markets. But, on the whole, there wasn’t much news here in the US to build on – with the possible exception of Friday’s disappointing non-farm payroll data. Fully 230,000 jobs were expected, only 142,000 materialized, yet the unemployment rate miraculously declined to 6.1%. That put a QE-hopeful bid into US stocks that helped erase nearly all of the week’s earlier losses (except for small-caps).
The next FOMC meeting is slated for Sept 17th, and at that time we’ll get a better idea about the Fed’s near-term goals. Janet Yellen cited the weak jobs report as a reason to stand pat on rates for a while longer, but said nothing about current tapering plans. We must therefore anticipate a $10.0 billion reduction to the current $25.0 billion/mo. bond-buying program, even though the risks in the consumer spending department are rising. Tapering to zero by October (as intended) may still be in the cards, but, as other central banks have discovered, maintaining a hawkish stance will be nearly impossible. If maintained, it may require supportive language to prevent a nasty deleveraging in stocks. In either case, it would be no surprise to see stocks start to tank in a “sell the news”-style proposition.
As for the future of QE here or abroad, we have pointed out several times that its effects on growth are becoming more and more negative by the day – causing higher long-term interest rates. Draghi’s pledge to ease may have pacified the crowd for now, but his efforts will be chasing already record-low interest rates in the region (thanks to his jawboning for 2½ years) that intrinsically have yet to stimulate anything in the eurozone this year. Instead, the results may be purely financial, as we’ve seen in Japan – short-run dynamics would suggest a rise in European stocks, a fall in the euro, and inflation that mutes any real economic progress. And as in Japan, the EU may experience a sharp increase in demand for the metals. Japan’s appetite for gold increased more than 500.0% year-over-year thru the second quarter. Simply put, there’s nothing bearish at work for the metals, which makes the recent price action in gold all the more frustrating. As markets go, however, that can change very quickly.
VP Investment Management