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A Quiet Look At History

The Week Ahead: Another all time market high. Fed will raise rates. It's in the prices. 

U.S. equities continued the reflation story. Just as a reminder this is how it goes: 1) a relaxed U.S. fiscal policy 2) lower corporate and personal taxes 3) repatriation of overseas earnings 4) deregulation and 5) a general price increase in a full employment economy. 

We saw the S&P 500 reach another all time high. Small cap stocks, with their domestic facing business, also roared ahead. They are now up 27% this year compared to the S&P 500 of 10.5%. Before we head into the week’s events, this is a good time for a long-term view. 

A Quiet look at history

First off, here’s a 67-year look at the U.S. economy. We live in a $18.6 trillion economy. Last week’s growth showed a 3.2% gain. This year alone, the U.S. economy increased nearly $700bn, which is like adding the GDP of Switzerland with change to spare. Meanwhile, U.S. stocks grew in line. 

Now we know that the very long term does not address an investor’s needs in the next year or so. Markets can set back for prolonged periods. But a couple of points we take from the above: 

1. The U.S. economy, at $18.6 trillion, can defy a lot of political and economic tinkering. It’s big. It has its own momentum. It grows pretty much regardless of what party, tax regime or policy in in place. 

2. Inflation was a ten-year problem in the 1970s. But long-term inflation in the American economy is around 3%. Today we are at less than 2%. If there is any “resurgence” in inflation, it will be from a very low level to a low level. 

Back to the present

Last week the ECB committed to more bond buying through to the end of next year. The market was initially disappointed because the amount dropped from €80bn a month to €60bn, but the total committed was much larger than before and adds another €540bn to the ECB balance sheet. Think of the Fed’s QE and double it. So with lower for longer you would expect three immediate things:

1. A lower Euro

2. Stronger bond markets

3. Stronger equities (because of #1)

Which is all well and good but European equities are living off aggressive monetary policy and a play on a U.S. bounce. But they are also facing political unrest (Italy last week was the latest but not the last), no fiscal policy and a suffering banking sector. So, while European markets are up 5% since September in local currencies, for the U.S. investor it looks like this: 

 

So, we are still wary of allocating more into non-U.S. markets.

Bottom Line

We expect U.S. Treasuries to back fill in the next few weeks. They look oversold and short-term international bonds even rallied last week. Last week’s claims numbers reached a record low as a proportion of the U.S. general and working population. It's a dead cert the Fed will raise rates later this week. But the market has priced it already. 

 

Other:

Philippines-style law enforcement

Another take on the President-elect’s conflicts of interest

Global policy uncertainty

 

--Christian Thwaites, Brouwer & Janachowski, LLC

 

 

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All charts from Factset unless otherwise noted.