Capital Market Comment
January 13, 2020
Frank Mastrapasqua, Ph.D.
Principal, Chairman & Chief Investment Officer
The new year has brought crosscurrents that have added another dimension to the economic and financial landscape. The increased tension in the Middle East has heightened sensitivities to the geopolitical vulnerabilities that policy makers and CEO’s must face. It appears that we have entered a new phase of international conflict that is likely to persist for some time and manifest itself in numerous and unpredictable ways. Policymakers, particularly those in the monetary arena, are likely adjusting their growth expectations and assessing the impact of volatile oil prices, as well as potential supply chain disruptions.
From the U.S. perspective, the Federal Reserve is likely to view these factors as placing downward pressure on the world economy.
Consequently, we would expect that the crisis with Iran will reinforce the monetary bias toward ease and sustain a “no rate increase” policy for 2020. Moreover, in Europe, the deep relationships with the countries in the Middle East will weigh heavily on the ECB (European Central Bank), particularly given Ms. Lagarde’s international perspective as former head of the IMF (International Monetary Fund), further fostering an accommodative strategy.
In China, prior to the Iran crisis, the Central Bank lowered reserve requirements in order to put additional liquidity into the financial system in response to slowing economic growth. The developments in the Middle East only reinforce the need for additional easing. The global monetary climate and the liquidity that is being injected into the system continues to place downward pressure on interest rates.
Interest rates are a key factor in financial market valuation and excess liquidity does manifest itself by moving asset values higher.
The key policy parameter that is driving Central Bank action is inflation, and it remains an enigma. As we have discussed in previous commentaries, the failure of the Federal Reserve to hit its 2% target over the last eight years poses a credibility problem that they are trying to rectify. In 2020, the research emphasis at the Fed and elsewhere will be focused upon the structural issues that have produced low inflation and the deflationary bias that appears to be in the U.S. and world economy. Any solution appears to be supportive of more liquidity and a tolerance for inflation being above 2% for a period-of-time (symmetrical).
The financial market structure, particularly since the financial crisis in 2008, has changed. As former Fed Chairman Bernanke said in a paper presented at a conference in San Diego, “the old methods do not work”. If monetary policy is to remain relevant, policymakers have to adopt new tools, tactics, and frameworks. Moreover, John Williams, President of the Federal Reserve Bank of New York recently said that low global rates are here to stay.
It is important to recognize that new methods are needed to offset the deflationary effects of demographics and technology in an effort to achieve the 2% target. This notion clearly implies a more aggressive policy is needed to reinforce cyclical inflation.
The aggressive policy stance the Fed took in 2019 continues to manifest itself in the growth in employment, which was evident last month with ADP reporting a 220,000 gain. The Labor Department showed a 139,000 gain, with an average over 180,000 in the last three months. The consumer remains vibrant and his/her debt burden is modest.
Given the market’s strong performance over the last several months, the upcoming earning season will have many surprises as well as provide excuses for traders, algorithms, etc. to sell. However, the year for the “investor” has favorable bias with strong monetary growth supporting the economy and rates likely to have a benign influence. Market volatility is likely to be influenced by the ebb and flow of the election as it tries to handicap the outcome. Additionally, Brexit, the continuing trade conflict with China, and geopolitical risks will come into play as the year progresses.
Against this monetary backdrop and the geopolitical climate, growth stocks may be the net beneficiary. If rates remain low globally for a long period of time, discounting earnings at a low rate enhances valuations. Moreover, the sectors that address directly the conflicts at hand – cybersecurity, aerospace, and defense will continue to be elevated in investor minds. Technology in general should also benefit, such as semiconductors.
If you have a question or need further information, please contact:
Don Keeney, CFA, CFP, Principal & Portfolio Manager in Nashville at 615-866-0882, or firstname.lastname@example.org
Claude Koontz, CFA, Principal & Portfolio Manager in San Antonio at 210-353-0519, or email@example.com
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The information and opinions contained in this report should not be treated as fact or as insight that will produce desired investment results over time. Investment conclusions always bear risk, and that risk may not be reasonable for any particular reader. Obviously the writer, even assuming good intentions, does not know of the reader’s particular financial circumstance and therefore is not able to assess the propriety of whether a named security makes sense as part of a given individual, family, or institutional portfolio. Mastrapasqua Asset Management clients may, from time to time, own some of the companies mentioned. We hold out no duty to give readers of this column advanced notification of when we may change an opinion. To our knowledge, none of the information contained in our column would, when it becomes publicly available, have an influence on the valuation of a particular stock. Investors should receive investment advice based on an assessment of their own particular investment circumstances and not on the basis of recommendations in this report. Past performance is not indicative of future returns.