Slow and Steady Wins the Race

With the market anticipating a 25 basis point increase by the Federal Reserve in a couple of weeks, we thought that this graph would prove insightful. At Cutler, our view is that the reasons at this point for a rate increase are tenuous, and therefore we would anticipate a a slow rate cycle. In the past, this type of environment has been a positive for equities.

Markets Begin Acting Like Markets

 

When China announced a devaluation of the Yuan, it was indicative of a sickness that has been festering in the global equity markets. Growth has been anemic for several years, but equities have generally rallied. The primary contributor has been the generally low level of interest rates around the globe. Today, the Federal Funds rate sits at 0%, with the prospect of a 25 basis point increase before year end. This, coupled with uncertainty in China, is in our view the catalyst of the current market volatility.

Cutler has been advocating that a 10% market correction could be “just around the corner” for several years. This is a normal occurrence for equity markets, but one that hasn’t happened since 2011- over four years ago. Last October, stocks had just over a 9% correction. The culprit at the time? The end of quantitative easing. The end of QE III is a similar factor (monetary tightening) as the onset of 0.25% interest rates. The market will adjust, as it is currently, and ultimately the economy will move forward under these very accommodative policies. The Fed continues to be a stimulus; even with modestly higher rates, we are in a historically low rate environment.

What should investors do? As we advocated last year, ensure that you are in a diversified portfolio. At any given time, certain asset classes may underperform and look unattractive. However, when investments shift leadership, this change can take place very quickly. Timing the market is not a sustainable approach to investing, but understanding your portfolio risk will help you remain invested during times of turmoil. Give Cutler a call if you would like to talk about your portfolio risk at any time.

China Devaluation; Time to Panic?

On Monday evening, the People’s Bank of China lowered the currency peg to the US Dollar by 1.9%. This was followed by additional weakening on Tuesday night, with the two-day move the largest Yuan fluctuation since 1994. Given that China’s currency reserves have been depleted by over US$300 billion this year defending against the rise in the Dollar, this is not entirely surprising. The devaluation immediately makes Chinese exporters more competitive and Chinese assets cheaper in Dollar terms. What does it mean for the US stock market and US multi-nationals? The market reaction has been pronounced, but not severe. The negative response is based, in our view, on two developments: 1) The USD continues to rally, decreasing the value of overseas earnings and hurting competitiveness, and 2) China’s currency movement may portend greater economic weakness in the world’s 2^nd largest economy.

We feel that the latter of these concerns is the greater risk. For much of this century, the Chinese economy was the global engine for growth. This growth, while still in excess of 6%, has abated while simultaneously the US is at the onset of a rising rate environment. We believe that investors should recognize that the Chinese government is showing its determination to maintain growth, at any cost. Such determination may ultimately be successful and greater currency flexibility will allow stimulative monetary policy. Furthermore, the devaluation of the Yuan is deflationary, meaning that if the Federal Reserve was cautious about impending rate increases, they are more so now. We believe that a September rate hike is still the more likely scenario, but the Fed Statement will likely have strong language regarding the cautiousness with which the central bank will proceed.  A Fed fueled rally may still be in the cards.

Updated Commentary

There has definitely been lots to discuss in the financial markets this Summer. Greece and China have led the way, with both having rollercoaster new cycles. We have updated our commentary at www.cutler.com with our most recent market review. Please visit to hear our thoughts and contact us anytime!

Where is the US consumer?

Economic data continues to baffle economist and the Fed. One day we get positive data and the next we get the opposite. We look for “reasons to believe’ in every data point and possible miscalculations or a fallacy in the data collection, estimation, interpretation. In the end, we all know that the US economy depends on the consumer.

1.      The energy industry remains weak, as evidenced by May’s regional survey of business conditions conducted by the FRB-Dallas. Yet, oil prices have risen from the lows, leaving the consumer a bit hesitant about spending their ‘new found’ wealth. Gas prices, at least in VA are up over 20% from the lows. Clearly the price of oil is key to a consumer led recovery. Stability, though, is extremely important.

2.      May’s Chicago PMI was released on Friday. It was relatively weak. We now have six such surveys. The average of their composite indexes fell from 0.6 during April to -2.4 during May, the lowest since July 2009. The average of the orders and employment components was also weak in May. It still looks like a soft 2Q recovery based on the averages of these surveys.
3.      The American Trucking Association’s preliminary For-Hire Truck Tonnage Index, which is seasonally adjusted, fell 3.0% during April and it increased just 1.0% yoy, which was the smallest such gain since February 2013. Neither the weather nor potholes can be blamed for this slowdown, which seems to confirm the recent weakness in consumer spending.

4.      The Association of American Railroads that US railcar traffic was down 2.7% yoy for the week ending May 23, with carloads down 9.1% and intermodal units up 4.3%. The carloads picture is less desirable for those of us rooting for the US economy to come out of its soft patch. Of the eight major categories in this segment of rail traffic, six are trending lower. Bloomberg Economist Michael McDonough found that carloads of waste and scrap, which have been particularly low in recent weeks, are highly correlated and coincident with real GDP. Maybe the recent weakness in real GDP wasn’t just a bunch of seasonal adjustment garbage.

Let’s not kid ourselves, there is no major global economy that is booming. The only thing booming is central bank debt. And, by the way, the Fed bought a ton load of mortgages last week. Who cares if they even raise rates, they have a ‘truckload’ of interest and pay downs that they are reinvesting.

The Markets Looks For Goldilocks Again

Today, the Labor Department reported that in April there were 223,000 jobs created. The unemployment rate continued its slow march southward, decreasing to 5.4%. While unemployment does not account for the historically low labor participation rate, the important news for the markets was a return to trend after a slowdown in March. The March jobs report was revised even lower to just 85,000 jobs created.

The market reaction was significant, with both bonds and stocks rallying on the news. This is the nature of the markets today, that both stocks and bonds move in tandem, and not in line with historical correlations. The market was “saying” that the news was positive, but not positive enough to initiate a June Fed rate hike. Thus, speculation on the Federal Reserve, and not company fundamentals, largely determined the value of assets. We are skeptical of a rally built around the postponement of the inevitable, but are not naïve to the powerful impact low interest rates continue to have on equity prices. Thus, continued low rate are likely to be positive for stocks; but, buyer beware when this current interest rate trajectory changes course.

Greece: a return to the table?

Cutler Investment Group doesn't trade in Greek bonds, but they still have a significant impact on what is happening in our client portfolios.

Yesterday’s move by the ECB was, in my opinion, the first telltale sign that a Grexit may just be in the works. Otherwise, why throw down the gauntlet even before you try harder to, at least, appear to be negotiating. Yes, I agree, who is looking for growth bonds from Greece? Certainly not any one of us. However, before any negotiation you first put on the table everything you want and more, then you scale back. The ECB simply rejected negotiations by imposing even more financial pressure on the Greeks. Who does that help? Don’t get me wrong, the Greeks placed themselves in this situation, but given that there is a new government in place, elected by the people of Greece, should we not try to negotiate first, then show them who is in charge?

Why do I think that a Grexit (I hate using that word but it shortens the message) may be more probable now than ever? Mind you, I am still not convinced that in the next few years there will be only Euro bonds issued by the ECB without any linkage to any country. That solves some problems but not the one in hand. Here is what we have. The Financial Times reports that the total debt for Greece is now around $362 billion and that only about 15% of the debt is now held by the private sector. This means that the public sector, the EFSF Eurozone rescue fund, the European Central Bank as well as the IMF hold approximately $308 billion of Greece’s debt.  The Greek debt to GDP ratio now stands at 177% and is growing rapidly. 

Well, who is hurt the most by a Greek default? Not the private sector but rather those that just levied extra pain. If Greece was to default, they would become the cheapest country in Europe. Tourist would flock by the boatloads. Shipping, a major source of revenue for Greece, is mostly transacted in dollars and not Euros, so they could control the olive oil market. A little inflation pain on the people but, in the long run, no debts and a private sector that just may be willing to take some early chances.

The ECB has a choice, lose money now or keep losing money forever.

A Greek exit is good for Greece, but the ECB has to be worried about: Spain, Italy, Portugal, Ireland, Cypress, and maybe even France looking to emulate.

“I know not what the future holds, but I know who holds the future.” -Homer

            

 Will the gods bless or punish Greece?

The Greeks, finally, have decided to dust off the Trojan horse and pull it into the city, where the Troika (Berlin, Brussels, IMF) stand in their luxurious garments lecturing the Greek ministry on how to run a country. They have lavished the Greeks with so much wealth and Ouzo to get them to join and stay in the Euroclub that the Greeks are in a no-lose position. It is either debt forgiveness or default, if they go back to the Drachma. A huge hit for the ECB and anyone else that holds Greek debt, but just a clean new slate for Greece. A land where their majority of income is tourism, and would make them the cheapest destination in all of Europe.  Their economy may not flourish immediately, but would certainly not be devastated. Greek banks would also default, so there would be no debts left to pay and there is always someone ready to take a chance at the very beginning in funding the next Greek Ponzi scheme.

Odysseus is alive and well!

Xavier

Rates Rally on Fed Patience?

San Francisco Fed President John Williams said yesterday “I see no reason whatsoever to rush to tightening” and that “This is a U.S. economy that although doing a lot better, still needs monetary accommodation for above-trend growth”. I won’t argue. Let’s think though about this next statement from Mr. Williams - “My view, that I've expressed previously in the past, is that the middle of 2015 is a reasonable guess when that discussion I think will become closer to, should we do it now (raise rates) or wait a little longer?" Apparently, having “patience” means about the same thing as “considerable time”.