Out of the Box: Risk On/Risk Off
After the October through December downfall, the world is looking brighter with all of the major American equity indexes up significantly. In the last three months, the DJIA is up 7.99% while the S&P 500 has risen 11.36% and the NASDAQ is up 15.91%. For the last year, the DJIA is up 9.18% while the S&P 500 climbed 10.11% and the NASDAQ is higher by 14.42%. So much for the Doomsday predictions.
Much of this has been caused by the amazing backflip of the Fed. In December, Chairman Powell sent the markets into a nosedive but then the Fed turned tail and decided, apparently, that no more rate rises were necessary. The bleachers cheered and the equity markets took off. Thank you, Chairman Powell.
To be quite blunt about it I think the Fed made the right decision. American interest rates are substantially higher, even now, than interest rates in Europe and Japan and the markets are global, without any question. I am not advocating for negative yields here, let me be clear, but we have plenty of room on the downside if the Fed decides to get even more proactive. Lower borrowing costs will push the economy ahead as both Corporate revenues and profit margins increase. It would also help the country as the cost of our national debt declines.
The situation in Europe, as predicted, is none too good. I have been an advocate of staying out of Europe for quite some time, unless you have a mandate to be there. Let’s look at the results. During the last year the Euro Stoxx 50 is down -0.52%, while the Dax is off -2.11% and the Italian Index, the FTSE MIB, has plummeted -9.15%. America shines by comparison.
In the bond markets Treasuries are virtually flat, for the last three months at -0.02%. For the year Treasuries are only off -0.50% now as the Fed’s new direction takes hold. What’s telling in fixed-income is the Corporate Bond Index which is up 4.04% for the last three months and up 6.60% for the year. Then the High Yield Index is up 4.66% for three months and 6.64% for the year. All of this tells us that the compression of “risk assets” to Treasuries is increasing, as the economy is growing far more quickly than thought by many. All of these Indexes, it should be noted, are provided by Bloomberg.
Our recent GDP number was far past the median expectations. It is proof, I believe, that the Tax Cuts and Job Bill is working and that the Administration’s relaxing prior regulations is also providing a positive effect. You may argue as you like politically, but it is tough to ignore the economic and financial numbers.
Globally, China seems to be stabilizing and there is always the hope that China and the United States will come to a trade deal. I, personally, think that President Trump has taken the right tact in these negotiations as China had been taking advantage of the United States, and Europe, for years, in a wide variety of manners. I am not blaming China for advancing themselves but I do think that the time had come for America to stand-up and object. I applaud our government in its efforts.
In my opinion, the “Big Risk” continues to be Europe. Brexit is coming at some point, in my view, it is just how and where and in what form. My prognosis is the result will be somewhere between messy and a catastrophe and I do not suggest investing in Europe at present. Way too much “Risk.” Way too little reward.
One major issue is Italy. Business Insider states that some “Economists in Milan and London are debating whether Italy is carrying so much debt that it might collapse into a Greek-style financial crisis. Their fear is that because Italy is so much bigger than Greece — and because Italy is one of the Big Three economies underpinning the Eurozone — that the scale of such a crisis might be more difficult to contain this time around. It also underscores the un-resolvable contradiction at the heart of the European Central Bank (which governs the 19 countries that use the euro as a currency): Once a country gets into too much debt, European Union austerity rules that limit government spending.”
In fact, Italy’s debt load is rising. It currently stands at about $2.25 trillion. Debt to GDP has now reached 130%, a level not seen since World War II. Also, Italy’s banks hold a high ratio of domestic government debt. If investors ever believe that either the banks, or the government, cannot sustain that debt, a national default becomes a real risk. This would be far worse than Greece, as the Italian economy is the third largest in the Eurozone.
Even more concerning to me are the upcoming European elections. Eurosceptic candidates are lining up to engulf the European Parliament, which elects a new batch of MEPs between May 23 to 26. A major study, carried out by news website Politico, claims that at least 150 populist, or nationalist, candidates are set to win seats in the upcoming European ballot. If the Eurosceptic groups manage to organize themselves into one bloc, they will challenge the traditional parliamentary giants and even have an outside chance of being the controlling the European Union.
What does seem clear to me, however the vote actually turns out, is that the domination of the EU by the German/French alliance is doomed. This will mark a turning point in how the European Union is run and this will be to the detriment of both Germany and France while countries such as Italy, Poland, Hungary and the Czech Republic will have a bigger say. More problems ahead in Europe, in my estimation.
So, I am “Risk On” in the United States and “Risk Off” in Europe and I have a neutral view of China, at this point in time.
Place your bets.
Mark J. Grant
Chief Global Strategist, Fixed Income
B. Riley FBR Inc.
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