July 2019 Commentary
July saw the Federal Reserve complete another highly signaled rate cut. Our previous commentary presented our concerns over the Feds ability to have true lasting economic impact when interest levels are as low as they are currently. It seems a losing proposition that the Fed has become the ultimate savior to the capital market psychology. We wouldn’t be surprised if they return to a zero-target rate over the coming months. While this may not have a meaningful long-term macroeconomic impact, it does offer tactical opportunities within our portfolios.
Brief Market Recap for July
Most of the capital markets were relatively docile in July despite the anticipated Fed move. Equity markets grinded slightly higher and intermediate and long-term interest rates moved mostly sideways. Shorter term (< 1 year) interest rates were impacted by the Fed decision and experienced a general downward trend. Precious metals were the most active exposure in the commodity space experiencing meaningful gains; other commodities were generally down slightly for the month. In other words, a typical summer month.
Geopolitics, Twitter Policy, and the Capital Markets
The rhetoric coming out of Washington has become overly toxic and counterproductive. Trade policy shouldn’t be executed on Twitter, but it seems that contemporary leadership believes otherwise. Twitter has become the platform for sharing every meandering thought traveling through the cranium of anyone with a device. It’s seems a dangerous game to be so capricious with the global economy. The Fed responded with a rate cut and we expect risk to increase throughout the equity markets as a result.
We believe increased volatility and uncertainty will push the Treasury curve down and offer opportunity in the fixed income market. As a result, we have reduced our equity exposures and increased our duration exposures to better manage risk and capture some return. Trade issues will be at the forefront the news cycle for the foreseeable future with China being resolved in the short term and President Trump also unlikely to backtrack substantially. We expect further Chinese currency devaluations to mitigate the effect of the tariff increases by the US government. As long as the global economy continues to soften and trade wars ratchet up, general volatility should increase, and the economy will trend lower. The Fed will attempt to assuage the markets and boost the economy with more rate cuts. These will have minimal impact but will offer tactical exposures along the way. Generally, risk management will return to the fore of the investment process.
We are focusing on any triggering event that can impactfully alter investor confidence. Outside of US-China relations, areas of focus and concern include Brexit, the German economy, Hong Kong, Japan-South Korea, and Iran among others. Most of these areas are rarely a source of good news and it is unlikely that will change in the short to medium term. The UK government wants a quick resolution on Brexit which, in principle, should be welcomed by everyone. However, there is little evidence that the UK government has a workable Brexit plan or has taken precautions to safeguard its economy. Expect weakness in the U.K economy as a result. In addition, the bedrock of the Euro-economy, Germany, which is a very export driven economy, continues to weaken in the face of a very soft global economy.
Less a threat to the global economy, but a more existential threat to freedom, and thus prosperity, we see a frightening escalation to the global trend toward authoritarianism in China’s aggressive stance toward a traditionally independent Hong Kong. Economically, Hong Kong is an important trade hub for the country, but one that has lost much of its status to the overall Chinese economy. It seems unlikely that Chinese leadership will be willing to be humiliated on two fronts at the same time for long and it is certainly easier for them to “pacify” the situation with a heavy hand; this would be bad for democracy and free will across the globe.
The Federal Reserve
Additional theories abound in an effort explain why the Fed lowered rates. Some suggest that the Fed is more interested in weakening the Dollar to gain advantage in global trade. This is a zero-sum game, but central bankers do seem intent on weakening their currencies to boost their respective economies; This game of “Chicken” is pure madness and dangerous to the global economy.
Others argue it is a coordinated effort with the White House to balance recent tariff threats. This arguably most viable rationale of the latest rate cut. It may be simply an effort to manage the cost of the fiscal profligacy implemented by our Federal government, intermixed with an occasional Pavlovian snack for the markets. Any or all of these may contribute to monetary policy, but the bottom line for us as investment managers is that the general suppression of Treasury yields and increased equity volatility will bring with it investment opportunity. Moreover, the markets will eventually need to incorporate the possibility that current market levels can’t be artificially sustained forever by increasingly marginal policy decisions.
The Fed’s Insertion into Private Banking - Beware
The Fed is now considering competing directly with the very industry they are supposedly overseeing. It is planning to move in on the real-time payments business which is the business of speeding up financial transactions. The overreach into the private sector can only have deleterious long-term consequences on both the banking industry and the way our economy operates. We are not fans of government insertion into competitive markets. History has taught us that society suffers whenever elected officials involved themselves in anything where they don’t have any expertise whatsoever. Given this and our current political environment we should all remember Margaret Thatcher’s famous line about Socialism - “The problem with socialism is that you eventually run out of other people's money.”
Looking Ahead
Though we are amidst the dog days of summer, we expect increased volatility throughout the capital markets. Treasury rates will trend lower and equity volatility will increase. These offer investment opportunities. An eye on the long term will be essential in positioning our exposures. Being nimble and deploying efficient product structures will prove important in the coming months. Risk management will again be the most important aspect of portfolio and wealth management Strategies.
As always, please contact us with any questions or comments.
Sincerely,
The Varium Investment Team