Commentaries
The “fundamentals” behind the U.S. bull market remain intact and the long-term trend is up. However, two points need to be made. First, we put the word “fundamentals” in quotation marks to acknowledge that there are some very big problems that remain to be dealt with in the longer run.
Global monetary expansion has been unprecedented. Chart 1 shows the average interest rate of the U.S., U.K., eurozone and Japan along with the U.S. $9 trillion added to these central banks’ balance sheets since 2007. As we have often said, this is an experiment with eventual consequences. From a cyclical perspective, monetary reflation has yet to gain much traction in the real economy and, therefore, more should be expected, perhaps much more. The Bank of Japan, for example, just announced that they intend to double the money supply over the next two years. Credit continues to contract in many countries and sectors and economies are once again softening in most parts of the world. This is a reflection of the fact that the long-term debt supercycle still has a long way to go before it is significantly unwound.
Macro Themes : The outlook for global growth is improving, but still weak enough to warrant ongoing central bank monetary expansion and interest rate suppression. The ECB will have to respond to catastrophic eurozone unemployment and growing social unrest by stepping up asset purchases this year, after a hiatus in the past few months...
The gold price is obviously influenced by many factors. We touch on some of these in this update.
Corporate profits and margins have continued to remain high despite the difficult macro-economic environment of the past five years. In this report we examine the sustainability of elevated corporate profits. Recently, reported U.S. earnings have been mixed, with some large companies surprising on the downside due to a combination of rising costs and weaker than expected sales, giving rise to concerns that the trend of total profits may be heading lower.
Beginning in late 2012, mutual fund and ETF flows indicate that investors have dramatically increased equity purchases. This signals a reversal of the trend favoring safe bonds over equities that has been firmly in place since the 2009 market crash.
World growth will remain low on average but negative in the UK and Europe; price inflation will remain sufficiently subdued for a while longer so as to impose no constraint on monetary expansion; central banks will sustain a regime of negative real interest rates and rapid monetary expansion; the risk of a eurozone collapse is off the table for now; finally, stock markets should continue to perform better than expected, even though the four-year old cyclical bull market is long by historical standards.
Macro Themes for 2013.
1. Tail risks are receding: the eurozone is holding together, Greece recently got an S&P upgrade, China has executed a soft landing and the U.S., despite its dysfunctional politics, has a number of things working in its favor.
2. Global growth will remain weak: leading indicators are not providing any evidence of an imminent return to trend growth rates in emerging or developed nations.
3. Central banks will likely step up the flood of liquidity and low interest rates will remain in place, as key central banks are set to drop inflation targets in favor of nominal GDP and labor market outcomes.
4. While excess capacity and labor market slack imply that the short-term inflation outlook is benign, shifting central bank policy and stepped-up government intervention may result in a pickup in inflationary expectations in the coming year.
The current economic data around the world is mixed and conflicting, making the outlook for the year ahead very uncertain. Employment prospects are poor in virtually all countries. The massive numbers of unemployed, taken together with the underemployed and those withdrawn from the labor force, continue to scare policy makers and politicians, putting pressure on central banks to do much more to stimulate demand.
Almost two years ago we wrote a special report entitled “Why the Secular Bears Are Wrong” (January 17, 2011). We received an enormous amount of feedback and virtually all of it was critical. Needless to say this made us feel more comfortable that our hypothesis had some merit. With widespread negativity on the future still palpable, it is appropriate to review our thesis in light of the passage of almost two years. Readers should keep in mind that we are talking about very long-term trends, not the outlook over the short term.