Season Investments


Monthly Macro: Falling Forward vs Just Falling

Posted on June 4, 2013

Our Monthly Macro is a recurring post that appears on the first Tuesday of every month and recaps the high level macro developments of the previous month. We highlight the global themes that we believe are the most important and discuss why they matter for investors. This month’s piece will focus on the US recovery, speculation about Fed tapering, the improving federal deficit and a shift in Germany’s stance on austerity. 

2nd-Speed Recovery Intact 

In last month’s Monthly Macro we discussed the global Three-Speed Recovery. Bookended by rapidly growing emerging economies and languishing Eurozone and Japanese counterparts, the US places solidly in the “2nd-speed” slot with its muddle-through growth. The month of May brought more confirmation of the US’s slow but positive trajectory. Housing data remained strong as RealtyTrac reported that foreclosures, down 23% over the past year, were at their lowest level since February 2007. Construction permits also approached a five-year high, and existing home sales rose above November 2009 levels. Additionally, the employment picture improved as the economy added 165,000 jobs in April and prior months’ numbers were revised higher by 114,000. As the chart below shows, the 4-week moving average of initial jobless claims has declined to territory associated with “normal” turnover in the labor markets.


WHY IT MATTERS: Lower unemployment and rising house prices have translated to an increase in US consumer confidence. The Conference Board reported that its index of consumer attitudes leapt to levels not seen since February 2008, and the most recent monthly retail sales report exceeded expectations by nearly half a percent. Even Stephen Roach, in his recent scathing analysis on the US consumer, had to concede that the vector was headed in the right direction. Could it be that Bernanke’s “Virtuous Circle” (discussed at the 28:25 mark in our Certainty of Uncertainty video) is taking hold? Given the policy-driven market environment we’ve been in, the most important implication here is what impact the economic reality will have on Fed policy.


Talk Of Tapering

Perhaps the single most important development during the month of May was all the talk over the Federal Reserve potentially tapering its quantitative easing program at some point in 2013. Certain Fed bank presidents began making statements such as “I believe the efficacy of continued purchases is questionable.” (Richard Fisher, Dallas) and “We could reduce somewhat the pace of our securities purchases, perhaps as early as this summer. Then, if all goes as hoped, we could end the purchase program sometime late this year.” (John Williams, San Francisco). This caused a flurry of speculation that the Fed may be poised to taper its asset purchases as early as this summer. However, Bernanke’s Congressional testimony later in the month threw a cold towel on all the chatter when he stated that a premature tightening of Fed policy would carry substantial risk to the economic recovery. His comments were echoed on the same day by New York Fed bank president William Dudley when he suggested that the FOMC would need to give it another 3-4 months before they knew that the housing recovery was real and the economic recovery was strengthening.

WHY IT MATTERS: We are in a policy-driven market environment. In our post on May 21st called Lack of Participation our reasoning for exploring the labor force participation rate was that anticipating future changes in Fed policy is one of the most important things an investor can do right now. Fed tapering will be seen as the first of many dominos in the multi-step process of the Fed withdrawing its easy monetary policy. This will impact short-term investor sentiment on the margin, potentially pushing interest rates higher and reducing demand for gold as an inflation hedge – two themes we have already begun seeing signs of in recent weeks.


Dwindling Deficit = Delayed Debates

The US federal budget deficit, which has eclipsed $1 trillion in each of the past four fiscal years, is poised to shrink considerably to $642 billion in fiscal year 2013 according to the latest estimates from the Congressional Budget Office. The improvement is attributable to a combination of factors including a healing economy, tax increases, spending sequesters and a special dividend from Fannie Mae and Freddie Mac. The positive implications of this are obvious, but one indirect consequence is that it likely delays any further discussion in Congress over the federal budget. Because of the unexpected improvement in the deficit, the US government is now projected to be able to pay its bill through at least Labor Day. This means, that despite the debt ceiling going back into effect on May 19th (it was temporarily suspended as part of the fiscal cliff deal), it could be tabled as a non-issue until, once again, it rears its ugly head. Senate budget committee chairman Patty Murray (D-Wash) put it well when she said, “The American people — all of us — are tired of management by crisis”. That sentiment will be put to the test over the next several months.


WHY IT MATTERS: As we saw in 2011 and again in late 2012, “management by crisis” in Congress often equates to high levels of uncertainty and volatility in financial markets. Congress would do well to tackle the budget head on now rather than waiting until the debt ceiling issue forces itself once again, but if they choose to delay this debate we would look for this issue to dominate headlines again this fall. Additionally, unclear fiscal policy is also impacting the Federal Reserve’s monetary policy decisions. Bernanke and company have frequently referred to Congress’s actions as restraining economic growth and making their job that much harder. Until there is more clarity on the budget the Fed is all the more likely to keep their easy policies in place.

Germany Capitulates

Last month one of our macro themes was Austerity On The Outs in which we profiled the dichotomy between the languishing southern periphery of Europe (France is the most recent addition to the list of nine countries in recession) and robust Germany to the north. We highlighted the recent shift towards anti-austerity rhetoric from the likes of Spain and Italy and contrasted that to the unwavering message of fiscal discipline coming from the Germans. This month we change our tune slightly as the major development throughout May was that German officials dramatically softened their tone. Finance Minister Wolfgang Schauble sounded like a new convert following a meeting with his Portuguese counterpart: "We need more investment, and we need more programs…The German government is always prepared to help." It appears that the Germans are capitulating to the economic desperation of record high unemployment and a Eurozone economy entering its sixth quarter of recession.

WHY IT MATTERS: Again, we remain in a policy-driven market, so any change on the margin in global fiscal or monetary policy can impact investment performance. The Eurozone is the worst performing economic region in the world right now. The winds of change suggest that government spending will become more accommodative over the next several quarters, and it may also be interpreted that the European Central Bank could become more aggressive in devaluing the Euro for the sake of boosting the region’s exports (see Exporting Unemployment for more discussion on currency wars). This dynamic could become a tailwind for European stocks and a headwind for the common currency.

 In summary, the month of May highlighted the widening gap between American and European realities. While US policy makers are faced with the decision of when and by how much to reduce their exceptionally accommodative programs, the Europeans are staring down an expanding recession and considering the prospect of finally jumping on the punch bowl bandwagon. Neither of these two dynamics represent wholesale changes to the macro landscape, but they are signals that we are nearing important inflection points where public policy in these two regions might slowly change direction.

These macro issues should obviously not be viewed in isolation, but rather should be added to the “research mosaic” as we consider how to best allocate our client portfolios. That said, one potential investment consideration in light of all this could be to increase our exposure to European equities. If we’re right about a coming shift in fiscal policy in the Eurozone we could see an increase in positive sentiment towards risk assets in the region, if not an actual improvement in the underlying economy. This would result in improving fundamentals, increased valuation multiples, or even a combination of both. If we did end up increasing our exposure to this region, we might simultaneously want to hedge out the currency risk in order to avoid the potential that the ECB becomes more aggressive in trying to devalue the Euro. This topic will definitely be on the agenda for consideration at our investment committee meetings over the next couple weeks.

david_headshot_bw.jpgAuthor David Houle, CFA is a founding member of Season Investments. He serves as the firm's Chief Compliance Officer as well as sitting on the investment committee overseeing the management of client assets. David spent nearly ten years in various roles primarily managing individual client assets prior to co-founding Season Investments. David graduated with a degree in Finance from Colorado University in Colorado Springs in 2003 and earned the Chartered Financial Analyst (CFA) designation in 2006. David and his wife Mandy have three children and spend most of their free time with friends and family.

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