Marking Time

April 15th, 2014

In the wake of last year’s 100+ basis point rise in U.S. bond yields and 32% return for the stock market, financial markets took a breather this past quarter: The S&P 500 Index returned only 1.8%, roughly matching the Barclay’s Aggregate Index.  January witnessed a stock market sell-off of 4%-5% and a dip in bond yields amid concerns about the U.S. economy and emerging markets.  However, the market subsequently recouped its losses in February and went on to post a record high in March, as investors shrugged off economic data as being influenced by severe weather.

In the meantime, investors are assessing what is in store for U.S. monetary policy with Janet Yellen as the Federal Reserve’s Chair. At her first FOMC press conference, she surprised market participants by suggesting the Fed could raise short-term interest rates as soon as six months after it completed its current bond tapering operation. This triggered a rise in the front end of the Treasury yield curve. However, investors reassessed the interest rate outlook when Yellen subsequently clarified that labor market conditions are far from normal while inflation is well below the Fed’s target.  Read the rest of this entry »

Palm Beach Forum Panel: Moving Beyond Bubbles

April 7th, 2014

Remarks delivered at the Palm Beach Strategic Forum, April 7, 2014.

Mr. Chairman, thank you for the opportunity to address this session on evolving global risks and asset bubbles. My perspective is that of a Chief Investment Officer for a U.S. financial institution. This topic has become of paramount importance in the wake of the 2008-09 Global Financial Crisis and ensuing test of the euro-zone. However, it should be recognized at the outset, this was not an isolated event; there have been a series of global crises over the past 25 years that have affected policymakers and investors alike.

In my remarks, I will first examine the factors that have given rise to asset bubbles and why financial crises have become more prevalent in the past three decades. I will then consider what policies are being created to lessen the risks of financial crises and what investors can do to be protected. 

What Are the Causes of Asset Bubbles?

There are two basic approaches to this question in the literature. One approach is non-economic, and views asset bubbles as being caused by irrational exuberance, while the alternative approach links bubbles to economic factors such as excessive credit creation and unstable international capital flows: Read the rest of this entry »

Is the Fed in Play (again)?

March 24th, 2014


  • At  her first FOMC press conference as Fed Chair, Janet Yellen surprised market participants by suggesting the Fed could consider hiking interest rates as soon as six months after it completed its current tapering operation.  This would move the timetable for Fed tightening to the second quarter of 2015.  Previously, the market had been pricing in the first rate hike in the second half of the year.
  • At the same time, the Fed’s FOMC policy statement dropped the 6-1/2% unemployment rate and 2-1/2% inflation rate thresholds.  Henceforth, guidance will be more qualitative and less quantitative.
  • Our own take is that market participants had become complacent that the Fed was unlikely to tighten before the second half of 2015.  This left the front part of the yield curve vulnerable to the surprise announcement.
  • We are unsure exactly when the Fed will begin raising rates and are focusing on the economy and jobs creation.  Bond yields will likely move higher this year as the economy gains traction, with the 10 year Treasury yield headed for 3.5%. 

The Fed Alters its Guidance

Prior to this week’s FOMC meeting, market participants expected the Fed would continue to taper its bond purchase program, but investors were unsure whether the Fed would alter its forward guidance about tightening monetary policy.  The bond market’s initial reaction to the FOMC minutes was neutral, as the minutes confirmed the Fed would scale back bond purchases by an additional $10 billion per month to $55 billion.  Read the rest of this entry »

U.S. Stock Market Rally Celebrates Its Fifth Anniversary

March 11th, 2014


  • The stock market celebrated the rally that began five years ago with the S&P 500 Index reaching a record level last week that is 2.8 times above the low in March 2009.  The rally rivals that during the expansion from mid-1982 until the October 1987 crash, and is exceeded only by the technology-driven boom in the second half of the 1990s that ended in a bust. 
  • In light of these experiences, we consider the possibility that the stock market’s gains may be unsustainable.  Compared with these two prior experiences, we conclude there is less risk of a market collapse today, because valuations are not at extreme levels and there is little evidence of inflation or a credit bubble. 
  • That said, we believe the period of supra-normal returns is over; henceforth, we expect returns that are more in line with normalized profit growth of 7%-8% over the long-term.  The main risks we contemplate are the possibility of earnings disappointments and the potential for contagion in the emerging markets. 
  • Meanwhile, we continue to maintain a moderate overweight of stocks versus bonds in balanced portfolios. 

The Rally in Perspective

This week marks the anniversary of the U.S. stock market rally that began when the S&P 500 Index fell to a low of 666 on March 9, 2009.  While the market reached a record level above 1880 last week, very few professional investors anticipated how powerful the rally would become.  Moreover, the vast majority of retail investors missed it altogether as evinced by net outflows from equity mutual funds over this period. For this reason some pundits have called it the most “unloved” rally in history.  Read the rest of this entry »

Assessing Contagion Risks in Emerging Economies

February 20th, 2014


  • Emerging economies have become a focal point for investors, as a handful of countries have experienced significant currency pressures over the past year. Some observers are questioning whether this development could be the precursor of a new bout of financial contagion.
  • My own assessment is that a replay of the contagion that occurred in Latin America and Asia in the 1990s or during the euro-zone crisis is unlikely.  The reason: Currency pressures have been confined to countries with large current account deficits and/or relatively high inflation. Moreover, the external imbalances, indebtedness, and inflation rates in most emerging economies are well below levels associated with previous crises.
  • The risk of contagion cannot be ruled out entirely, however, as it is difficult to know how much leverage there is in the respective corporate sectors and banking systems.  Also, a significant slowing of China’s economy or problems in China’s financial system would likely affect emerging economies adversely.
  • In these circumstances, we believe investors need to pick and choose among emerging economies carefully: Compared to previous cycles when they moved up and down in tandem, we believe there will be greater differentiation of performance going forth.   

Increased Pressures on Emerging Market Currencies  

Over the past year there has been an ongoing build up in currency pressures for several emerging market countries. These pressures were linked initially to the Federal Reserve’s surprise announcement in May-June that it was contemplating phasing down its quantitative easing (QE) program of bond purchases. The announcement was accompanied by a surge in U.S. bond yields, and it spawned a wave of capital flight from countries that included Brazil, India, Indonesia, South Africa, and Turkey – the so-called “fragile five.”    Read the rest of this entry »

Global Market Jitters

January 29th, 2014

I wish to acknowledge the contribution of Zulfi Ali, Fort Washington’s emerging market specialist.


  • Following very strong performance in 2013, global equity markets have sold off by about 4% since the beginning of this year, mainly due to worries about emerging economies. The catalysts for last week’s sell-off were currency depreciations in Turkey and Argentina and concerns about a looming slowdown in China.
  • Economic news in the United States, by comparison, suggest fourth quarter growth was strong — in the range of 3%-4% – while Europe and Japan showed continued improvement.  Nonetheless, the respective equity markets have retraced some of the gains at the end of 2013.
  • Looking ahead, we expect the Federal Reserve will announce an additional $10 billion cutback in its quantitative easing program at this week’s FOMC meeting.  This could place additional pressures on some emerging economies.  
  • We are monitoring these developments but have not altered our portfolio positioning, as we believe the recent market moves reflect a shift in investor sentiment more than a change in underlying economic fundamentals. Read the rest of this entry »

2014 Outlook: No Encore Performance, But the Run’s Not Over!

January 14th, 2014

As the New Year gets under way, consider the mixed emotions of investors today: Equity investors are jubilant, after the U.S. stock market returned more than 30% in 2013; however, their fixed income counterparts are frowning, as Treasuries and investment- grade corporate bonds posted small losses (see Figure 1). Globally, international equity markets generated stellar results with the EAFE Index returning nearly 23%; however, emerging markets fared poorly with the MSCI Index negative for the year.  All of this occurred against a backdrop of continued moderate growth of the U.S. and global economy, a lessening of tensions in the euro-zone and tremendous uncertainty about the conduct of U.S. fiscal and monetary policies.  Click here to read more

Assessing China’s Plans for Economic Reform

November 25th, 2013


  • The Chinese government unveiled a series of proposed reform measures at the conclusion of the third Plenum of the Communist Party Central Committee. They serve as a blueprint for policy changes that grant market forces the determining role in China’s development over the coming decade. 
  • The reforms are truly comprehensive and far reaching – covering not only economic, but also political, cultural, social, environmental and national security issues. I have focused on the impact of the market-oriented ones and whether they will enable China to sustain relatively strong economic growth.
  • After reading a variety of assessments, my take is that the reforms, if successfully implemented, will improve China’s overall economic efficiency.  As such, they enhance the prospects for China to transition to more sustainable growth and are a positive development for the global economy and markets.
  • There are also challenges ahead:  Most notably, liberalization of the financial system, while necessary, could uncover problems with overly-indebted institutions.  While skeptics believe this will spawn a crisis, the history of China’s reforms is to proceed gradually, which should lessen the risk.

Background on Chinese Economic Reforms

The origins of China’s economic miracle are rooted in a series of reforms that were implemented by Deng Xiaoping in the late 1970s.  Deng’s vision was to transform China’s centrally planned economy into one that was more market-oriented, but which retained a prominent role for the central government in overseeing the evolution. The approach was to proceed by implementing a series of experiments with various sectors and studying the outcomes, rather than embarking on “shock therapy” as some Eastern bloc countries did after the collapse of the Berlin Wall. Read the rest of this entry »

Grappling With Obamacare’s Impact on the Economy

November 5th, 2013


  • The wrangling over the U.S. debt ceiling and the ensuing snafu over the government’s healthcare website has brought the launch of Obamacare to the fore.  While the debate between the two political parties is largely a philosophical one about the role of government, investors eventually will be weighing its impact on the economy.
  • Two issues are of particular interest: (i) Will Obamacare succeed in slowing escalating medical costs? and (ii) Will it encourage employers to shift more workers to part-time status to lessen the associated insurance costs?
  • My own take is that it’s very questionable whether Obamacare will increase healthcare productivity and curb rising medical costs.  More likely it will shift the burden of who pays to make the program “affordable.”  At the same time, I doubt it will boost the share of part-time workers materially, as critics contend. That said, it is too early to form definitive conclusions considering the program is just being rolled out.   

Background on Obamacare

When the Patient Protection and Affordable Care Act (PPACA, also known as “Obamacare”) was passed in March of 2010, the stated objectives were to make healthcare coverage more secure and reliable for Americans, make coverage more affordable for families and small business owners, and reduce skyrocketing healthcare costs.  The Act recognized that more than 45 million Americans lacked access to affordable health insurance, and many who had insurance were not covered for pre-existing conditions. Read the rest of this entry »

Will 2014 See a Replay of the Debt Ceiling Fiasco?

October 22nd, 2013

In a pattern that has become all too familiar, the two political parties were able to reach a last minute agreement to reopen the government until January 15 while extending the debt ceiling until February 7.  While markets rallied on the news that a technical default on Treasury debt would be averted, most people were left wondering if there will be a repeat of this month’s saga early next year. That possibility certainly exists, as Senator Ted Cruz and other Tea Party members have made it clear defunding ObamaCare remains their top legislative priority.

Nonetheless, I suspect there will be less brinksmanship in 2014 for the following reasons: Read the rest of this entry »