Macro Investing Views – 2018

The global economy is currently framed by two dominant macro forces:

1.     Extraordinary monetary easing programs by major central banks (Fed, ECB, BOJ)

2.     Disruptive business models and technologies

Since 2008 the major central banks have collectively pumped ~ $14 trillion in liquidity AND lowered short-term rates to zero and beyond (negative deposit rates). This has been an extraordinary experiment. The eventual outcomes and unintended impacts are uncertain. Currently there’s about $8 trillion of global sovereign debt with negative yields.

The Fed is now ‘normalizing’ (i.e. raising) short-term interest rates and has embarked on a program to let its excessive balance sheet run-off by not reinvesting maturing securities. That is, reversing its quantitative easing (QE) by quantitative tightening (QT) albeit at a slow pace. The ECB soon begins tapering its liquidity injections but is still expanding the monetary base significantly. The BOJ continues to pump whatever amount is needed to keep the 10 Yr JGB yields at zero in addition to buying equities (ETFs) and Japanese REITs.

The results of this massive monetary stimulus collectively are nothing short of extraordinary:

·        Artificially manipulated interest rates eliminating natural price discovery function of markets.

·        Low and negative rates have forced investors, those seeking or mandated to provide performance, to chase lower yields and assume higher risks, and seek other asset classes.

·        Borrowers of all types have been rewarded – consumers, corporates and sovereigns.

·        Lenders of all types have been punished – consumers, banks, insurance companies, pension funds, endowment funds.

·        The $8 trillion in negative yielding securities are guaranteed capital loss providers. Pray that your money is not parked there.

The other dominant macro force is how emerging technologies – AI, AR, big data, bloc chain, quantum computing, robotics, autonomous vehicles (to name just a few) are disrupting existing business models and inventing new ones. There is a total paradigm shift.

Banking, financial services, retailing, transportation, energy, healthcare, media, entertainment, telecom – there isn’t a single industry or service sector group that is not being disrupted or reinvented. Think Amazon, Uber, AirBnB, Netflix, Facebook, Google and Tesla. When technology replaces humans in the work force (e.g. 500k checkout cashiers in fast food/grocery stores sector replaced by machines) it keeps wage inflation in check. Extend this to other manufacturing and services sectors and the cumulative effect is much larger.

Rising wages, without rising productivity, are the single most important component for rising inflation. Commodity prices, imputed rent, oil prices don’t really factor much. And the machines-replacing-humans is a strong deflationary trend that’s likely to persist and hold measured inflation in check.

Economic growth globally is now in a secular rebound and absent a catastrophic geopolitical event (unpredictable) there are elements in place for continued, healthy global growth ahead.

The U.S. is still my most favored region for economic growth and opportunities. Strong technological innovation and business formations. Regulatory oversight and markets’ transparency. Globally, the strongest banking sector. A relatively prudent central bank monetary policy. Political stability. And higher interest rate differentials amongst the G20 likely ensure the US Dollar’s reserve currency status and strength.

Over the next 12-24 months…

·        U.S. economic growth 3-3.5%

·        U.S. core CPI ~ 2%; PCE ~ 2%

·        U.S. 10 Yr Treasury yield: ~ 2.5% YE 2017; 3.5-4% YE 2018

·        U.S. Treasury yield spread (yield curve) 2s vs 10s ~ 50 bps

·        Fed likely to continue raising short-term interest rates gradually to get to “neutral”. Say a nominal Fed Funds rate of 3%.

·        Long dated Treasury yields, e.g. the 10 Yr UST are more a function of yield spread differentials between Euro zone sovereign debt yields (Bunds) vs US Treasuries than the Fed raising short-term rates or inflationary forces (I don’t expect a rapid rise in inflationary expectations). AS LONG AS THE ECB KEEPS UP ITS QUANTITATIVE EASING (expanding its balance sheet) ITS HARD TO SEE A RAPID RISE IN U.S. 10 YR YIELDS. And the ECB is at least 1-2 years away, at its earliest, before it adopts a Fed-like plan of QT.

·        The Fed is already on the path to shrinking its balance sheet. The day the ECB does the same…watch out. That’s when normalized market forces and real price discovery comes back into play and we’ll find out how this great monetary experiment plays out.

Fixed Income:

·        I would not own ANY fixed-income instrument with a fixed coupon – sovereign, corporate, municipal or high-yield. Period.

·        If one has to invest for current income then invest in 6-month T-bills and keep rolling or find floating rate notes with good credits.

·        Longer-duration bonds are high probability bets for guaranteed capital losses.

Equities:

·        Expect continuation of market indices higher as rising productivity, topline growth and improved earnings continue to surprise to the upside.

·        Expect tech and bank sectors to outperform all others.

Currencies:

·        Long US$ vs all other major currencies (i.e. Euro, Yen, Renminbi)

Crypto Currencies:

·        Small experimental long position in BitCoin (USD). Enough rational potential to warrant having a little “learning” skin in the game.

Good luck and happy investing in 2018.

The author, Rajan Chopra, is a former derivatives trader turned executive coach, advisor and markets strategist. You can learn more about him and his coaching services at www.chopracoaching.com.