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September 25, 2019 –  Impeachment inquiry causes near-term concerns. A bigger concern for investors is how the last ten years of low interest rates has created a record amount of debt and distorted asset pricing.

//  by Tower Bridge Advisors

While Jim is away on vacation, other members of the TBA Investment Committee will write the market comment. Today’s comment is from Chris Gildea.

Stocks declined and the benchmark 10-year Treasury yield fell amid news that Speaker Pelosi is opening a formal impeachment inquiry of President Trump. Investors are concerned that the already slowing economy could be further damaged by all the mudslinging and distraction that could reasonably be expected during such proceedings. Oil prices also declined and have now almost completely erased the gains that followed the attack on Saudi Aramco’s processing facility just over one week ago.

While news of a forthcoming impeachment inquiry by the House is disturbing, it only reinforces my conviction that our political disfunction in Washington is not going away anytime soon. And, while prices of stocks and bonds react to news headlines such as yesterday’s impeachment inquiry, there are bigger concerns that keep me awake at night as far as potency potential for future market dislocations. Today, I will highlight one.

Central bankers around the world are convinced that lower interest rates and looser monetary policy is needed to fight deflation. But, as Jim’s previous commentaries have accurately noted, these policies have encouraged companies to borrow and invest in capacity to deliver goods and services far in excess of actual demand. Capacity underutilization contributes to both disinflation and deflation and thereby counteracts the inflationary outcomes that central bankers are seeking.

Now, rather than investing in more physical plants and equipment, companies have used lower interest rates to fund acquisitions, share buybacks, and dividend increases. These are rational decisions on the part of boards of directors. But the fact is that U.S. corporate debt has grown 65% to roughly $10 trillion since 2010 and, at more than 46% of GDP, is more today than it was prior to the Great Recession.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

It is not just corporations; government spending is rising as a percentage of GDP even while the economy is good. The United States is now running a $1 trillion+ fiscal deficit at a time when we have full-employment. Imagine what will happen if we actually slip into recession. If government revenues decline as they do in a typical recession, it is not inconceivable that the budget deficit could balloon to nearly $1.8 trillion. Under normal monetary conditions, we expect interest rates to rise when governments become less restrained in their spending. However, the central bankers’ aggressive monetary policies have removed market signals so politicians have reacted logically, and spent even more.

Lower interest rates have stimulated demand from all types of borrowers and for even larger amounts of debt. In fact, the global bond market has grown from roughly $10 trillion to $110 trillion since 1990, a rate of nearly twice global GDP growth. Now, global debt has become so large that it is almost impossible for central banks to raise interest rates for fear of facing a violent market reaction which serves as investors’ collective fear of a severe recession. In fact, we witnessed such a reaction one year ago when the Fed indicated its tightening actions were expected to continue on “auto-pilot.”

Ultimately, U.S. Treasury short-term rates are determined by the Fed and set the bar for hurdle rates that investors must earn on riskier investments. Based on my observations of history, if rates are kept too low for too long, investors will do stupid things. We have seen this with WeWork and its failed IPO. As Jim noted recently, there are likely dozens more WeWork examples trapped within the portfolios of venture capital and private equity firms.

The Fed has created an investment environment where borrowing costs are too low and there is simply too much liquidity and capital. This capital has prevented bankruptcies and ensured excess capacity remains in some industries rather than being rationalized. Ironically, low interest rates and money printing may actually be causing deflation rather than inflation. It has also caused good businesses to be priced like great businesses. And, while businesses can continue to grow their intrinsic value over time, macroeconomic forces cannot be ignored. These same forces may very well propel valuations much higher and for much longer than anyone anticipates. So, the message is not to become a bear just yet.

So, what is my point? We are collectively (all investors) being forced to invest in assets (stocks, bonds, real estate, etc.) at prices that are affected by low interest rates because “there is no alternative” (i.e. TINA). For public market investors like us, we must be cognizant of the low interest rate environment we are in. Moreover, the debt fueled growth will have to be dealt with by politicians, central bankers and the citizenry at some point. We must remember that cycles do turn, liquidity dries up, and confidence reverses. However, market timing is not a reliable option either. So, it all comes down to balancing “fear and greed” by being prudent with asset allocation.

Chris Gildea, 610-260-2235

 

Additional information is available upon request.

# – This security is owned by the author of this report or accounts under his management at Tower Bridge Advisors.

Additional information on companies in this report is available on request. This report is not a complete analysis of every material fact representing company, industry or security mentioned herein. This firm or its officers, stockholders, employees and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned. This communication shall not be deemed to constitute an offer, or solicitation on our part with respect to the sale or purchase of any securities. The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed. This report is prepared for general information only. It does not have regard to the specific investment objectives, financial situation or the particular needs of any specific person who may receive this report. Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized. Opinions are subject to change without notice.

Filed Under: Market Commentary

Previous Post: « September 23, 2019
Next Post: September 27, 2019 – The direction of the broad stock market is important for investors’ equity allocations. We look deeper and examine major segments of the stock market, namely value and growth/momentum, and how they have been behaving as the trade war continues to persist. »

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  • December 4, 2019 – While markets wavered yesterday as President Trump hinted at some delays in trade negotiations, the odds of a December 15 hike in tariffs don’t really change. Watch the actions, not the words. Tariffs, however, are a tax and the threat of tariffs against Brazil, Argentina and France are a cause of some concern.
  • December 2, 2019 – Good economic data over the weekend should lift stocks early. U.S. economic data this week will be important, particularly the PMI numbers out this morning and the employment data coming on Friday.
  • November 27, 2019 –  You may not outperform the market if you don’t own those stocks making the biggest impact in any one year. But your goal shouldn’t be to beat the market. It should be to meet or exceed your own objectives.
  • November 25, 2019 – It’s hard to short a dull market, especially at year end when everyone wants to defer taking gains until 2020. But there is no apparent external catalyst to lift stocks higher and the threat of higher tariffs may be escalating.
  • November 22, 2019 – Stock markets are likely to become more volatile as next round of tariffs, due December 15, are implemented or not. To separate winners and losers in a slow growing economy, start by looking to see who invests for success and who tries to cut costs to survive. Not all who invest win, but those that don’t are almost always losers.
  • November 20, 2019 – It is earnings reporting season for retailers. What we are learning is those that invest to stay current and support their customers are winning, while those who fail to adapt are destined to fail.
  • November 18, 2019 – Markets continue to march higher in anticipation of a trade deal between China and the U.S. But perhaps a bigger factor in rising confidence is that no recession is imminent. With less economic downside to fear, investors are increasingly confident to buy equities.
  • November 15, 2019 – While stock prices continue to move to new record highs, the gains are not supported by rising earnings or lower rates. Investors are trying to defer taking gains to next year. Valuations are becoming extended once again. A 2-4% correction would do a lot to heal an overvaluation state.
  • November 13, 2019 – In a dull day without news, the Dow ended flat for the first time in over 100 years. While futures point lower this morning, profit taking more than any news item, appears to be the dominating factor.
  • November 11, 2019 – Logically, it is time for markets to pause. Stocks have risen in a straight line for several weeks, a critical tariff deadline is approaching, and another government shutdown looms if Congress can’t pass a funding bill that the President will sign.

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