Perhaps the major financial issue entering the third quarter was whether the Federal Reserve would tighten monetary policy at its September meeting as many speculated they would. Investors received some level of comfort in July when Fed chairman Ben Bernanke clarified that the decision to taper with its $85 billion per month bond buying program would be separate from its decision on raising short-term interest rates. Further solace was offered as he added that the Fed would not be in a hurry to raise short-term interest rates even after the unemployment rate falls to the central bank's threshold of 6.5%. Those in favor of the easy monetary policy received more good news in September when the Fed decided to continue with its bond-buying program, citing a more uneven economic climate than they expected and the potential for fiscal discord in Washington.
Unfortunately, the Fed's clairvoyance about discord in Washington was quite accurate as Congress failed to pass a budget leading to a partial government shutdown as the third quarter came to a close. Further exasperating the situation was the status of raising of the U.S. debt ceiling by nearly $17 trillion that was needed to prevent the U.S. from defaulting on its outstanding obligations. As is now normal operating mode for Congress, it wasn't until almost the midnight hour that a deal was reached to avert a default that likely would have severly disrupted world markets. This "deal" basically extended the debt limit and fund the government through the early part of next year when it appears we will be hearing about these same issues yet again.
Lost in the shuffle of all the political bickering was the fact that global eqiuty markets continued surging near fresh highs during the quarter. Most of the strength seen in returns was realized during the earlier part of the quarter before volatility spiked in conjunction with the actions of U.S. policymakers. In the short term, we would expect investors to continue to focus their attention on fundamental developments and, in this regard, the ability of companies to maintain robust profits amidst moderate economic growth will be critical. The expansion seen in profits may be pressured somewhat for many companies that have exhausted cost-cutting measures that have abetted profits over the last several years. However, even with subdued economic growth, companies have been generally successful in maintaining reasonable levels of profitability.
Consumer demand will likely remain the primary driver of continued economic growth and, to this point, the U.S. consumer has remained resilient despite a difficult environment of stagnant wages and limited take-home pay. These deterrents have thus far been offset by increased consumer confidence, likely due to rising home prices and improving personal balance sheets as well as a somewhat brighter employment picture.
Recovery in European markets did not seem to be significantly adversely impacted by a potential U.S. strike against Syria and continued violence in Iraq, Afghanistan and other hot spots. The push towards emphasizing growth ahead of austerity continued to gain momentum as the G-20 formally backed this policy at their July meeting and as the European Central Bank reaffirmed that its policy will be accommodative as long as necessary. Even some green economic shoots presented themselves in Britain which has showed some modest growth well before many would have predicted. Euro zone business activity continued to rise modestly and European corporations appear to generally be in reasonable fiscal health. This is a result of declining labor costs, aggressive cost-cutting and the presence of a large number of multinational companies, which generate a significant percentage of their earnings from outside of Europe as a relatively weaker euro has supported exports.
Turning to Asia, China's economy continues to grow, buoyed by improving demand from developed countries. Although continuing to converge toward a lower long term growth rate, China has grown faster for longer than any previous country in history and is more than double the size economically today than it was just a decade ago. Although the days of double digit growth rates may be limited, even these lower rates still add more to global demand than it did ten years ago due to the sheer magnitude of the Chinese overall economy. Thus, it would be reasonable to conclude that the Chinese economy will adequately accommodate global demand going forward.
In Japan, bold stimulus policies continue to result in GDP growth, however a significant sales tax increase was recently announced in an effort to trim the public debt burden. Time will tell whether this austerity measure can co-exist with stimulus policies or if Japan’s economic recovery is still too frail to accommodate a tax increase.
Lastly, many of the emerging market countries continue to grapple with the excess liquidity that has found its way in to their economies. This has partially been as a result of easy money policies of the developed nations such as the U.S. This has created a cycle of loose credit, large budget deficits, depreciating currencies as well as inflationary pressures. Shorter term, this creates a challenging economic environment for many of these countries, but longer term could force governments to put structural reforms in place which would result in favorable outcomes for these economies and investors.
Critics are quick to point out that the post-recession U.S. economy is recovering at historically slow rates. An alternative viewpoint is that any level of sustainable growth can be viewed as positive given the severity of the 2007-2009 financial panic. In any event, the fact is that the global economies generally continue to slowly recover, albeit with the inevitable regional roadblocks that are inherent in relatively free markets. Adhering to an investment policy that avoids the prediction of the timing and magnitude of these roadblocks should add value to returns over the longer term. Thus, we continue to suggest an investment policy that emphasizes time and diversification in conjunction with detailed reference to your personal financial plan.
Urban Financial Advisory Corporation