In with The Bear out like a Lion.
The first two months of the year have been as frustrating for
investors
as a Phil Niekro knuckleball is on a fast ball hitter. Then March
greets us with the awakening of the Russian Bear invading neighbor
Ukraine sending equity markets reeling and oil spiking. The equity and
for that matter the US Treasury markets in the face
of such turmoil and uncertainty have remained exceptionally resilient.
First Equities.
The US market exited 2013 on a strong bullish note buoyed by a
strengthening economy
, strong cash flows and expectations for the economy to finally
accelerate towards historical trend growth rates of 3-3 ½%. We were
immediately greeted with a polar vortex slap in the face of weak
economic data and an ensuing selling that sent the indices
down 6 ½%. Just when many investors began to question their
commitment to equities and sales began to mount the buyers showed up.
Upon inspecting the economic data it suggested even more strongly the
current weakness was due to exceptionally cold weather.
Then buyers began bottom fishing and took the indices back to record
highs.
Now US Treasury Bonds.
In August of 2013 10 years Treasury yields popped from 1 5/8% up to 3%
as the
Federal Reserve merely hinted at tapering their monthly $85 billion
monthly purchases of US Treasuries and Mortgage Backed securities.
Flash forward to December when the Federal Reserve actually did
announce their plans to cut their monthly bond purchases
by $10 billion followed by another such announcement in January 2014.
With a cut of $20 billion in purchases one would naturally expect to
see prices fall and rates to rise. What actually happened is just the
opposite as prices rose and yields fell nearly
38 basis points. Another swing and a miss.
Let’s look through
both markets for a clearer understanding. Equities fell and recovered
in January and February due to the acknowledgement that
there was a bout of economic weakness but that the weakness was
inspired by severe weather which was impacting consumption and
manufacturing data to the downside. Taking a closer look at the
internals of many economic data points exposed the positive forward
looking points of new orders indexes, capital expenditures, inventory
draw down and expectations for hiring. Then the Ukrainians spoke and
Russia responded. The Ukrainian people ousted their President and moved
to elect a new government more representative
of their goals, ambitions and a move towards a free market and free
speech society. Russia moved quickly to protect their interests and
military bases in Crimea. Fear and volatility spiked at the thought
Putin would attempt to reclaim Ukraine. It appears
not. From a simplistic view, either Putin is attempting to rebuild the
Russian empire by embracing Georgia and bear hugging the Ukraine or he
is protecting a strategically important military base and personnel
forcing the Ukrainians to include both the West
and Russia in further determining how this plays out. His next steps
will be telling. With an outright war and invasion averted for the
time being, the markets responded with a huge reversal rally that
continued into Friday.
Now Treasuries. The
Federal Reserved has clarified its plan to cut its monthly asset
purchase plan $10 billion every meeting unless data suggests
the need to halt or reverse their course and ultimately ending their
purchases by late 2014. Why haven’t rates spiked higher? First
geopolitics which brings the Russia, Ukraine conflict front and center.
When there is such uncertainty of relative safety
in various parts of the globe, investors typically flock to US
Treasuries for their relative safe harbor. Second the precipitous drop
in the budget deficit also helps. The US budget deficit is projected to
come in at $514 billion. So, with the Federal
Reserve now agreeing to purchase $35 billion a month if that figure
stayed constant they would buy 81% of all new issuance. Combined both
these points could account for the lid on yields so far this year.
Going forward.
On Interest rates and bonds. The Ukraine situation should be resolved
through diplomatic
channels and not on the battlefield. The question currently appears
to be of a free and democratically run Ukraine with or without Crimea.
Once resolved, for bonds the focus will be on the decreasing demand
coming from Feds QE purchases and expectations
for inflation. Combined the march towards 3% and higher for 10
Treasuries should begin in earnest. Onto Equities. Equities will
need the support of strong and improving fundamentals to propel us
higher, which we anticipate. The cold weather should have
the effect of creating pent up demand. As the weather warms up we
should see strong snap back gains in home purchases, automobile sales
and construction related employment. Failure for these three
cornerstone legs of our economy to materialize would surely
send us reeling again.
For now we maintain
our strong commitment to the market, protecting the plate and looking
for dead red, but wary of any potential curve balls to adjust
our stance.
Thank you for your confidence and patience in this trying environment.
