Timely policy execution is needed to boost business confidence
Financial markets, global business leaders and households are seeking policy leadership in a global economic landscape that is challenged by structural and cyclical risks. Thus far this year, financial markets have benefited from systemic risk reduction as a result of Central Bank support across both sides of the Atlantic. Looking ahead, there is scope for more targeted monetary stimulus by the ECB, particularly in peripheral Europe, in an attempt to achieve effective monetary transmission across the broader Eurozone. Moreover, there is scope for monetary accommodation in China post the government transition by the end of this month. Yet, apart from global monetary action, business leaders and households are seeking answers with regards to fiscal and economic growth sustainability, which have been hampered by unfavorable demographics and fiscal profligacy in developed economies. In this context, markets are focusing on the outcome of the U.S. elections and the subsequent impact on 2013 growth and fiscal consolidation. From our investment lens, we continue to allocate capital selectively and in financial instruments that offer visible cash flows and income.
As the U.S. Presidential race is entering its final stage, investors are trying to handicap the policy repercussions that will ensue i.e. taxes, healthcare, energy, entitlements and fiscal sustainability. Structural challenges are significant for both political parties and the new Congress. As we discussed in our last article, the market already expects a sufficient degree of compromise with regards to the Jan. ‘fiscal cliff’ (~-4% of GDP). Although a tax compromise may be achieved in the upcoming lame duck congressional session, we are less optimistic on the prospect for compromise on more challenging fiscal areas such as healthcare reform. Current election projections seem to point to a very tight election outcome. Therefore, this may point to continued political gridlock that at a minimum may cause some volatility in risk assets.
U.S. economic data have been mixed as of late, with some improvement in industrial production, retail sales and the labor market. At this point in the economic cycle, business leaders need the necessary confidence in order to reinvest profits and ample cash back in the economy. CEO confidence has been dented due to fiscal policy uncertainty in the U.S. and due to the slow global growth outlook; which has been hampered by the Chinese growth slowdown and the European debt/growth challenges.
Despite a recovery in profits and corporate balance sheets, the current business cycle has been characterized by underwhelming levels of investment. Fiscal visibility and economic reforms would certainly be a confidence boost to business leaders, which would facilitate more capital expenditures and labor hiring.
On the global growth front, there are some tentative signs for growth stabilization. We see scope for a monetary policy catch-up in China as inflation measures have eased for both the consumers and producers. Specifically, the PBOC can reduce the required reserve ratio within the banking system and Chinese money supply growth seems to have stabilized. Thus, although we recognize China’s lower GDP growth profile (~7% according to China’s new 5 year plan) we expect some policy action after the government transition by the end of this month.
In Europe, the ECB has been lagging behind other global central banks and we see scope for conventional rate cuts and more unconventional measures such as asset purchases in the peripheral sovereign bond markets; in an attempt to reduce economic segmentation within the Eurozone. Having said that, financial markets have already priced in to a fair degree the prospect for further monetary stimulus. Thus far, we have seen piecemeal approaches to the European debt crisis, given the divergence in national interests. We may see further risk-off episodes until creditors and debtors reach difficult compromises, and a sustainable fiscal framework is put into place across the Eurozone.
In conclusion, we are open-minded with regards to further global policy action that can support risk-assets. Expectations of such policy moves have been priced in to a fair degree by financial markets and there may be some policy execution risk ahead. Therefore, we continue to focus on our income and late-cycle investment tilt by allocating capital in financial instruments that offer cash flow visibility and a margin of safety from a valuation point of view.
Christos Charalambous CFA
Senior Strategist
christos.charalambous@edgewealth.com
Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product made reference to directly or indirectly in this newsletter (article), will be profitable, equal any corresponding indicated historical performance level(s, or be suitable for your portfolio. Due to various factors, including changing market conditions, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this newsletter (article) serves as the receipt of, or as a substitute for, personalized investment advice from Edge Wealth Management, LLC. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing. A copy of our current written disclosure statement discussing our advisory services and fees is available for review upon request.