The ECB Fully Enters the Risk-Backstopping Business
The much-anticipated European Central Bank (ECB) quantitative easing program (QE) officially began this week. We are happy to cast our yes vote on the ultimate market efficacy of the program, though we also see evidence that Europe’s economy is already making incremental progress. Perhaps other, less-mentioned European stimuli — falling oil prices, fiscal austerity easing and a drastically “cheaper” euro — are pre-empting the highly telegraphed ECB monetary easing.
While European financial markets were struggling in late 2014, economic indicators were rising. Most notably, newly stress-tested European banks began easing credit conditions while incrementally confident business owners and consumers increased their loan demand. History tells willing listeners the importance a banking industry plays in an economy’s well-being. Certainly, the U.S. banking sector’s gradual healing aided the U.S. recovery and now “threatens” to accelerate future U.S. growth. We are not forecasting an easy road for Europe. However, if markets weaken, investors will need to heed the ECB’s resolve. Benoit Coeure, ECB board member and Mario Draghi confidant, recently summed it up: “If we haven’t achieved what we want to achieve, then we’ll have to do more, or we have to do it for longer.”
The Federal Reserve Exit Chatter Grows Louder & Closer
Last Friday’s employment report increased the decibel level of those advocating earlier Federal Reserve (Fed) rate hikes. However, the report’s lackluster wage growth provided a counterbalance. Given the market’s addiction to easy monetary policy, it is important to investigate the future path of wages.
We believe anecdotal and economic evidence is mounting that labor slack is ebbing. The recently released Fed Beige Book points to worker shortages and incipient wage pressures. Add in the historically large 29% of small business owners who answered February’s NFIB Small Business Survey by noting they had job openings they could not fi ll, and one can reasonably conclude that employee bargaining power is increasing. Perhaps retail behemoth Walmart’s recent decision to raise minimum wages reflected economic reality rather than political pressure.
The Fed appears poised to meet their 2015 rate hike promise. U.S. investors would be well advised to prepare for the Fed’s removal of the risk-backstopping measures it used to help push markets higher during the “lean economic years” of the past, in particular its promise to do more QE if needed. Perhaps New York Federal Reserve President William Dudley put it best in December when he warned, “Let me be clear, there is no Fed equity market put… Because financial market conditions affect economic activity only slowly over time … we should look through short-term volatility.”
Given the changing policy reality discussed above, coupled with favorable relative valuations, we have incrementally pushed our focus from U.S. equities toward those of Europe and Japan. While we remain positive on the U.S. economy and the U.S. equity market, we expect U.S. financial market volatility to increase as investors weigh the economy’s ability to stand on its own.