The Market Corner: the month in review
By: Filippo Lecchini, Phillip Capital Inc.
Commodities are rallying
The bearish trend of the last few years started reversing at the end of 2016 and is continuing into 2017. There are a number of reasons behind it. Some are specific to certain markets and others are more global in nature, but all have to do with some notion of a reflation trade.
The new American administration set the tone during the campaign with an economic plan built on fiscal stimulus: increased military spending, infrastructure building and updating, and tax cuts to incentivize economic activity.
Inflation has also resurfaced, although still timidly, and for those seeking a reserve of value the precious metals are still the place to be.
How about fundamentals? They play an important role in the energy market where over supply seems to be finally abating.
And lastly international politics. The prospect of conflicts makes investors jittery, oil supplies might be disrupted and materials are needed and used to make armaments.
Everything right now seems to be suggesting that the rally will continue but investors should be wary of how fast the markets can turn. Iron ore is the perfect example, after hitting an all time high, is now on a downward trend.
The end of Quantitative Easing (QE)
In 2008 the FED started the asset purchasing program to stimulate the economy once cutting rates was no longer an available option. In essence the strategy was to buy all sorts of fixed income products, particularly Treasuries and Mortgage Backed Securities across the duration, with the goal of supporting prices and keeping the yields low. By getting involved with a wide range of products the FED was seeking to keep the credit market liquid and operating, from student loans to credit cards.
At first the Federal Reserve was actively purchasing large lots of securities. Eventually it started reinvesting the proceeds only, and now is finally getting ready to phase out the program entirely. QE certainly defeated economic orthodoxy and was widely criticized as a distortion for the markets that, if allowed to operate independently, would have found a way out of the crisis purging the least performing corporations, economic entities and individuals. The other side of the argument was that the number of poorly performing corporations, economic entities and individuals was so large that the survival of the world economy would have been at risk without extreme measures.
As it often happens both points of view have some merit. The economy needed a strong intervention but the bailout could have been less extensive. No matter what we think, the end of an important chapter is in sight after almost a decade. What is unknown now is how effective the traditional monetary policy tools can be when the next crisis materializes, and how well the markets can withstand turbulence on their own.
Looking ahead:
After the healthcare debacle the Trump administration has to deliver on campaign promises as the first 100 day milestone approaches. Infrastructure, tax cuts and deregulation are what everybody is waiting on. Commodities and equities are already pricing expansionary expectations that now need to be fulfilled to extend the rally. As mentioned in a previous note these outcomes are relevant not just for the US, but for the entire world economy.
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