Investors have gotten so used to low inflation that it is sometimes hard to imagine seeing it rise. However, Morgan Stanley is warning that inflation is rising across the globe and investors need to keep an eye on it. In Europe, Asia, and the US, inflation has risen from 1.1% to 1.4%, and it is bound to move higher, according to Morgan Stanley’s chief global economist. Interestingly, MS argues that the Euro area and Japan will see a higher rise in inflation than the US.
FINSUM: If inflation rises more strongly in other developed markets than the US, will that lead to even more foreign buying of US bonds because yields in those locations are so much lower? In other words, will there be even more demand for US bonds?
There has been a big change of opinion for investors over the last two weeks or so. For almost all of this year, a Biden victory, and especially a blue sweep were seen as potential negatives for the economy vis-à-vis a Trump reelection. Any gains in the polls for Democrats was seen as a negative for the economic outlook, particularly because of the chance for higher taxes. However, the rising odds for a blue sweep have managed to assuage an even bigger fear for investors—a contested election that could drag on for months. Accordingly, gains in the polls for Democrats have seen rising markets. Goldman Sachs feels strongly enough to say this: “All else equal, a blue wave would likely prompt us to upgrade our [US economic growth] forecasts”.
FINSUM: We think there are two specific reasons perceptions have changed. Firstly, the decreased chances for a contested election (very arguable if that is actually true); and secondly, the odds for bigger stimulus and infrastructure packages, which would be positive for the economy.
The market has been increasingly betting that Biden is going to win the election, but there is still a great deal of uncertainty. The outcomes seem like almost diametrically opposed routes for the country, and accordingly it feels like many asset classes could head in opposite directions depending on the outcome. With that in mind, Savvas Savouri of ToscaFund Asset Management, has published a very interesting and clear diagram explaining how each asset class will react to either a Trump or Biden win (see above). The most interesting thing about this is how similar the response will be across several asset classes. For example, no matter who wins, it appears likely that commodities, gold, US domestic staples, and exporters will gain, while in either scenario, Treasuries, REITs, and the Dollar will lose.
FINSUM: This is an excellent diagram that gives a concise view on how things may change following either a Biden or Trump victory. Two things jump out to us here. Firstly, that tech shares look likely to lose if there is a blue wave; and secondly, that the Dollar is headed down in either outcome, so exporters are likely to do well. It is easy to imagine that a blue wave would result in a broad rally of the S&P 500 that is not led by tech.
Because of how the polls are trending, very few seem to be thinking about the fact that a Republican sweep of all three chambers of the government could happen. When you step away from the polls and think about the fact that Republicans currently control two of the three chambers, it becomes more realistic; and even more so when you consider that polls are likely skewed towards Democrats because of “silent” Republican supporters. If the Republicans sweep, or even just if Trump wins, then the sectors that will surge are energy, banks, healthcare, and defense. In particular, think names like Marathon Petroleum, Bank of America, Pfizer, and Northrop Grumman.
FINSUM: This may be unlikely, but it is not as wildly unrealistic as some make it sound. Perhaps smart to have a portion of the portfolio in these sectors headed into the election?
US investors are growing increasingly interested in European equities. The reasons are many. Europe has undertaken huge levels of stimulus and its economy seems to be recovering from the pandemic more quickly than the US’. Further, the Stoxx Europe 600 is still down 10% on the year versus a 6% rise in the US, which means continental stocks may have more room for gains. Another interesting aspect to note is that the continent’s mix of equities has changed markedly over the years and is no longer dominated by banks. This means higher trending earnings and less volatility.
FINSUM: So you have an economy that might get out of recession faster than the US and returns that are 16 points behind, all with very accommodating monetary and fiscal policies. Investing in Europe makes sense!
While many are worried about the domestic economy and whether the US is headed for a recession, those invested in emerging markets should perhaps be even more concerned. One of the fears specialists in the area have is that there is probably about $200 bn of unreported Chinese loans on the books of emerging market borrowers. China is not obligated to report these loans anywhere, so no one is quite sure of the size of the exposure. The risk is that as the economy sours, and these credits debts become distressed, China could impose some severe conditions on borrowers, which could cause emerging markets to seize up.
FINSUM: We could see this becoming an issue, especially because China will be feeling distress itself, which means it is likely to use a heavy hand. Even if nothing comes of this, it will likely weigh on EM asset prices in the near-term because of the uncertainty.
The Fed announced an unprecedented monetary stimulus package this morning. The central bank declared that its new bond buying program was unlimited, and that it would immediately start buying hundreds of billions of different types of bonds in an effort to unclog credit markets. They also extended lending facilities to new markets such as municipal bonds.
FINSUM: The Fed has been far from shy to in reacting to this crisis, but nothing it is doing seems to be helping markets much. Post-announcement, the Dow is already down over 3%.
The yield environment is a terrible one for anyone who is seeking income from their investments, especially those in retirement who may be living on a fixed income. So where can investors seek strong domestic yields? Check out mortgage REITs. Mortgage REITs have long offered some of the highest yields in markets because of the leverage they utilize. Most of the group have yields over 10%. Look at the following names as an example: AGNC Investment Corp. (AGNC, yield 10.2%), Annaly Capital Management, Inc (NLY, 12.9%), Anworth Mortgage Asset Corporation (NH, 14%), and Armour Residential REIT (ARR, 12.3%).
FINSUM: So obviously mortgage REITs have significant interest rate risk, but can you imagine a period where interests rates seem less likely to rise?
Markets and polls are favoring Joe Biden to win the presidency, and markets think there are increasing odds that a blue sweep could occur. So if Democrats take over, what does the regulatory environment look like in wealth management? According to legal and policy experts there are a number of key changes. One big high-level difference between Trump and Biden is that Trump has always favored a principals-based approach to regulation in an effort to lower the compliance burden on companies. Biden would adopt a more rules-based approach with stricter enforcement. Here are five key items that would likely change under a new administration: restarting the debate on Reg BI (i.e. trying to get rid of it or modify it), move towards a rules-based approach in many areas, revive the CFPB, create a public credit reporting agency within the CFPB, and replace SEC commissioner Jay Clayton.
FINSUM: All of this makes perfect sense with what Democrats are signaling. We have another key item to add to the list—killing the new DOL proposal and replacing it with a more robust fiduciary standard either through the SEC or DOL.
Gold has been doing well this year alongside all the market turmoil and uncertainty. While one could construe recent progress on a trade deal with China as potentially bad for gold—given its status as an uncertainty hedge—the reality is that rates are headed lower via Fed cuts. This means the Dollar will weaken, and in turn help gold. Societe Generale, for instance, is advising a maximum allocation to gold, saying investors should have 5% of their portfolios in it. Additionally, a resolution to the trade war would probably also weaken the Dollar as there would be less desire to take advantage of its safe haven status.
FINSUM: Basically Soc Gen is arguing that gold will benefit from both lower rates and a risk-on trade. The former aspect seems sound, but gold benefitting from less anxiety? Sounds a weak supposition to us.
Financial advisors often wonder about the best way to get client money into private equity. The industry has long had very high hurdles for investing directly in funds, and publicly traded funds that try to replicate private equity returns are still nascent. However, there is another good way to get PE like returns by proxy—buy publicly traded private equity company stocks. KKR is a very well known firm that is currently trading very cheaply and seems like a good buy. The stock rose 50% last year but badly trailed its rivals in a year that saw many PE companies double in value as they shifted from partnerships to corporations.
FINSUM: The market seems to be underpricing KKR’s ability to create management fees based on its dry powder, which is causing the weaker valuation.