DAY HAGAN RESEARCH UPDATE
ACCOMMODATION AND AUSTERITY
Next Wednesday (the 21st), in the wee hours of the night, Japan’s central bank will announce its latest monetary policy views. Then, at 2:00am EST, the FOMC will tell us what they think....
Donald L. Hagan, CFA
September 16, 2016
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Next week, the central banks for Japan and the United States will provide their latest views on monetary policy, as well as reveal their latest prescribed actions.
While Japanese authorities are struggling to find and implement even more stimulus, U.S. central bankers are contemplating moving the punch bowl closer to the edge of the table. The FOMC has hinted for months now that they are looking to normalize interest rate policy by potentially hiking the fed funds target rate.
Next week’s announcements have major implications for both economies and are likely to foreshadow investors’ macro expectations into mid-2017. The questions remain: Does Japan need more stimulus? Is the U.S. ready for less?
Our view is that the Bank of Japan (BoJ, Japan’s central bank) is panicking. In July, the BoJ doubled the targeted annual purchases of Japanese Equity ETFs (yes, you read that right—the BoJ is actually buying stocks through ETF purchases as part of their monetary policy initiative! This is equivalent to the FOMC buying the SPY or the DIA ETFs to support our current monetary policy when all other stimulus fails), has had a zero interest-rate policy in place since 1999, has forced much of their sovereign debt into negative interest rates, and, at the end of July, owned 38.1 percent of all Japanese sovereign bonds outstanding. And keep in mind this doesn’t include the activities of Japan’s Government Pension Investment fund (the world’s largest pension fund at about $1.3 trillion in AUM), which was “advised” by government officials to double its equity stakes in Japanese stocks in October 2014. That’s spending a lot of monetary bullets with little return.
Remember, Japan has been the clear trendsetter with regard to QE. They’ve been trying to shock their economy into growth since 1990! So if you’re wondering how long a central bank will believe that it can force long-term economic growth, there’s your answer—at least twenty-six years. This makes the FOMC (which has been delving into QE “only” since 2008) look like a piker. And, unfortunately, Japan also provides a real-life example of how QE doesn’t engender long-term economic growth.
Expectations for the BoJ’s announcement next week have gyrated wildly over the past few days, but our view is that investors are looking for a further push into negative interest-rate territory along with a slight increase in expected asset purchases. Anything less will likely disappoint investors. From our perspective, further easing measures over and above what’s already priced in would likely allow the yen to weaken (which is good from Japan’s perspective, as widely held economic theory would suggest that this would provide Japan with an export advantage) and give a lift to their equity markets. (Note: We have a small position [<2.5 percent] in the Hedged Japanese ETF [symbol: HEWJ] looking for a lift on the news. We are maintaining a tight stop-loss as the position is on the cusp.)
Following the BoJ announcement, though, we don’t see where they can go from there except to keep piling on new stimulus, i.e., robbing Peter to pay Paul. The clock is ticking.
There is similar sentiment around the FOMC’s meeting next week. We view the probability of a September rate hike as nonexistent, but the financial markets are forward looking. At 2:01 EST on Wednesday, after the initial release of the FOMC’s statement, investors will quickly turn their attention to December and start worrying about a rate hike happening then.
The widely cited reasons for no rate hike in September include: 1) the Fed is waiting until after the elections so it maintains an aura of political agnosticism and 2) a wide array of indications show that U.S. economic growth is slowing. We agree with both.
However, there are two more reasons: 1) interest rates are already increasing as sovereign longer-term interest rates are higher across the board. In other words, the gamut of long-term relative rates is shifting higher, while not necessarily shifting the spreads between different countries’ rates. 2) Due to SEC rule changes, there has been a shift from non-Treasury-only money market funds to Treasury-only money market funds. The net result has been that short-term LIBOR rates are much higher. And LIBOR rates are the base rates for a majority of global loans outstanding. Higher LIBOR rates equal higher interest payments, which equal economic headwinds. Between the natural response to higher interest rates and the higher cost of borrowing, there has already been a de facto tightening. We think the Fed will have to consider this carefully before adding another rate hike.
Bottom Line: The BoJ is expected to ease, but may not ease enough to satisfy current expectations. Concurrently, the FOMC may not raise rates, but it doesn’t matter. Once the meeting is over, the markets (equities, fixed income and currency) will be expecting a rate hike for December and will re-price accordingly. Our view is that both central bank action outcomes could be problematic, given the recent slower global economic indications, already slightly higher rates, valuations on the expensive side, oil sliding again and political uncertainty.
We rely on our quantifiable, disciplined process that utilizes a weight-of-the-evidence approach. Our goal is to stay in tune with major trends, knowing that we don’t have to bet the farm on bullish or bearish prognostications, and that we can risk manage our portfolios with the appropriate balance of cash and equity holdings supported by model strength.
At this point, our models’ message is that this isn’t the time to be overly bearish (negative), nor is it the time to be overly aggressive. A more neutral/mildly bullish stance is currently warranted. We will be looking for our models and the weight of the evidence to turn more positive before committing additional capital to equities.
If you have any questions or comments, please feel free to call any time.
Have a wonderful week,
Donald L. Hagan, CFA
Day Hagan Asset Management
Day Hagan Investment Research
— Written 09-16-2016
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