It certainly has been a week for the books as the calamity of this highly contentious Presidential debate have left many still wondering who our new President-elect will be. One thing I know is that when it comes to this election, or politics in general, everyone is certainly uncertain on the ultimate outcome. With continued angst amongst individuals as it may take days/weeks until the courts officially confirm our next President, we can find solace that these uncomfortable times prove to be fleeting. And although financial markets react violently in the short-term to political uncertainty, we must remember that the ultimate path for financial markets stems from the economic changes in Central Bank Policy, Inflation, Interest rates, and Liquidity. It is important to remember that while the President is the most important person in the country for Americans, the Fed Chair and Federal Reserve are the most important to financial markets.
Today over coffee we are going to review our DCA PIIL components as they continue to suggest we are amid an early economic recovery. So, grab your cup of coffee and enjoy!
Bullet points for my high-speed espresso drinkers:
Presidential election uncertainty is a short-term volatile event.
Financial markets take their cues from central banks.
Ultra-accommodative policy is here to stay.
Global zero interest rate policy lifts economic growth, thus financial assets.
With the election dominating the media headlines, and rightfully so, little attention was given to the latest Federal Reserve meeting that occurred on Wednesday and their continued affirmation to maintain the current level of interest rates; accommodatingly low. As mentioned earlier, our DCA investment process is rooted in the belief that financial markets are acutely sensitive to changes in economic conditions. And while our toolbox is filled with many different sets of data, we have found that the four key variables that act as the transmission mechanism between financial assets and the economy are Central Bank Policy, Inflation, Interest rates, and Liquidity (PIIL Model). Now with the latest Federal Reserve announcement of prolonged ultra-accommodative interest rates alongside continued quantitative easing (bond purchasing), we are further convinced of the impending economic recovery. Exhibit 1 shows how the lagged effects of low interest rates place upward pressure on leading economic indicators, such as the PMI. As mentioned in previous Coffee with Andrews, rising PMIs coincide with better growth prospects thus strong financial market returns.
What makes this even more important, is that this low interest mandate is a global phenomenon which strengthens the viability of a global economic recovery. With global central bank mandates centered around renewed zero interest rate policy (ZIRP), the net effect of increased money supply, liquidity, and cooperative financial conditions will serve as the petrol for economic growth well into 2021. Exhibit 2 shows the global weighted (weighted by GDP) zero interest rate policy from our friends at Fidelity.
While we expect the market backdrop to remain highly volatile until the next President is determined, we believe the amount of liquidity in the economic pipeline from the Federal Reserve coupled with falling global interest rates over the last two years continue to support our thesis of an economic revival. It is important to remember that the path forward is never a straight line up, especially following a catastrophic event such as COVID-19, and now the impending Presidential election.
Have a relaxing and good weekend.
Sincerely,
Andrew H. Smith Chief Investment Strategist andrew@delosca.com asmith971@bloomberg.net
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