What the U.S. Offers Global Investors
It is easy to lose sight of the fact that two of the world’s three largest economies — namely Europe and China — are significantly out of step with our own economy. Consider that the unemployment rate in the Eurozone is still above 11% and deflation is a reality (consumer prices are down 0.3% year-over-year). China just reported another month of plunging imports (down 20% on a year-over-year basis for a second month in a row).
Europe is readying a program of 60 billion Euros in monthly asset purchases to address stagnating growth and a falling price level. The program will eventually total 1.1 trillion Euros and pump the European Central Bank’s (ECB) balance sheet back up to its previous high water mark near 30% of Gross Domestic Product (GDP). At the same time, additional monetary easing appears very likely in China, given a recent surge in Chinese equity shares. Against this backdrop of easy-leaning global central banks, our own Federal Reserve (Fed) is acting and behaving as if it really is going to raise interest rates this year. It really isn’t a question about when or how much the Fed will raise rates. The mere fact that they are doing it while the rest of the world is moving toward further easing means that the world’s reserve currency, the U.S. dollar, is again the global investor’s go-to currency, as evidenced in the dollar’s 20% gain since last summer.
And why shouldn’t the dollar be strong? Last week we saw that the economy added another 295,000 jobs in the month of February. Final demand in the United States has been, and continues to be, relatively steady. Macro policies have been the most flexible among the world’s major economies. Global investors can see the United States as a place to get more consistent positive growth, higher real interest rates than many places, and a recently stronger currency that is adding a boost to foreign investor returns. While foreign capital flows can feed back into investment and growth, most economists are busy cutting this quarter’s domestic GDP forecasts. Despite the cuts, there is still an underlying sense that 1) demand here is still solid, and 2) that slower growth is mostly due to “noise” from energy sector disruptions, lousy winter weather, inventory effects, and the strong dollar’s impact on trade. If it turns out these items are all there is to the recent pessimism over domestic growth, then the Fed should look right past the weakness and move forward with their planned exit from a long-held zero interest rate policy.
This week we will hear more from Europe as Euro-area finance ministers meet again in Brussels. Greece’s bailout program will be right up there near the top of the docket. You might remember that a couple weeks back, a tentative agreement to extend the Greek bailout program was met by global financial markets with a sense of uneasy optimism. The agreement required Greece to submit a list of measures for reform. The new Greek government’s proposed list of reforms underwhelmed European officials, and tensions between Greece and their creditors are again on the rise. This week’s meeting is another page in this ongoing saga. Greece’s long-term government bonds still yield above 9% (in a 52-week range of 5.7% to 11%) as they still need to refinance or repay $7.2 billion in debt or interest this month, according to Bloomberg data. The Greek drama highlights some of the unique circumstances and risks of investment in a not-quite-fully formed European Union.
Neither is the United States a perfect union, but then again, our forefathers never sought to build a perfect union — just a “more perfect union” according to the preamble to our Constitution. For more than 200 years, that “imperfect union” has been a relatively attractive place for global capital to find opportunity, reward, and fair treatment. Generally speaking, this has happened because the United States has had a relatively sound fiscal policy compared to many other countries, and government has been less intrusive on the private sector than many other countries. American culture tends to value and reward competition as the way to individual opportunity. Entrepreneurial spirit is encouraged within the private sector. A system of laws is well-developed, and property rights are generally respected when compared with other parts of the world. It helps that we finance our borrowings in our own currency, the dollar, which has also served as the world’s reserve currency for most of the past century. We have developed significant infrastructure through public and private initiative to facilitate growth and trade. Human capital is developed through our colleges and universities, which continue to attract a talented and diverse group of people from around the world. These and other traits all distinguish the United States and no-doubt contribute to our unique ability to adapt and recover from setbacks.
This does not mean that opportunities do not exist outside our borders, however. Clearly, they do. Faster-growing emerging markets and potential for a turnaround in Europe are both real long-run opportunities, and valuations seem relatively appealing. Therefore, we continue to watch closely how events and trends unfold from here. For the moment, we remain slightly underweight in equities overall in asset allocation portfolios. Within the equity mix, we lean more towards domestic equities, and within the bond mix, we are relatively short on duration.