a Critical Junction

One year ago most investors would not have made this set of predictions: Gold prices would crash, interest rates would move higher, China’s growth would slow, the US markets would be at all time highs and the U.S. dollar would be the strongest currency. In fact, a poll of most investors and professionals on Wall Street would have predicted the exact opposite for each outcome.

Gold prices are crashing because fundamentally speaking, the only reason to own gold besides the “catastrophe” scenario is for a hedge against inflation. The crash in prices is signaling that inflation is not of concern. Treasury Inflation Protected Securities (TIPS) are also signaling that inflation is being kept at bay. Add to this a gold market that is thinly traded and you are seeing a rotation out of resources like gold and into resources like stocks. There is some history behind this. Over the past 200 years, the stock market has outperformed every asset class. And it’s doing so again.

China’s growth is slowing. This is a fact, but let’s not get carried away. Slowing growth in China means 6.5% GDP growth. But, China’s slowing growth is affecting the resource sector, especially the metals and mining sector. Companies that produce steel, iron ore, and other industrial metals are taking it on the chin. China is a major market participant but it’s not a major consumer economy for goods and services so while it has had a severe impact on emerging markets and resources, it has not really impacted companies that are selling finished goods globally. The Chinese still don’t have the individual economic clout to significantly impact the likes of Proctor and Gamble or Johnson and Johnson.

The U.S. markets are at all time highs. This is a reflection of both cheap money and growth in GDP. But that’s the macro story. The micro story is one of an improved housing market and an improving employment market. The beneficiary of low interest rates, the housing market is booming and that makes consumers feel good. U.S. companies had shaved expenses to the bone during and after the financial crisis and this led to higher productivity. In addition to shaving expenses the companies also refinanced debt at very low interest rates. The combination of “getting their house in order” during tough times and a resurgent consumer today, resulted in U.S. companies reporting stronger profits than ever and balance sheets that are flush with cash.

The U.S. dollar is now king. It is the strongest currency of the major ones (Yen, Pound, and Euro). Against the Japanese currency, the dollar has gained more than 40% in the past six months. The dollar is stronger as a result of weakness in the economies of Europe and Japan. Japan is on the verge of an economic boom as a result of the crashing yen. As an export driven economy, the Japanese love it when the yen is cheap as it results in more goods sold abroad. Europe is weak and continues to struggle as member countries of the Euro are experiencing unbelievably high rates of unemployment and staggering losses in the real estate sector. Unlike the U.S., which stimulated its economy immediately after the financial crisis began, the Europeans dawdled and are only now adopting similar stimulus measures meaning that Europe will be in recovery mode for quite some time.

These factors bode very well for the U.S. stock markets in general. Volatility is low right now and the market has shaken off the recent correction, as we said it would. The markets overreaction to the Fed’s announcement was short-lived as people realized that interest rates may rise, but they’re not going to shoot higher in a short time frame. It’s still our opinion that any sell-off the market represents is a buying opportunity, especially in the financial and technology sector.

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