Cash reserves have been pared back and monies have been redeployed into exchange-traded fund (ETF) strategies. There are several reasons.
What this means is that the two largest central banks in the world, the Eurozone's ECB and the US dollar zone's Fed, will be at zero interest rates for at least another six months and maybe a year or longer.
There is no apparent inflation acceleration that would cause the Fed or ECB to act. The current data does not support tightening. At year-end, the Fed will be at neutral, and the ECB will be at neutral or easing. Add that the Bank of Japan appears to be preparing for another round of quantitative easing, and the outlook for continued global monetary ease remains intact.
The end result is that monetary stimulus worldwide remains positive. The markets have made substantial corrections. The US economy appears to continue its gradual recovery. It’s not robust, but it is improving and not slipping back into recession. For us that means that the upward bias in stock prices is intact.
We took a cash reserve position and cut back our market exposure on July 3 and again on July 16. Those moves were based on the perception of rising geopolitical risk both in Europe (Ukraine) and in the Persian Gulf and Middle East. The risks are still there. The beheading of reporter James Foley is a gruesome reminder.
What is different now is that there appears to be some movement in Europe among Ukraine, Germany (really the EU) and Russia toward an accommodation. A potentially positive ingredient is the relationship between Angela Merkel and Vladimir Putin. The outcomes remain to be seen.
In the Persian Gulf, the US has now become aggressive. It has introduced the use of air power and selective skilled combat boots on the ground. The White House has recognized that IS is a murderous foe of the US. It threatens every American, every American interest, every American facility, and every American ally worldwide. It appears the Obama White House is now ready to be aggressive in the attack on IS in the same way that it was aggressive in the attack on Osama bin Laden. That means that sharply honed American technology will be directed at strategic IS targets. That’s a good thing. Obama set aside criticism over “mission creep” and acted. Finally, we will not wait for the foe to fire the next shot, we can also shoot first. We expect a lot more precisely targeted firepower to be aimed at IS.
So, we are back into the markets with a nearly fully invested posture. We do not think markets are cheap. Fairly priced, perhaps, but not cheap. We think there is an upward bias in stock prices. The US economy is recovering at a gradually improving rate. As John Maynard Keynes said, “When things change, I change with them.”
On July 3 and 16 we built a cash reserve to be safe. It appears that amount of cash is too much to hold now that there is a little more clarity. That does not mean risk has gone away. Nimble strategies with ETFs can be accommodative on a very quick basis.
For today we are back in, but we are fully prepared to change rapidly if risk premia warrant such action.
David R. Kotok, Chairman and Chief Investment Officer