World events are getting more complicated. U.S. markets are ignoring these issues as central bank zero-interest-rate policies continue to drive asset prices higher.
When things are event-driven, an investor has two options:
- Stand aside. Today that means cash earning zero while inflation erodes value.
- An investor can remain nervously invested and attempt to move nimbly. Other options are really allocation combinations of these first two.
The list includes: Washington's political antics, China's growth vs. real estate bubble policy, Japan's central bank's highly stimulative regime change, Italy's government-election mess, Eurozone recession risk, the Bank of England governing body's recomposition, Egypt's civil instability, Syria, Iran nukes, the dispute between China and Japan over islands and what lies beneath them or in the territorial waters around them, Nigeria's instability, and post-Chavez Venezuela. Lastly in this partial list, and newly on the front page, is North Korea.
Let's Get To North Korea
The situation seems to be intensifying. The young Kim has set a course that is more harsh and militaristic than expected. When armistice agreements are revoked and readiness states of armies ratchet up, the risk rises of an accident leading to war.
We have obtained permission to post a March 7, 2013 commentary about North Korea on our website. NightWatch is following these events closely. You can find their discussion here
Two key points must be noted:
- In the NightWatch experience, the last time North Korean media and behavior were so bellicose was prior to the 1988 Olympic Games in Seoul. That's the historical reference.
- North Korea failed to act in the late 1980s. At that time the U.S. had an aircraft carrier group and a battleship group deployed off the North Korean coast. Contrast then with now, as we find ourselves dealing with sequester-induced defense cuts and withdrawal from wars of questionable value. Does North Korea perceive that the U.S. is vulnerable? Add the Korea-Iran scientific-cooperation pact (Wall St. Journal, March 8) and you have missile and nuclear collaboration between two dangerous parties. We think the risk on the Korean Peninsula in 2013 is much higher than it was in the 1980s.
Is the recent behavior of North Korea mere bluster and nothing more? If yes, global monetary policy will prevail and markets will head higher. If no -- and shooting breaks out -- markets are in for a jolt.
The G4 Link
Essentially, 80% to 85% of the capital markets of the world are now involved with or linked to one of the G4 currencies. The policy among all the managers of those currencies is to be stimulative, expansive as to central bank activities, and focused on a short-term interest rate near zero. This is a truly global phenomenon.
We have long maintained that when the use of money has no cost (a zero interest rate); asset prices have an upward bias. We see that now in stock markets around the world, in the recovery of real estate, and in other asset classes as well. The dilemma that confronts an investor is whether to (a) wait for a pullback and enter the market, (b) sit on the sidelines and possibly miss a very large upward move in asset prices, or (c) commit at new, high levels, with trepidation.
Last week, we covered 10,000 miles visiting clients, consultants, and referring professionals in several U.S. locations. It was quite a week. At each stop, we found investors and their agents trying to determine what action to take. Rarely did we see them fully invested. Many suggested that a correction would create an entry opportunity and they would be buyers in such circumstances. Many are bewildered at the intensity of the rise in stock markets in the U.S. and elsewhere. Many do not know what to do.
Reading The Central Banks
The global central bank policy of a zero interest rate has created a platform unlike anything seen in the modern era. Investors have to determine whether they can accept central bank policies that are likely to be in place for a considerable additional period of time. The longer investors wait, the harder it will be for them to make a move into markets. Meanwhile, the pressures will mount for central banks to alter policy and change direction. They, too, are not sure what to do; but as central bankers they can hardly say so.
On the stock market side, Cumberland remains fully invested in a selection of exchange-traded funds (ETFs). We are deployed into sectors, industries, and broad-based ETFs in ways that will let us capture the upward bias of these markets. FOR TODAY we are fully invested. We will again emphasize the words for today. In an event-driven world, "for today" must be part of the conversation.
Depends On The Exit Strategy
As long as this existing central bank policy continues to unfold, markets will have an upward bias. However, if central banks act in any way to create a disorderly exit strategy, Cumberland fears there will then be a shock. The idea now is to patiently experience the present upward bias in assets worldwide. Do so nervously and with uncertainty. And thoughtfully start to rebalance early and be ahead of what may be a big shock in the future.
At Cumberland, we remain fully invested on the stock market side and are gradually hedging duration or using barbells on the bond side, with emphasis on spread product rather than U.S. Treasuries. The stock side can change any day or may not change for months. Zero interest rates are ubiquitous worldwide and very bullish for all asset prices, including global stock markets.
The bond strategic-change process takes months. We believe we have months to work with, since the Federal Reserve has committed itself repeatedly to a prolonged period of very low interest rates. Also, increasing geopolitical risks result in the driving of global money flows into the U.S. dollar, and that helps the Fed keep the Treasury yield curve at low interest rates for all maturities.
We leave on Sunday for Paris and then on to Dubai. All meetings in Paris are private. In Dubai, besides private discussions, we will take part in one public forum, and we are excited about it. GIC has teamed with Wharton for a conference. See www.interdependence.org for the full schedule. Dallas Fed President Richard Fisher is scheduled to keynote. My friend John Silvia and I are the discussants. My slides will be on the Cumberland website after my return.
We fly back to New York from Dubai on March 27 and are scheduled to discuss our findings on Bloomberg Surveillance with Sara Eisen, Scarlet Fu and Tom Keene. That will be from 6 to 7 AM New York time on March 28.
We will try to send some notes along the way.
David R. Kotok, Chairman and Chief Investment Officer.