As we concluded 2015 Outlook Part #1 we promised that we would provide an update on real estate, currencies and interest rates. Let's start by taking a look at interest rate trends as they are the most likely to impact all of our clients in one way or another.
Interest Rate Themes
Our current base case is that the U.S. Federal Reserve Bank will NOT raise short term rates in 2015. We also think the odds favor longer term rates declining from present levels. It looks like the global economy is slowing enough to remove any motivation for raising rates. We think raising rates has been pushed back to at least 2016. Other major central banks around the world continue to surprise markets by lowering rates. There does not seem to be any significant pressure for higher interest rates anywhere in the world. Inflationary pressures are easing everywhere. In fact long term yields have collapsed around the world.
If the U.S. FED does raise short term rates in mid-2015, as many believe they will, we would consider that to be a policy mistake.
The only thing that worries us about our "base case" is that it is rapidly becoming a more popular opinion. If it becomes consensus we are probably wrong!
The annual World Economic Forum was convened at Davos, Switzerland last week. A major theme of the conference is how to get a fragile and weakening global economy on a more solid footing.
The consensus for global GDP growth is still holding at 3.5% for 2015, but the forecast for global inflation keeps coming down and is now below 2%. There is growing concern about deflation rather than inflation.
Christine Lagarde, Managing Director of the International Money Fund opened her presentation with this comment:
"At the start of 2015, policymakers around the world are faced with three fundamental choices: to strive for economic growth or accept stagnation; to work to improve stability or risk succumbing to fragility; and to cooperate or go it alone. The stakes could not be higher; 2015 promises to be a make-or-break year for the global community."
5T agrees that 2015 is likely a "make-or-break-year" for many economies and many markets. We grow more concerned by the day that it will be a volatile year in most financial markets.
It is incredibly hard to accurately forecast market trends when every market is being distorted by Central Bank activity. The European Central Bank seems very late to the party with their new round of Quantitive Easing (QE), but we are all going to have to deal with it now.
Will European stocks rise, as ours did when the U.S. FED initiated QE? Will the U.S. stock market move downward as a rising U.S. dollar puts pressure on earnings of American companies? We are about to find out.
In the meantime interest rates around the world should stay low. If you are worried about rising mortgage rates, we would suggest that you shouldn't be. The path of least resistance for interest rates is downward.
Here is a long term chart of the 10 year Treasury yield going all the way back to the 1970's. This rate peaked in 1981 and has been declining ever since. The slope of the decline accelerated in 2008. We have often thought this rate was poised to rise, but there is absolutely no evidence of that yet.
We need to see this rate rise back into the blue channel before there is any hope of a complete trend reversal.
Real Estate Themes
Very low interest rates, below normal supply of new housing and demographic trends should support single family housing prices in most of the U.S. during 2015. For most of our clients that is all that matters relative to real estate.
The Bay Area economy is growing faster than many other regions of the U.S. and commercial real estate should continue to do well here.
Both Napa County and the City of Napa should see continued appreciation for both residential and commercial real estate in 2015. The rate may slow from 25% appreciation in 2014, but it should still be substantial.
The rest of the nation may experience more normalized markets. We have done a lot of reading about it and talked to real estate experts around the country. Consensus opinion may be best expressed in this excerpt from a report by U.S. News and World Report:
"Experts say that 2015 will be marked by a return to normalcy and balance for real estate markets across the country. Stan Humphries, chief economist for Zillow.com, predicts that home value growth will slow to around 3 percent per year instead of the 6 percent seen recently, and that will make real estate less attractive to many investors. "It's been a tough market for buyers," he says. "I think it's going to get easier in 2015. Negotiating power will move back to buyers and away from sellers. It will be a much more balanced market." (Too many buyers and too little inventory, or the opposite, contribute to an unbalanced market.)
Redfin.com's chief economist Nela Richardson agrees. "It's been a clear pattern that the investor activity has been shrinking over time," she says. "Investors like to go in where they can buy low and sell high. Price growth is starting to slow dramatically, so they can't sell much higher than what they buy. Investment property is less compelling going into 2015."
If you have the patience to look out more than a year 5T thinks that residential real estate is poised for a very long term, slow but sure, recovery. Demographic trends and the need for housing for a growing population trump other considerations.
We think that foreign buyers will also help boost residential and commercial real estate markets over the long haul.
The U.S. dollar looks like it is in the early stages of a new long-term secular bull market. Check out this chart. The $USD last peaked in 2000-2002 and has been in a "bear market" ever since. However since 2004 it has been in a very long term consolidation pattern forming a "saucer". This pattern is consistent with a very long term conversion from falling values to rising values. The longer it takes to form the "saucer" the more likely the pattern is to have very strong follow through to the upside.
In the past two weeks it has finally broken out above the top of the "saucer".
Chart provided by Breakpointtrades.com
This lengthy consolidation pattern should be interpreted as very bullish for the very long term. However, the next most likely move for the dollar is to fall back temporarily. It is very "overbought" right now. A "backtest" of the bowl of the saucer or the breakout level could provide the perfect set up to buy the dollar for a new multi-year bull market.
5T has rarely participated in currency markets. Frankly our clientele does not follow this market and it seems a bit esoteric to most of our clients. But currency markets are the biggest and most liquid in the world and we have rarely seen so compelling a chart. Therefore we are likely to take at least a small "long position" in the U.S. dollar on any near term pullback for our tactical models that can own this asset class.
Instinct should tell you that the Euro chart looks just the opposite. It is imploding.
The Japanese government is also throwing the Yen under the bus. It too is depreciating rapidly.
The Chinese continue to play a very long term chess game that will eventually make their Renminbi a global "reserve currency", taking its place along side the Dollar.
Here is an excerpt from a recent report by Central Banking Journal:
"There is still a long way to go, but the direction is surely heading towards greater trade flows with China. Already the world's largest trading country, nearly 20% of China's foreign trade is now settled in RMB (Renminbi) - up from just 3% in 2010. However, this is still low compared with around 50-60% of the eurozone's external trade settled in euro, and 30-40% in yen for Japanese trade. The Hong Kong Monetary Authority (HKMA) expects RMB settlements to reach 30% by the end of 2015.
While the RMB continues its journey as an international trade and investment currency, some structural shifts in the world reserves market are also under way. Twenty years ago, 65% of reserves were held by developed countries and 35% by emerging markets. Now that position is reversed, with 67% of world reserves held by emerging markets, reflecting the economic rise of Asia in general and China in particular.
The euro was seen as a prime candidate for those seeking alternatives to the dollar, or greater diversification, but it has unfortunately faced its own share of uncertainties arising from the eurozone debt crisis. This has led to increasing interest across the world in holding non-traditional currencies in foreign exchange reserves. Many central banks and global investors are increasingly seeing the RMB as another alternative.
This year, HSBC reaffirmed its view that the RMB will be fully convertible over the next two to three years. An important indicator of the RMB's maturity would be its inclusion in the IMF Special Drawing Right (SDR) basket of reference currencies - currently the euro, yen, sterling and dollar. The SDR will next be reviewed in 2015, and RMB inclusion is sure to be high on the agenda."
The alternative to all other currencies is Gold
Gold and the $USD often trade inversely from one another. If one is going up the other is going down. But recently that relationship has broken down. They are both going up. We indicated in Part 1 that gold seems to be reversing the downtrend that has been in place since 2011. We would not be surprised to see gold move up to $1350 from its present price of $1286. Our current upside target is $1500.
Some additional comments on stocks
We are becoming increasingly concerned that the U.S. stock market is forming at least an intermediate term top. In Part #1 of this forecast we indicated that our base case suggests very modest gains in U.S. stocks during 2015. We also indicated that the near term direction for stocks was more likely downward. This table may help you understand our current cautionary stance. It may feel like stocks have been doing nothing but going up, but that is not the case. Since July 2014 the market has actually made little progress. The Russell 2000 and the NYSE Composite Index are lower than they were seven months ago.
Stock Index July 2014 High Now Gain/Loss %Gain/Loss
Wilshire 5000 21100 21360 260 1.23%
Dow Jones Industrials 17151 17367 216 1.26%
S&P 500 1991 2024 33 1.66%
Nasdaq 100 3997 4191 194 4.85%
Russell 2000 1213 1185 -28 -2.31%
S&P Mid Cap 400 1452 1455 3 0.21%
NYSE Composite Index 11105 10707 -398 -3.58%
It usually takes months for tops to form in markets. It feels more and more like that is what's happening now. It just wouldn't surprise us to see the U.S. stock market take a breather to regroup before making any additional progress. We are monitoring the situation carefully.
All the best,
MANAGING MEMBER & CHIEF INVESTMENT OFFICER
5T Wealth Management
(707) 603-2672 Office
(707) 486-7333 Cell
Disclosure and Disclaimer - Updated last on July 23, 2012 by Paul Krsek:
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