Antia: Rallying Stocks, Euro Fixed Income Finds & Trouble Spots

May 05, 2015

Shehriyar Antia is founder and lead strategist at Macro Insight Group, an investment strategy firm based in New York. Previously, he spent 10 years as a senior market analyst at the Federal Reserve Bank of New York, where he was closely involved in quantitative easing programs, capital markets and monetary policy. Antia is a regular contributor to prominent publications including Institutional Investor and Barron's. How are you feeling about the U.S. economy and equities right now?
Shehriyar Antia: The U.S. economy in general had a very poor first quarter, but we're poised to do better over the rest of the year, growing head winds notwithstanding. I expect the GDP growth to rebound in the second and third quarter. There are some indications that consumers will start to spend some of the fuel cost savings that they've been accruing. I expect inflation to stabilize over the summer and then to start to trend up in the fall. And the punch line for that is that I expect the Fed consequently to be extremely patient with the rebounding prices. I don't expect an FOMC rule before December. What does that delay mean to the ordinary citizen investor? Is that anything they should be thinking about?
Antia: CNBC cares about the timing of the first rate hike, but the yield curve and interest rates don't. It's about the pace of normalization, and where the Fed leaves rates at the end of the cycle.

Janet Yellen, in a speech a couple of weeks ago, really for the first time articulated a view around the pace of normalization. She laid out that that normalization process would be deliberate and slow, very gradual. The Fed certainly seems like it learned something from the "taper tantrum" a couple of years ago. Any sort of interest-rate or policy actions are really going to be very, very well communicated and likely to be long anticipated.

What that means for markets is that a slow-moving, deliberate Fed is generally supportive of stocks, both here and abroad. Valuations tend to be a bit richer here, but looking at equities broadly in the U.S., the combination of the patient Fed and the better growth outlook means that equities are likely to have some more room to run. Many investors are looking outside the U.S., to Europe for instance. Is that a good idea?
Antia: I'll answer that by talking a little bit about the head winds facing equities. So yes, U.S. equities have had some more room to run, but I anticipate there are going to be fewer record highs than the last few years as some of these head winds continue to grow. There are two head winds in particular I'm thinking about: One is a stronger U.S. dollar that actually challenges earnings. The other head wind is short-term and medium-term rates rising in anticipation of Fed action. And we've already seen that happening.

So the argument for switching to European equities would largely be valuation-based, and you could make the case they have much more room to run relative to U.S. equities.

Europe has gotten so many things wrong over the last few years, and they've finally gotten some things right. They've got some fairly strong momentum for the first time. We can say that both inflation and growth seem to be headed in the right direction. They actually have a couple tail winds working in their favor, one of which is that oil prices overwhelmingly benefit Europe overall. The other tail wind is the declining euro.

But as their economic risks are abating, their political ones only seem to be growing. And of course, I'm talking about those recurring episodes regarding Greece and repayment of debt and the threat of default, and the dance around that, and the possible exit from the eurozone.

So while something calamitous could happen in Europe around Greece defaulting and possibly exiting, I still view that as a very low probability, though the probability of it seems to be increasing over time. What do you see in fixed income?
Antia: Sovereign yields in Germany have been driven down tremendously by quantitative easing, and they were driven down even prior to quantitative easing. So it seems like there are more opportunities for fixed income in the peripheral sovereigns.

Specifically I'm talking about Spain. I'm talking about Portugal. I'm talking about Italy to some extent. These are all countries where it seems like there are sovereigns that have some more room to run. They're poised to be beneficiaries of some good policy and some structural reforms. So I definitely see opportunities there.

Other fixed-income opportunities in Europe are with the global exporters that actually benefit from a falling euro. But one fixed-income area in Europe that I really like is the subordinated bank debt—things like capital bonds, high grades, convertibles. These are really, really good ways to play the improving macro conditions overall in Europe.

With the European economic story becoming stronger, and as we see both inflation and growth sort of headed upwards, that's a very strong, supportive environment for credit expansion and a very strong environment for profitability of banks. Even these quantitative easing programs are going to be relatively supportive of bank income and bank revenue. What are some worrisome spots out there? Capital preservation and avoiding unnecessary risks are important.
Antia: Emerging markets in general are still in the midst of adjustments to a stronger U.S. dollar and rising rates. And they're not done with their process there. Now, unlike tightening cycles, there are some emerging countries that are really positioned to weather those adjustments much, much better than others. But emerging markets in general are still very highly correlated.

So Brazil and Russia, for example, are not in good shape at all. China seems to be flashing yellow, soon to be red. Where there's some possibility for some outperformance might be Mexico, India and Poland.

Having said that, I also mentioned that the emerging markets still tend to be highly correlated. So you can be in the right countries in emerging markets, but still suffer losses, because the whole category gets sort of taken down. That's one sort of asset class worry.

Bigger picture, going into 2015, I was thinking there were two things out there. One was disinflation and the other was volatility. There have certainly been significant disinflationary forces across the globe. It's caused policy easing by more than 15 central banks around the world just in the first couple of months.

But we're already seeing some upward trends in Europe. There are some signs of—at the very least—stabilizing inflation in the U.S. and Japan. Like I said, we're in the late innings of the disinflation thing.

When it comes to markets, I think monetary policy's going to continue to dominate markets, but in different ways than it has been in the past. In the past, we were talking about quantitative easing, accommodative policy, and so forth. Well, going forward over the next six to 12 months, we are going to be talking about what happens when monetary policy goes from ultra-accommodative to nearly extremely accommodative, which is kind of where the Fed is headed in general.

And while it may be late innings for disinflation, it's still pretty early in the game for market volatility. We've seen across the board here rising volatility. So rising volatility isn't a big concern, but one area that is a concern for me and that I've started to think about, when I look forward six months, 12 months down the road, I'm seeing very few real drivers of strong growth or excessive inflation.

Yes, disinflation and inflation are stabilizing, but I'm not seeing any signs of runaway, really strong, robust growth or excessive inflation. The typical drivers of growth over the last era have been emerging markets, the U.S. consumer. They're all kind of stumbling along and it isn't clear that anyone is stepping up and taking leadership to sort of drive global growth going forward.

There are unintended consequences that are going to be out there that are not quite foreseen at this time. So anything that helps those policies linger is going to be, not a ticking time bomb, but something analogous to it down the road. Thanks for your time.

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