The S&P 500, which is made up of large U.S. stocks, has had outsized returns when compared to most major asset classes over the last 12 months. International stocks have had low single-digit returns over the last year, and hard assets like commodities and gold have shown negative returns. The outperformance of stocks over hard assets is even more pronounced when looking at the difference over the last 3 years:
As September began, the European Central Bank surprised markets by cutting interest rates to a record low. Their benchmark "refinancing rate" dropped to .05%, and they increased their "charge" for leaving money on deposit with them from .10% to .20% (those are NEGATIVE interest rates). They also announced a plan to increase their purchases of asset backed securities, which is a nuanced way of saying that the ECB will be buying pools of bad loans that commercial lenders want to unload on the taxpayers of Europe. Summing it up nicely, Valentin Marinov, currency strategist at Citi, said "The ECB will now be giving banks money to spend and penalizing them for not doing so." This is the current prescription worldwide for "shocking the patient back to life": provide nearly free money to any takers.
Echoing the Federal Reserve in the U.S., ECB Chairman Mario Draghi said "Should it become necessary to further address risks of too prolonged a period of low inflation, the Governing Council is unanimous in its commitment to using additional unconventional instruments within its mandate." In other words, the punch bowl at the party will be full until everyone has had a good time (markets/economies recover).
Investors didn't seem to like what they heard. The Euro fell on the news, as did European stocks. Eurozone bond yields are also falling. Eurozone economic indicators are looking punk, and most forecasters are muttering the "R" word (recession). Sanctions against Russia are crippling their exports, with even powerhouse Germany succumbing to a slump. Inflation, at .3%, is at a five year low, and growth, unlike the U.S., is still below the 2008 crisis peak. Investors seem to be in a "show-me" mode at the moment: what's it going to take for the Eurozone to get its mojo back?
We also noted comments made to the Financial Times this month by Larry Fink, Chairman of Blackrock, the world's pre-eminent money manager, with $4.3 trillion under management. They are "the smartest guys in the room", so when their chief talks to the press, we listen. Regarding Europe, he said "it's going to take longer to stabilize Europe than anyone thinks...you're going to have very aggressive ECB behavior for a long time, just like you're going to have very aggressive Bank of Japan behavior to stabilize both sides." He was reminding everyone that these central banks are just getting started with their "quantitative easing" plans, so don't think higher rates are just around the corner, including in the U.S., which can't upset the global economic apple cart by bucking the trend.
What really caught our eye was his blunt criticism of policy-makers and regulators, a fusillade if you will. Fink squarely laid the blame for pushing investors into risky assets at the feet of policy makers, like the Fed, whose suppression of interest rates has "crushed savers", and stifling regulations.
From the FT article: "What frightens me the most is the narrative that's being discussed," he warned. "You're hearing from banking sources - whether it's the BIS or the FSB or the Federal Reserve - a narrative that 'there's bubbles', a narrative that 'the private sector is guilty of investing in products that maybe lack long-term liquidity at interest rates that in the long run would probably represent some form of losses'. And the reality is, though, they're to blame - and they're not taking any of that responsibility. The narrative should be 'OK, we're all in it together, how do we manage this together?' instead of the admonishing of these markets." Mr. Fink added "Actually, if you look at the behavior of central banks, they have rewarded the debtors and crushed the savers...We've never debated that." This is pretty straight talk, and very refreshing.
Meanwhile in the U.S., Chinese e-commerce company Alibaba (BABA) went public on Sept. 19th on the NYSE for a record $230 billion. The IPO was a "food-fight", as investors clamored for shares, which soared 38% by the close of the first trading day. Overall, a record $25 billion was raised, making this the largest debut ever for any company on any listed exchange anywhere in the world. (The Eurozone malaise doesn't seem to be affecting Chinese technology companies!) Note how only 3 of the 10 companies below are U.S. based:
The company now has a market cap greater than Amazon, which speaks to the potential of e-commerce in Asia. Fundamental valuations look ridiculous (as an example, BABA trades at 62.3X book value versus 2.75X for the S&P 500), but investors are looking through that to growth rates in excess of 175% over the last three years. So, while it is nice to see some optimism on the horizon, the BABA IPO was fueled by the classic "hope" strategy that may or may not play out. What's really interesting is that, more than a decade after its IPO, Amazon still has a nonsensical PE ratio of 845X, but the shares have done well (albeit in very volatile fashion). A brave new world after all? Time will tell.
The other very notable event in September was the quick push-back by the Obama administration against "off-shoring inversions", which we wrote about early this summer (when a U.S. company re-incorporates in a tax-friendlier country, usually through a merger or acquisition). Even though authorized through legislation, these activities (excoriated by the President Obama as "unpatriotic") proved so offensive that they took matters into their own hands.
On September 22nd, the U.S. Treasury and the IRS issued new rules to reduce the tax benefits of corporate inversions (http://www.treasury.gov/press-center/press-releases/Pages/jl2647.aspx). As Treasury Secretary Lew stated "We cannot wait to address this problem. Treasury will continue to review a broad range of authorities for further anti-inversion measures as part of our continued work to close loopholes that allow some taxpayers to avoid paying their fair share." There could not be a more crystalline example of those in power thinking they can dictate what is "best" for those over whom they "govern". In this case, corporations have the wherewithal and motive to push back, so, just like Obamacare, there will likely be years of litigation to come. (Maybe somewhere along the line we can get back to the basic blocking and tackling of debate, compromise, and legislation that makes sense.