On Thursday, I had a meeting with Ed Yardeni, someone who I consider a legendary investor on Wall Street. He was the Chief Investment Strategist at Prudential and Deutsche Bank, and the Chief Economist at E.F. Hutton. When Ed talks, people listen.
Ed Yardeni is the one who coined the term “Bond Vigilantes” in the 1980s, referring to the Bond Market’s focus on fiscal and monetary discipline. Based in New York, Yardeni has his own research firm now, and for years I have met with him in San Francisco annually with a small group of investors. This meeting was a little different. He was at his home on Long Island while I was at my now, home-office. No surprise, the meeting was on Zoom.
The discussion was a trip around the world, from a Market standpoint. Of course it starts and ends with the forced economic lockdown. Most in the meeting are surprised the Stock Market is up as much as it is, considering the economic devastation and the continued risks around the health crisis.
Yardeni is modeling a 40% contraction for Q2 GDP. That is an eye-popping number for sure, but it’s not a surprise considering the US Economy was purposefully shut. Q3 could see a rebound, as regions continue to open up and Americans increase their spending. Yardeni expects 20% growth in Q3, and then slower growth ahead, settling in at 3% in 2021 and 2% in 2022. He believes there will be some economic aftershocks, and a return to a 2019 level economy won’t happen until 2022 at the earliest. The outcome of the Presidential election will certainly influence these estimates, because the future of tax rates is unknown.
Questions about the role of Globalization were discussed. It’s been under assault for years, and continues to fray. 2016 was a launching pad against Globalization. Brexit was a major catalyst for protectionism. Donald Trump ran on Making America Great Again, attacking bad trade deals, particularly with China. The political divide and global divide has complicated the issues. The Coronavirus has exacerbated it further, having every nation fending for themselves.
Monetary policy and the Fed was another focus. Whatever it takes is everything they’ve done. To combat the crisis, Ed cleverly said the Fed put down the bazooka, bypassed the helicopter and used B-52s to carpet bomb the Market with cash. He doesn’t see negative rates on the horizon, but is confident that the Fed will stay at zero for a while. He calls it QE to infinity and beyond. The problem is, there is only so much the Fed can do.
A likely outcome from all of this is another age of Big Business and Big Government. There is a restructuring of the American Economy in place. We’ve covered the advancement of the Tech Titans and their dominant size and influence. They are getting bigger and more influential in this crisis. The Federal Government is getting bigger too. The Fed has a balance sheet of now $7 Trillion. $7 Trillion! There has been financial aid and bailouts everywhere, and that has no foreseeable end.
Unfortunately, small businesses could struggle. It is increasingly more difficult for a small restaurant or store to compete. Restaurants can’t survive at 25-50% capacity. The American Dream of working hard, taking a risk and getting ahead is challenged for all things not digital. Small Business accounts for 2/3 of American jobs. At least it did.
Where is this heading? Many economists are looking towards Japan. Fiscal, economic and monetary policy might get a big dose of Japanification. This is the term being used to describe the country’s three-decade battle against deflation and anemic growth. The Bank of Japan has used extraordinary but thus far ineffective monetary policy, which sent bond yields lower while debt ballooned. It is characterized by the aggressive use of negative interest rates. Japan has an aging population and an export-oriented economy, protecting its own companies. Sound familiar? Europe has dealt with its issues similarly. Negative rates have also landed in Europe. The problem is, there is zero evidence of it working. There is concern that the United States, despite its better demographics, more dynamic economy and stronger post-crisis recovery, will follow this same path.
Japan dominated the 1980s. They dominated the car industry. They dominated consumer electronics. It was Toyota. It was Nintendo. It was Sony. Donkey Kong and Walkmans were all the rage. Feeling overly confident, Japanese investors scooped up American crown jewels like Pebble Beach and Rockefeller Center. The euphoria didn’t last. Pebble and 30 Rock were sold at steep losses. The Japanese Stock Market, 30 years later, is still only half its 1989 height.
Careful what you wish for. US inflation is stubbornly low. The tax-cut stimulus faded, though it really helped Corporate America most. The Stock Market entering 2020 was reflective of that. The Fed took interest rates to zero and there is a mountain of debt. America is starting to look a little like Japan.
The primary symptom of the Japanification spread is negative interest rates. Japan accelerated this monetary tool in 2014, with no end in sight. The Bank of England just issued long-dated negative rate bonds this week for the first time ever. There is more than $16 Trillion worth of bonds trading with subzero yields. That is over 30% of the global total. Japan is the biggest contributor to that pool, accounting for nearly half. The US is one of the few with positive yielding bonds, which are under strong demand, as evidenced by the 60% foreign demand for the anticipated return of the 20-Year Treasury, also this week. There’s talk of negative rates in America too.
An American version of Japanification could happen. The Fed has made it clear it’s comfortable keeping rates low for long. They’re going to stay that way. Low rates are normally good news for borrowers. They’re generally good for asset prices. But as Japan showed, persistently low rates do not guarantee sustainable economic growth. And for long-term investors, such as pension funds and insurers that depend on a stable, yet healthy returns from fixed-income instruments, ultra-low rates are devastating.
The cure to all of this is growth. Growth of fresh ideas, growth of ingenuity, growth of capital, growth of hard work. I would also throw in some growth of patience and respect. It’s always said in business: if you’re not growing, you’re dying. The good news is, Silicon Valley is ground zero for innovation. America is the fertile-ground for opportunity, with no rival. Monetary policy, issuing debt and blaming others won’t cure it. What matters is the doing. Life is all about choices. The decisions made in 2020 are going to set the course for the rest of the decade, and beyond. America is a nation of doers. It’s the doing that matters most.
Have a nice weekend. The Market will be closed Monday in honor of Memorial Day. Our home-offices will be too. We will be back, dark and early on Tuesday.