The rich have never been so wealthy. I have never been so wealthy. In fact, a great many Seeking Alpha readers have never been so wealthy. The reason? People with money own price-appreciating, income-producing stocks that continue to register all-time highs; meanwhile, their property values are recovering and, in some cases, they have acquired more price-appreciating, income-producing real estate during the “Great Recession.”
Yet here’s the thing. Very little of the U.S. Federal Reserve’s electronic money printing (a.k.a. “Quantitative Easing” and “QE”) has benefited small sole proprietors and individual consumers. Whereas big businesses found it easy to refinance their debts to improve their balance sheets, and while people like myself encountered no troubles on route to borrowing at unbelievably low interest rates to buy more stocks and real estate, “Mom-N-Pop Business” and “Average Joe Consumer” did not reap much in the way of rewards.
Many people will say, “Gary, you’re crazy. The U.S. economy is clearly improving. Just examine the downward trend in unemployment, now at a 5-year low with 7% unemployment! Just look at consumer confidence according to the University of Michigan’s sentiment survey to see that is at the highest point in five months!” To those who only view half of the portrait, I remind them that actual employment via labor force participation is near a 35-year low and that the Conference Board’s Consumer Confidence Index has been on a steady decline since June.
So for some readers, we can simply agree to disagree, right? Well, no… not exactly. The primary proof of income disparity as well as the extreme side effects of central bank rate manipulation is its failure to rein in the threat of recession-inducing deflation. While we can debate the efficacy of inflation indicators such as the Consumer Price Index (CPI), the fact remains… U.S inflation resides at less than 1% year-over-year, and has been declining steadily. Meanwhile, Europe’s latest consumer price reading logged an appalling 4-year low of 0.7%, with Spain at a paltry 0.1% and Germany at an exceptionally modest 1.2%. In sum, roughly 18 of 27 inflation-targeting central banks are well below their stated goals of price stability a la 2% inflation.
Perhaps the reader is persuaded that, in spite of unprecedented global monetary accommodation via rate cuts and various forms of QE, prices are still falling. And perhaps the main follow-up question might be, “Why in the sky would falling prices be anything but wonderful for everyone?”
As difficult a concept as deflation may be for educated folks to wrap their minds around, I will try to simplify its insidious nature. For public corporations, falling prices typically mean lower profits, and that is often bad for their share prices as well plans to spend on R&D or HR or equipment. When corporations get squeezed, they cease wage increases at best and they may lay off workers and/or impose wage declines at worst. For borrowers, inflation makes debt repayment easier since you are paying the money back with cheaper dollars, whereas deflation makes debt servicing more difficult; that is, you are repaying debts with more expensive dollars. For consumers, when people expect falling prices, they become less willing to spend as they hold out for even lower prices.
Already in the United States, wages are declining for the 90-plus million unemployed and under-employed. Already in the world, 2013 global inflation chimes in at its second lowest level since World War II. This is taking place at a time when the U.S. Federal Reserve has been unable to achieve price stability/inflation targets, in spite of nearly $4 trillion in existing QE dollar creation; this is occurring in spite of the fact that the European Central Bank (ECB) cut its benchmark lending rate to a scant 0.25% due to what President Mario Draghi describes as a period of “a prolonged period of low inflation.” And with European unemployment near a record of 12.2%, you can be sure there’s very little prospect of wage growth occurring.
So with all of this deflation talk, you might think that this places me in the bearish camp on equities. Not so. For one thing, all of the money printing efforts by the world’s central banks (e.g., U.S. Federal Reserve, Bank of England, Bank of Japan, etc.) have not ended, even with so-called tapering by the Fed. In fact, U.S. monetary stimulus through a variety of tools is roughly the same going into 2014. By the same token, the Japanese government believes that its campaign of QE has succeeded in pushing prices higher, as its “core” inflation measure logged a year-over-year 1% for the first time since the financial meltdown of 2008; Japan’s not about to slow down its electronic money creation with this perceived success. And Europe? Sooner or later, the ECB will decide to cut its benchmark lending rate to zero, and eventually, join Japan, England and the U.S. in quantitative easing, money creating endeavors. Everyone will fight deflationary pressure.
Understanding the most probable course of action by the most influential institutions, I see reasons to be optimistic in two key arenas: dividend-paying U.S stock assets and dollar-hedged foreign stock assets. Keep in mind, I am a money manager who respects the enormous power of trend-following and stop-limit loss order protection; therefore, I like the aforementioned areas as long as a representative ETF remains above its long-term trendline.
For example, WisdomTree Hedged European Equity (HEDJ) is above its 200-day moving average. Mario Draghi and the ECB’s ongoing need to battle deflation will mean more stimulus for the embattled region. Central bank intervention continues to be a bona fide boon to investors. Moreover, European equities trade at 20% discount to U.S. counterparts. And while U.S. stocks are breaking records, European stocks remain roughly 35% below all-time peaks. For all of these reasons, I expect HEDJ to outperform the majority of the stock ETF field on the upside.
In Japan, I expect the monetary policy authorities to get increasingly bold. After all, they are already heralding their recent achievements in confronting deflation. And yet, the accomplishment of 1% inflation pales in comparison to its 2015 goal of 2%. With a looming sales tax to sap some of the strength of consumers, expect the Bank of Japan (BOJ) to print its yen like there’s no tomorrow. That should in turn send WisdomTree Hedged Japan Equity (DXJ) on another remarkable rise at some point in 2014, in much the same way that DXJ skyrocketed from 10/12-5/13.
Finally, in my money management practice, I am not overly concerned with an interest rate spike. Janet Yellen, chairwoman of the Federal Reserve, still recognizes the fragility in the U.S. economy and the debilitating nature of deflation. That said, the Fed feels pressure to walk the tightrope between battling deflation and seeking to keep interest rates in a relatively tight range; a huge yield spike in 2014 is unlikely.
It follows that I will stick with U.S. corporations and U.S. stock ETFs that are most capable of handling any deflationary scares. Whereas 2013 may have had a slightly negative impact on dividend growers and dividend yielders due to a rapid spike in interest rates, a more stable rate environment will be kinder to companies that do not necessarily wither in the face of deflation; that is, divided growers and dividend yielders provide a measure of comfort in their coupon-like payments to shareholders, and these companies view dividend cuts as a last resort. I like both Vanguard Dividend Appreciation (VIG) and Vanguard High Dividend Yield (VYM).
All of the above-mentioned stock ETFs, hedged foreign equity and domestic equity, are demonstrating strong uptrends. Yet I am not a buy-n-hold-n-hoper. If a price on one of my ETFs hits a stop-limit loss order, I may sell all or a portion of the asset. I may do the same if the price falls below a long-term, 200-day moving average.