Relationship Problems
As global conflict escalates, Fed policies keep Wall Street calm. Plus, more trouble for Trump in Atlantic City.
Breaking up still is hard to do, and it can be frightfully expensive to boot. Voters in Scotland nonetheless seem undeterred by that prospect as they head to the polls on Thursday to consider whether to sever their three-centuries-old tie with England, which could create what might be called "Not So Great Britain."
You'll be forgiven if the Sept. 18 referendum on Scottish independence had eluded your notice, as it had for most on the western side of the pond. And it had not aroused much attention in the markets so long as rejection of an independent Scotland and an intact United Kingdom seemed the likely outcome of the vote.
But a poll showing a pro-independence "Yes" vote eking ahead shocked the markets and sent sterling into a tailspin. The British establishment was roused to warn of the dire economic consequences of Scottish independence, so by week's end the "No" vote regained a narrow lead in the polls, although it's still too close to call.
Maintaining the status quo would certainly elicit a huge sigh of relief from the currency and bond markets, but would likely mean little for big U.K. equities. As I noted in my Up & Down Wall Street Daily column on Barrons.com last week, the main British exchange-traded fund in the U.S., theiShares MSCI United Kingdom fund (ticker: EWU) isn't terribly British. Indeed, the two classes of Royal Dutch Shell shares (RDS.A, RDS.B ) together constitute nearly 9% of the U.K. ETF, while its single-largest component, HSBC Holdings (HSBC), with a 7% weighting, used to be known as the Hong Kong and Shanghai Banking Corp., with vast operations around the globe, many of them far from the Sceptred Isle.
Beyond the particular interest of Great Britain -- and England, Wales, and Northern Ireland have an interest in whether Scotland secedes even if they have no vote in the matter -- are growing independence movements in the rest of Europe and beyond. Catalonia wants to go its own way from Spain, while Flanders seeks independence from Belgium. That calls into question the notion of a United Europe, especially if the U.K. votes to withdraw from the European Union in 2017.
All of which is a symptom of a broader and more serious trend toward conflicts around the globe that aim to redraw borders that many had thought to be indelible. And not by plebiscite but by brute power. The incursion of Vladimir Putin's Russia to annex Crimea and attempt to build a so-called land bridge through eastern Ukraine threatens a new economic cold war, albeit one using sanctions instead of the ultimate deterrent of Mutually Assured Destruction.
Meanwhile, the atrocities of the Islamic State spurred President Barack Obama last week to assemble a coalition of the kinda, sorta willing. Ten Arab states, including Saudi Arabia, will join in what Obama called a campaign to "degrade, and ultimately, destroy" the Islamic State, although Turkey -- a member of NATO -- declined to permit airstrikes to be launched from within its borders.
This adds up to the tensest global situation since the end of the Cold War, Loomis Sayles' peerless fixed-income manager, Dan Fuss, told colleague Jack Willoughby in last week's Fund of Information column. With the benefit of a half-century of investment experience during that perilous period, the octogenarian retired U.S. Navy officer is trimming the sails of his portfolio and raising cash.
Clearly, the equity and credit markets evince rather less concern. While U.S. stock indexes notched their first weekly loss in six weeks and bond-market yields backed up from their recent lows, the bull markets in both sectors remain intact. Crude oil and gold, two traditional beneficiaries of geopolitical angst, slid further.
The world may be a mess, but the world's central bankers have the palliative in the form of endless free money. The effects are ticked off by Bank of America Merrill Lynch chief investment strategist Michael Hartnett and his colleague Brian Leung: 1.4 billion people around the globe are experiencing negative real (inflation-adjusted) interest rates; 81% of the global equity market capitalization is supported by zero-interest-rate monetary policies; and 45% of all government bonds yield less than 1%.
The eventual removal of this heavily spiked punch bowl is of primary importance to the equity and credit markets that have partied heartily on this hooch. So they will be looking keenly for some clues as to when "last call" will come from the Federal Open Market Committee's meeting this week. The two-day confab will wind up on Wednesday and include the various panel members' projections of where the federal-funds rate target will end in 2015 and 2016 -- the infamous "dots" for their graphical depiction -- as well as a postmeeting press conference with Fed Chair Janet Yellen.
There she should be asked to elucidate the array of indicators the policy makers are using to assess the state of the labor market, which is likely the main focus of Fed policy. On its other main target, inflation, the central bank has gotten a reprieve from a recent easing of price pressures, which should be increasingly visible at the gasoline pump. A gauge tracking real-time prices online from State Street, free of government finagling, also shows inflation rolling over.
The Fed has adopted a series of job-market indicators to augment the traditional unemployment rate, which gets the headlines but is distorted by the widely recognized decline in participation in the labor force by American adults. Employing so many indicators recently led Dallas Fed President Richard Fisher to quote Pimco's Bill Gross in a speech, noting that rather than the two-handed economists derided by President Harry Truman, the Fed was becoming more like a multi-armed Hindu god. Sorry, Dick, that was my quip from my Aug. 25 column, which your speechwriters footnoted but didn't cite correctly.
Words also are likely to be the main points of contention at the FOMC meeting, specifically "considerable time" for maintaining ultralow rates. Economic data, not the calendar, should guide policy, say critics. That would introduce a bit of uncertainty into financial markets, which are beginning to fret that the flow of free money won't last forever.
Whatever the verbiage, the markets are pricing in the fed-funds target to rise from a range of zero to 0.25% (where it has been since the depths of the financial crisis in December 2008), to about 0.25% by next Memorial Day, 0.50% by next Labor Day, and 0.75% by December 2015. The last set of FOMC dots had a median funds target of 1% at the end of 2015, 2.5% at the end of 2016, and 3.75% for a long-run "equilibrium" rate.
Against the backdrop of continued ultralow interest rates, the BofA Merrill strategists note that this week's sixth anniversary of the Lehman bankruptcy will be marked on Wall Street with the initial public offering of Alibaba, potentially the biggest IPO in history. With that, they add, "we have no doubt that hubris is also on the rise." That, despite the perilous world in which these deals are coming. But easy money readily eases such anxieties.
OF THE HUNDREDS OF COLUMNS written by my illustrious predecessor, Alan Abelson, the one he singled out involved a brokerage analyst who was sacked in an act of "unsurpassed spinelessness" for deigning to denigrate the financial prospects of the Trump Taj Mahal in Atlantic City as well as the New Jersey shore resort itself. That was back in 1990.
Last week, Trump Entertainment, which operates the Trump Taj Mahal, filed for bankruptcy protection for the third time, the last being in 2009. The company also owns the Trump Plaza, which will be shuttered this week, and the Trump Taj Mahal, which is slated to close on Nov. 13 if the company can't come to terms on expense cuts with its largest union, according to the bankruptcy filing. If that happens, it would be the fourth of Atlantic City's 12 casinos to shut down.
The result has been a "Detroit-like" socioeconomic picture, writes Triet Nguyen, managing partner of Axios Advisors, an independent research and advisory boutique specializing in high-yield municipal finance. Shrinking employment and a declining tax base raise a bigger question, he writes: "Is Atlantic City heading for default on its outstanding $245 million in [general obligation] debt?"
Debt service and pension contributions absorbed 25% of the city's budget as of fiscal 2013. Nguyen says the tipping point occurs when these expenses "crowd out" other expenditures.
It would seem that Alan was prescient not only about the Trump casino but Atlantic City overall.
THERE ARE PRECIOUS FEW ORIGINAL THINKERS in the investment arena, or elsewhere. Paul Macrae Montgomery, whose unique observations graced these pages over the years, passed away on Sept. 6, too soon at age 72.
Paul, who penned his Universal Economics newsletter out of Newport News, Va., took issue with the shibboleths that markets were run by totally rational players with perfect knowledge to maximize their long-term returns. Markets, Paul asserted, were made up of human beings subject to emotions that could be influenced by all sorts of things outside their understanding or control.
Perhaps his greatest contribution was the tracking of cover stories of Time magazine and their relationship to the financial markets. It seems more than reasonable that by the time a story gets published in the popular press, markets will have largely discounted it. Paul's empirical evidence of magazine covers going all the way back to the 1920s was that the market-related stories appeared just when a wave was about to crest -- and reverse shortly thereafter.
Moreover, Paul was a gentleman, the likes of which is rarely seen anymore. He'd invariably end a call placed to seek his insights by thanking the caller for taking an interest in his work. That's maybe an even greater legacy.
E-mail: editors@barrons.com
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