November 14, 2013 – Weekly Market Commentary

At Waterloo Capital Management, we monitor certain economist and capital market theorists on an ongoing basis for the development of our tactical themes that we use in steering our portfolios. In light of all the news you are bombarded with, we thought we would help you “tune out the noise.

We have taken the liberty of highlighting some of the more noteworthy interpretations from the last two weeks. This letter is merely a summary of their interpretations and should not be construed as advice, especially considering the varying opinions of the authors.

News from Economists

Jack Lew
Revision of Sweeping Spending Cuts Needed

Jack Lew believes the effects of sequestration are harmful, and warns that by the third quarter of next year real GDP may have dropped by as much as 1.2 percent due to the indiscriminate nature of sequestration’s budget cuts.“The truth is, that if we grow and we actually accelerate the growth rate the debt will get itself managed,” he said. “And if we don’t, we do all of these programs and cuts and the debt will not get itself managed.” As budget discussions draw near, Mr. Lew advocates tax reform and prioritizing spending, as opposed to across-the-board cuts. READ MORE

Alan Beaulieu
Housing Industry Trends Unrelated to Shutdown

Mr. Beaulieu believes that arguments made last week in a Bloomberg article that the housing industry was threatened by the government shutdown are untrue. According to the article, mortgage approvals would be severely hampered and would, in turn, “squelch” a housing recovery. Beaulieu stated that this hiatus in approvals would merely disrupt housing growth, and that key indexes had already begun to decline starting in March due to economic fundamentals and business cycle swings, not governmental issues. “The truth is that the economy is too large for the government to control, let alone effectively manage.” READ MORE

Allan Meltzer
Yellen is Poised for Mistakes

Allan Meltzer expressed great concern regarding recently appointed Fed chair, Janet Yellen’s lax view on inflation, and hypersensitivity to unemployment rates. “[Yellen] will repeat the mistake that the Fed has made many, many times — that is, delaying concern about inflation until inflation rises. She follows in the tradition of most of the Fed: that is an overemphasis on the problem of unemployment and an underemphasis on inflation.” READ MORE

Alan Greenspan
Inflation is a Matter of Courage

As the Fed’s balance sheet expands to levels around $3.8 trillion, Alan Greenspan worries that inflation may spike to double digit levels over the next 5 to 10 years. The Fed’s plan to keep inflation in check lies with its power to raise interest rates, simultaneously causing banks to keep the money on deposit. Mr. Greenspan acknowledges this plan, but he wonders aloud whether the Fed will have the courage to act. “Unless the economy unexpectedly moves quickly into high gear, any credit tightening will, as usual, run into considerable political opposition. It always has.” READ MORE

No Update: Art Laffer, Ben Bernanke, Henry Paulson

Thoughts from Capital Market Theorists

Bill Gross
Ultra-Low Rates to Continue Past 2015

Fed officials have recently stated that they will attempt to raise federal funds rates to 2%, but Gross does not believe this to be the case. A good example of the effect of increasing rates is market reactions to the mere possibility of tapering of quantitative easing. Ten-year Treasury yields spiked followed by an uptick on mortgage rates. Mr. Gross believes the economy is not in a healthy enough state to prompt a need for higher interest rates. READ MORE

John Mauldin
Renminbi as a Reserve Currency

Mauldin believes, contrary to some dollar skeptics, that the Chinese renminbi will not replace the dollar to become the world’s reserve currency, but rather rise to a level that would supplement the dollar. As the U.S. current account deficit continues to decline, dollars become less available in global trade. This void will be filled with the renminbi due to subtle Chinese efforts at internationalizing their currency through loosening capital controls. “China is on its way to becoming a reserve currency not because of weakness in the US dollar but precisely because the US dollar is going to get stronger and become less readily available.” READ MORE

John Calamos
China to Briefly Stumble, Then Rise

China is currently struggling with some near-term issues, including declines in manufacturing PMI and tightening of credit conditions. The Calamos investment team recently visited China and interacted with local levels of influence and has concluded that China will face difficulties in the next two to three years as new reforms and cut-backs in government spending are put into place. Mr. Calamos remains bullish on China in the long-term, due to the country’s transformation into a consumption-and-service-driven economy and as private enterprises continue to siphon jobs from state-owned enterprises.

George Soros
EU Won’t Survive Decade of Stagnation

George Soros recently commented that the EU is on the verge of dissolution due to a consistently faltering economy, and that problems stem from the fact that the European Union is not a country, but an association of sovereign nation-states. These individual identities form a union of “creditors and debtors that is by its nature compulsory and unequal.” This underlying issue has the power to disband the EU. READ MORE

Kyle Bass
Hedging Against a U.S. Default is Useless

If the federal government had shutdown last week, there would have been little to be done by investors to protect themselves from the risk because limited remaining dollar values would have dropped significantly following a U.S. default. He warned individuals who were highly leveraged to take precaution because they were the ones who were most at risk, if at all. READ MORE

The Leuthold Group
MTI Muted Response to Bullish Markets

A continued rise of 0.03 to 1.15 by the Major Trend Index places the stock market once again in bullish territory, furthering confidence in Leuthold’s commitment to stocks.
The MTI has remained mostly positive throughout 2012 and 2013, with the last bearish reading in the week ending October 7, 2011. While general consensus within Leuthold points to slight overvaluation of U.S. stocks, the Momentum/Breadth/Divergence’s category stands healthy, drawing attention to smaller, growth stocks. A weekly point of development was a 74-point gain.

Frank and David James
Stock Market Analysis

Although a rough week for stocks, it ended profitable: large stocks gained 2.4%, small stocks gained 2.8% Pessimism continues to plague domestic equity funds, with net outflows continuing this week and a barely positive net inflow year-to-date. Additionally, domestic ETF fund purchases continue to rise, resulting in a short-term, bullish outlook for stocks. The Economic Cycle Research Institute’s index 2.2 percent since June, while the index released by the Department of Commerce continues its downtrend. These suggest a downtrend in the economy. With multiple red-flags being raised, James investment does not recommend reckless or speculative trading.

Bond Market Analysis

The yield on 10 Year U.S. Treasury notes dropped last week by 1 basis point, while 1 Month T-Bills dropped from 0.25% to 0.01%.
Uncertainty remains for the future U.S. economy. The results from the previously mentioned ECRI do not look bright, however dry freight shipping costs have risen by over 60% in the last 90 days, indicating higher demand. The government shutdown’s effect was minimal, but provided a reason to continue quantitative easing activity.
The coming week will be intensify the markets as important indicators on employment will be made available. Bond indicators remain moderate.

No Update: David Einhorn, Warren Buffett

Return Data November 1, 2013

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