“Kee” Points with Jim Kee, Ph.D.

  • Government Funding
  • Debt and Unfunded Liabilities
  • The Weak Dollar?
  • Markets First
  • Emerging Markets

Here are a few quick points to help make sense of what’s going on as we head into 2018:


Government Funding

There is a growing threat of a government shut-down, according to strategists like Greg Valliere, due to internal dissent in both parties as to what to support and not to support (e.g. defense, immigration) prior to the January 19 deadline (that’s the end of the temporary funding bill passed in December). I would reiterate that markets historically have not viewed government shutdowns as a crisis, and most strategists seem to think that 2018 will be the year of flexibility or compromise with respect to the Trump administration. That’s an interesting thesis, so we’ll see.


Debt and Unfunded Liabilities

I’ve talked before about the importance of comparing debt to total assets, and of comparing the annual cost of servicing that debt to annual income or GDP. Nothing there is alarming; it is the future unfunded liabilities (Medicare, Medicaid, and Social Security pretty much in that order) that are precarious. But there is a difference between outstanding debt versus future liabilities. Commitments on outstanding debt have to be paid in order to avoid default, which would cause repricing of outstanding debt (downward) and a whole lot of chaos. Future liabilities, however, are promises that can and will be “altered.” That can occur with means testing and other modifications, and does not involve default and the consequent potential for financial chaos. That may not sound fair or just, but it makes all of the difference in the world when it comes to assessing the impact of government commitments on the investment landscape.


The Weak Dollar?

The dollar has dropped to a three year low against a basket of major currencies, and the press seems to be struggling both with how to explain this and how to make it a bigger story than it is. Typically, exchange rates are determined by a lot of things that are impossible to measure while they are occurring, like relative growth rates between countries, and actual tightness versus looseness of central bank policies relative to each other. On that last point, an example is the Federal Reserve, which has raised short-term rates (i.e. the federal funds target rate) 5 times since 2015, and yet the actual federal funds rate, after adjusting for inflation, is still negative. Is that tight?

 

Here’s how I see it: When the price of oil plunged in 2015 the dollar shot up sharply. Oil bottomed and the dollar peaked in 2016, then oil gradually rose (and the trade weighted dollar fell) until the beginning of this year, when oil rose sharply and the dollar fell through 2017. Currently, Brent crude is pushing (but hasn’t quite hit) $70 per barrel. It is tempting to describe this inverse behavior of the price oil and the dollar solely in global “petro dollar,” terms. And indeed, with the advent of fracking and the increase in production from Saudi Arabia, the price of oil fell dramatically, which should result in fewer dollars required to purchase oil (lower supply of dollars globally), as oil is generally purchased in contracts denominated in dollars. That would put upward pressure on the dollar, because the supply of dollars needed to buy oil is less, and reducing the supply of anything increases its price. But missing in this analysis is the “safe haven” role that the dollar also plays.


You might recall that oil’s plunge was associated with a sense of panic by markets and the press, while its climb has been greeted with sighs of relief. When oil plunged, risky assets like stocks and high yield bonds flat-lined or sold off, then started back up as oil prices started back up. The dollar was clearly being moved during this period by its role as a safe-haven, with money bidding up the price dollar-denominated debt, lowering yields. 10-year Treasury rates more or less reflect this - they fell when oil prices fell, and rose as oil prices recovered.


What Now?

I’ve talked before about Robert Mundell’s notion that the dollar/euro exchange rate is perhaps the most important price in the world, particularly because other countries like China peg to the dollar to some extent. The euro was way too strong up to 2014 at $1.40 per euro, and then fell to almost $1.00, meaning the dollar was way too strong. It has since risen back to its current level above $1.20. Somewhere between $1.20 and $1.30 for the euro would be normal, meaning neither currency is too strong or too weak. There’s a lot of “guesstimate” in this sort of thing, but the bottom line is that I see the dollar’s movement as more a normalization than anything else.


Markets First

The Wall Street Journal over the weekend highlighted trade talks, infrastructure spending, and immigration policy as big domestic agenda items for 2018. Trade policy in particular has the potential to be most worrisome. On trade, the US has pulled out of the Trans-Pacific Partnership (about a year ago), and the Trump administration seems to want to “update” everything from NAFTA to the World Trade Organization. The UK is expected to spend the first half of 2018 negotiating what its trade status will look like vis-à-vis the European Union, and in China the ambitious Belt and Road initiatives to increase trade over land and sea will probably see resistance from involved countries (Financial Times). It would be nice to have a crystal ball for all of this, but we do have markets. In other words, it probably makes more sense to watch markets in order to gauge how positive these things are going (or not), rather than the other way around, i.e trying to anticipate the unknown and get ahead of markets. It’s not perfect, but most strategists, myself included, wake up to a headline and check markets in order to get a quick gauge of legitimacy versus sensationalism.


Emerging Markets

China is expected to grow in the 6 percent range for 2018, while India (1/5 its size economically) is expected to grow in the 7 percent range. Raghuram Rajan, India’s former Central Bank Governor, recently made the profound point that India should hold off on any “chest thumping” (his words). Rajan stated that 7% growth for the next 15-20 years is what is needed to meaningfully lift the billions of people there to a higher standard of living. I thought that was a colorful point to end Kee Points on.


I hope you will join us for one of our upcoming market update presentations. Please see the dates and times below. To reserve your space, please email the appropriate RSVP contact.


Corpus Christi Market Update

Wednesday, January 24, 2018

Ortiz Center- Nueces Room

11:30am-1:00pm

RSVP to Joni Bedynek- jbedynek@stmmltd.com or 361-904-0551


Austin Market Update

Wednesday, January 31, 2018

Austin Country Club- Ballroom

11:30am-1:00pm

RSVP to Kelli Stricklen- kstricklen@stmmltd.com or 512-342-2272


Houston Market Update

Wednesday, February 7, 2018

River Oaks Country Club- Ballroom

11:30am-1:00pm

RSVP to Maribel Everett- meverett@stmmltd.com or 713-683-3818


San Antonio Market Update

Tuesday, February 13, 2018

San Antonio Country Club- Ballroom

5:30pm-7:00pm

RSVP to stmmevents@stmmltd.com or 210-824-8916


Dallas Market Update

Thursday, February 22, 2018

Fairmont Hotel- Parisian Room

11:30am-1:00pm

RSVP to Kelli Stricklen- kstricklen@stmmltd.com or 512-342-2272