Hallelujah, Reflation!

A few years ago, we were asked by concerned clients if the U.S. was slipping into a deflationary cycle somewhat like what Japan has experienced for the past 28 years.  Like Japan, we have aging demographics, a mature economy and our government is overburdened by debt.  The Japanese example is disconcerting as the Nikkei 225 peaked in December 1989 and still has to double before reaching a new high.


A few years ago, the S&P 500 was mired in a 13-year bear market that extended from 2000 to 2013.  The Fed Funds rate was zero.  Deflationary concerns were justified.


The S&P 500 reached new highs in 2013.  The Dow Jones Industrial Average achieved this milestone in 2012 and the NASDAQ definitively surpassed its 2000 high in 2016.  On price action alone, measured from 1989 or since 2000, we are not Japan.
Fed Raising Rates
The Fed raised the Fed Funds rate (overnight lending rate between banks) by 0.25% to a range of 0.75%-1.00% this week.  This is further compelling evidence we are not Japan.

  1. The Fed is raising the short-term interest rate to curb inflation which by a variety of measures is at or near its 2% target rate.  The worry is inflation, not deflation.
  2. The Fed is reiterating its intent to raise rates three times this year and three times next year.  They have confidence this rate hike schedule will not derail U.S. economic expansion.  From an economic cycle point of view, we have moved from the recovery phase to the expansion phase.  Given that interest rates are still near historic lows, the economy may expand for several more years before we peak and contract again.

To highlight how different our overall economic condition is from Japan’s  (growth versus deflation), the U.S. ten-year treasury interest rate is roughly 2.5% while the Japanese rate is roughly 0.07%.  The Japanese government 2-year and 5-year interest rates are negative -0.27% and -0.14%, respectively.  Negative interest rates are rudimentary and emblematic of deflation.  U.S. rates are among the highest in the developed economy world and rising.
As long as inflation and interest rates are not too high, stocks generally do well during inflationary periods.  Bonds often don’t.  JP Morgan Asset Management calculates that the correlation between rising rates and rising stocks is positive until the 10-year treasury rate surpasses roughly 5%.  At 2.5%, we are only half way there.
Think Global
Europe appears to be earlier in the expansion cycle and is coming off of lower interest rates than in the U.S. On February 10, our newsletter was titled “Value Shopper, Europe on Sale.”  We believe adding international stock exposure to your U.S. equity exposure is a good idea today.
This week, we rebalanced our Multi-Fund Diversified strategy to increase our international exposure.  This strategy offers a balanced, agile approach to owning many of the top performing markets globally.  Importantly, the strategy has a rules-based mechanism for selling stocks and moving to defensive assets when the bull cycle eventually reaches it end.  It seeks to offer the growth of the stock market with bear-market protection.  Give us a call or email if you would like to learn more about how to capture the expansion while maintaining downside protection.
One of the keys to investing is sifting through all available information and sticking to a plan.  Somehow, we need to control our emotions about something that is very important to each of us. We invite you to call or email anytime if you have questions about how we can help you with your wealth management.  Please give us a call at (415) 249-6337 or email us at info@uscapitalwm.com  to learn more.

Erin Go Bragh!

Stock Market Dashboard

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This commentary and a sampling of previous editions are available as PDFs:

3/17/2017: Hallelujah, Reflation!
3/10/2017: Small Cap Stock Divergence
3/3/2017: Velocity Pivot Good for Stocks
2/24/2017: How Safe Are The Banks
2/17/2017: Climbing A Wall of Worry
2/10/2017: Value Shopper - Europe on Sale
2/3/2017: What, Me Worry
1/27/2017: Extraordinary Earnings Louder Than Trump
1/20/2017: It's Not All About Trump
12/30/2016: Predicting the Future -2017
Trade What Is, Not What You Think It Should Be – 2017 Outlook

US Capital Partners

Pursuant to the provisions of Rule 206(4)-1 of the Investment Advisors Act of 1940, we advise all readers to recognize that they should not assume that recommendations made in the future will be profitable or will equal the performance of past recommendations. This publication is not a solicitation to buy or offer to sell any of the securities listed or reviewed herein. The contents of this letter have been compiled from original and published sources believed to be reliable, but are not guaranteed as to accuracy or completeness. Nicholas Atkeson and Andrew Houghton are also principals of US Capital Wealth Management, a registered investment advisor. Clients of US Capital Wealth Management and individuals associated with US Capital Wealth Management may have positions in and may from time to time make purchases or sales of securities mentioned herein.


Jeffrey Sweeney