The following is a summary of our recent FS Insider podcast, "Louis-Vincent Gave on Tech, Fed Balance Sheet, and More," which can be accessed on our site here or on iTunes here.
Louis-Vincent Gave, Founding Partner and Chief Executive Officer of Gavekal Research, says there are a number of tailwinds continuing to pushing stock markets higher, though, that story may be about to change, especially as we get closer to 2018.
What Could Tank Markets?
There are three fundamental prices that drive markets, Gave stated: the oil price, the US dollar, and US interest rates.
These three matters over everything else. In the current environment of flat or negative oil prices and flat or declining US dollar valuation, these two serve as a large tailwind for financial assets.
That leaves the cost of money, or interest rates, as the thing to watch, given that their direction isn’t certain.
“This is the big question confronting investors today,” Gave said. “Do you think that US interest rates — let’s say the 10-year yield — are broadly going to stay between 2.15 and 2.35 and that we’ve reached some kind of stable equilibrium?”
If we are in equilibrium, Gave noted, the market will continue rewarding growth-at-any-price as we've seen with high-flying US tech stocks: Facebook, Amazon.com, Netflix, Alphabet, Microsoft, and Apple.
Where are Interest Rates Headed?
The only serious threat Gave sees to the US tech sector and global markets as a whole is if central banks decide to meaningfully shrink their balance sheets.
Though the Fed has already signaled its intent to do this later in 2017, it would take at least two of the three other major central banks — either the Bank of Japan, the European Central Bank, or the People’s Bank of China — to move toward a tightening posture. The Chinese central bank is already tightening, so we only need one more bank to potentially create a disruption.
“Until you get a meaningful reduction in liquidity injections from all central banks, it’s hard to imagine markets crashing,” Gave said. When it comes to market risks, “the most meaningful one seems to be central bank intervention, but it may well be a risk more for 2018 than 2017.”
Equity Market and 10-Year Yields
We aren’t in a stable interest rate equilibrium because of Fed tightening and balance sheet reduction and, therefore, if US interest rates are heading lower, Gave stated, then equity markets and crowded trades such as Tech become much more vulnerable.
If 10-year yields are moving to 1.8%, investors should move to a much more defensive portfolio made up of high dividend-paying stocks with high-income stability, comprised of staples, healthcare, utilities and the like, Gave stated.
However, for investors who think interest rates are going above 2.35% as the Fed starts to shrink its balance sheet, and other central banks potentially follow suit, the expectation should be that yield curves everywhere will steepen. If that happens, Gave noted, investors want to own financials and perhaps even deep cyclicals such as materials and energy, all of which have been beaten up.
“Often in money management, it’s not about what you own; it’s about what you don’t own,” he said. “Personally, I don’t think the 2.15% that we’re sitting on right now is a stable equilibrium. … Depending on the day, I can be convinced that we’re going to either 1.80 or 2.50, and thus at this point, I want a barbell portfolio with … some high-dividend yield paying stocks, and … some beaten-up financials that will give me the upside should the growth accelerate.”
Listen to this full interview and gain access to all our daily podcasts with leading guest experts by clicking here.
