Geopolitics and
monetary policy and deflation! Oh my!
It was a wild, wild
week. First, the Russian central bank announced a massive rate hike and the country’s
main deposit rate rose from 10.5 percent to 17 percent. The move was the
largest single increase in Russian rates “since 1998, when Russian rates soared
past 100 percent and the government defaulted on debt,” according to Bloomberg.com.
The central bank
was desperately trying to shore up the ruble which was suffering from lower oil
prices and Western sanctions imposed after Russian annexed Crimea. The rate
hike wasn’t immediately effective and the ruble sank to a record low. The
currency has lost 52 percent of its value during 2014 to date, and the outlook
for the future of the country’s economy isn’t bright. If oil averages $60 a
barrel, Russia’s gross domestic product – the value of all goods and services
produced in the country – might fall by 4.5 percent to 4.7 percent in 2015.
Events in Russia
put investors in a selling mood, and stock markets around the world moved lower
early in the week. Barron’s
commented, “From all appearances, investors were selling stocks while they were
doing their holiday shopping.”
The investor
stampede was headed off by a bit of whooping and hollering from the Federal
Reserve. After the Federal Open Market Committee meeting, the Fed announced its
policies remained unchanged:
“…Based on its
current assessment, the Committee judges that it can be patient in beginning to
normalize the stance of monetary policy. The Committee sees this guidance as
consistent with its previous statement that it likely will be appropriate to
maintain the 0 to 1/4 percent target range for the federal funds rate for a
considerable time following the end of its asset purchase program in October,
especially if projected inflation continues to run below the Committee's 2
percent longer-run goal, and provided that longer-term inflation expectations
remain well anchored.”
The Fed’s decision was
enough to calm markets, many of which showed attractive gains by week’s end.
as people get richer, do investment
returns get better? No, they don’t. Research shows there is a negative
correlation between gross domestic product (GDP) per capita – a measure of how wealthy
people in a country are becoming – and investment returns.
In
other words, the countries with the fastest growing economies don’t always
produce the highest investment returns and vice versa. For example, between
1900 and 2013, South Africa rewarded investors with long-term stock market
returns of about 7.4 percent while its per capita GDP growth was 1.1 percent.
At the opposite end of the spectrum was Ireland, where markets returned 2.8
percent while per capita GDP growth was 4.1 percent. The Economist described the research findings:
“The quintile of countries with the highest
growth rate over the previous five years produced average returns over the
following year of 6 percent; those in the slowest-growing quintile produced
returns of 12 percent... Why might this be? One likely explanation is that
growth countries are like growth stocks; their potential is recognized and the
price of their equities is bid up to stratospheric levels. The second is
that a stock market does not precisely represent a country's economy – it
excludes unquoted companies and includes the foreign subsidiaries of domestic
businesses. The third factor may be that growth is siphoned off by insiders – executives
and the like – at the expense of shareholders.”
Here is another interesting
economic tidbit. While past economic
growth does not predict future equity market performance, changes in stock
prices do correlate to future economic growth. That’s because expectations play
an important role in markets. The expectation of poor future economic
performance may cause a country’s share values to fall, and vice versa. A
research report from Schroders said, “If
expectations are key, a poor economic outlook will already be priced in, and
investors’ returns will depend instead upon whether market expectations are
overly optimistic or pessimistic with regards to future GDP growth.”
Weekly Focus – Think About It
"Not
everything that can be counted counts, and not everything that counts can be
counted."
--Albert
Einstein, Theoretical physicist
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