In one of my recent articles, I discussed about the CBO forecasting recession in the first half of 2012 if fiscal restraint was exercised. The CBO also projected a GDP growth rate of 4.4% in 2013 if the fiscal restraint were not exercised. In my opinion, the forecasted growth rate of 4.4% is way too optimistic under any scenario.
This article looks at the view of FOMC participants on the appropriate time for policy firming. In my opinion, it is a good indicator of the expected growth in the foreseeable future and hence the investment strategy.
If the FOMC participants really believed that growth in 2013 will be 4.4%, the policy firming measures would have come relatively soon.
The chart gives the opinion on the appropriate time for policy firming (number of FOMC participants).
I have compared the FOMC participant's views from the January and June 2012 meet to capture the change in opinion of FOMC participants during this period.
On the positive side, no FOMC participant believes that 2016 would be the right time for policy firming in June when compared to January 2012.
On the flipside, there are an increasing number of participants with the opinion that 2015 is the right time for policy firming.
The more extended the view on the time for policy firming, the higher is the probability of prolonged period of muted economic growth. For now, FOMC's views do suggest that growth will remain depressed for a relatively long time.
I wanted to discuss this view for three reasons -
CBO estimates budget deficits of less than USD1 trillion in the next few years. In my opinion, budget deficits will remain over USD1 trillion with no meaningful economic recovery in sight
The kind of investments one needs to make in the medium-term with interest rates at near-zero levels for at least 2014 (and probably 2015)
Impact of low interest rates and high deficits on inflation and asset markets (in general)
Budget deficits will remain high
The proposed spending cuts will not be implemented and budget deficits will remain high in the medium-term. Many will argue that deficits don't matter. I would say that taxes are not needed or increase in taxes is not needed if deficits don't matter. I don't see the reason for the big debate on Bush era tax cuts if deficits really didn't matter.
High budget deficits will mean more debt monetization. This, in turn, will lead to an increase in global inflation. I have to add here that even the Euro zone economic growth will remain sluggish for a prolonged period and quantitative easing in the Euro zone will also contribute to ballooning global liquidity.
Asset markets will remain volatile
One of the primary features of asset markets after the financial crisis has been volatility. Artificially low interest rates and global economic uncertainty have been the key reasons for the volatility exhibited by almost all asset classes.
In my opinion, the volatility will stay with sluggish economic growth and swift movement of money from one asset class to another. In particular, industrial commodities and energy prices will experience higher volatility.
For an investor, this is important to understand as trading in volatile markets can lead to significant capital erosion. Therefore, investors need to consider quality long-term investment options rather than looking to trade highly uncertain markets.
Suggested Investment Options
Prolonged sluggish growth would mean that policymakers would keep supporting the economy with more quantitative easing. Precious metals like gold (GLD) and silver (SLV) will do well in such an environment.
I also expect equity markets to do well and in relation to investing in gold, I will consider investment in gold miners. MSCI Global Gold Miners Fund (RING) and Market Vectors TR Gold Miners ETF (GDX) do look interesting from a long-term perspective.
As mentioned above, equities should do well with relatively better corporate sector performance and the government's commitment to support asset markets. Investment in the index (SPY) is a good option. For investors who believe that sideways markets might be the way forward, investing in high dividend yield stocks would be the suggestion. Few such stocks would be Johnson & Johnson (JNJ), BP plc (BP) and Eni SpA (E).
Investors have to live through volatility across all asset classes in the current investment environment. Also, prolonged sluggish economic growth leading to artificially low interest rates can punish savers. Therefore, being largely in cash will help only at times (when global sentiments are very bearish and the only asset class moving higher is the dollar). Investors need to diversify their investments in different asset classes and regions in order to retain their purchasing power.