Market Changes and Why

Cash reserves have been pared back, and monies have been redeployed into exchange-traded fund (ETF) strategies. There are several reasons.

  1. The geopolitical risk involving the Mosul Dam has declined. The US used air power and clearly had some very skilled forward observers on the ground, embedded with Kurdish troops. They were effective in displacing IS and preventing the detonation of explosives that would have blown the dam.
  2. The most recent reports show that inflation is subdued in the US and elsewhere. Energy prices are softening globally in response to a temporary respite from geopolitical risk. The risk is still there but is less dramatic.
  3. Housing sector reports are positive, and the trend seems intact.
  4. A market correction of 4% to 5% and not more seems to be confirmed. Risk premiums were selectively restored (high-yield bonds), and temporarily oversold positions reached extremes in some sectors.
  5. Expectations for the continuation of a benign and positive low-interest-rate Federal Reserve policy are emerging and, we expect, will be confirmed in Jackson Hole, WY. At the same time, European Central Bank President Mario Draghi will affirm his central bank’s policy stance that suggests very low interest rates for a very long time and a possible introduction of additional quantitative easing measures.

What this means is that the two largest central banks in the world, the Eurozone’s ECB and the US dollar zone’s Fed, will be at zero interest rates for at least another six months and maybe a year or longer.

There is no apparent inflation acceleration that would cause the Fed or ECB to act. The current data does not support tightening. At year-end, the Fed will be at neutral, and the ECB will be at neutral or easing. Add that the Bank of Japan appears to be preparing for another round of quantitative easing, and the outlook for continued global monetary ease remains intact.

The end result is that monetary stimulus worldwide remains positive. The markets have made substantial corrections. The US economy appears to continue its gradual recovery. It’s not robust, but it is improving and not slipping back into recession. For us that means that the upward bias in stock prices is intact.

We took a cash reserve position and cut back our market exposure on July 3 and again on July 16. Those moves were based on the perception of rising geopolitical risk both in Europe (Ukraine) and in the Persian Gulf and Middle East. The risks are still there. The beheading of reporter James Foley is a gruesome reminder.

What is different now is that there appears to be some movement in Europe among Ukraine, Germany (really the EU), and Russia towards an accommodation. A potentially positive ingredient is the relationship between Angela Merkel and Vladimir Putin. The outcomes remain to be seen.

In the Persian Gulf, the US has now become aggressive. It has introduced the use of air power and selective skilled combat boots on the ground. The White House has recognized that IS is a murderous foe of the US. It threatens every American, every American interest, every American facility, and every American ally worldwide. It appears the Obama White House is now ready to be aggressive in the attack on IS in the same way that it was aggressive in the attack on Osama bin Laden. That means that sharply honed American technology will be directed at strategic IS targets. That’s a good thing. Obama set aside criticism over “mission creep” and acted. Finally, we will not wait for the foe to fire the next shot, we can also shoot first. We expect a lot more precisely targeted firepower to be aimed at IS.

So, we are back into the markets with a nearly fully invested posture. We do not think markets are cheap. Fairly priced, perhaps, but not cheap. We think there is an upward bias in stock prices. The US economy is recovering at a gradually improving rate. As John Maynard Keynes said, “When things change, I change with them.”

On July 3 and 16 we built a cash reserve to be safe. It appears that amount of cash is too much to hold now that there is a little more clarity. That does not mean risk has gone away. Nimble strategies with ETFs can be accommodative on a very quick basis.

For today we are back in, but we are fully prepared to change rapidly if risk premia warrant such action.

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About David Kotok 42 Articles

Affiliation: Cumberland Advisors

David R. Kotok cofounded Cumberland Advisors in 1973 and has been its Chief Investment Officer since inception. He holds a B.S. in economics from The Wharton School of the University of Pennsylvania, an M.S. in organizational dynamics from The School of Arts and Sciences at the University of Pennsylvania, and a masters in philosophy from the University of Pennsylvania.

Mr. Kotok’s articles and financial market commentary have appeared in The New York Times, The Wall Street Journal, Barron's, and other publications. He is a frequent contributor to Bloomberg TV and radio, CNBC TV programs, Fox Business, Yahoo Finance and others.

Mr. Kotok currently serves as a Director and Program Chairman of the Global Interdependence Center (GIC) (, whose mission is to encourage the expansion of global dialogue and free trade in order to improve cooperation and understanding among nation states, with the goal of reducing international conflicts and improving worldwide living standards. Mr. Kotok chairs its Central Banking Series, and organized a five-continent dialogue held in Philadelphia, Paris, Zambia (Livingstone), Hanoi, Singapore, Prague, Capetown, Shanghai, Hong Kong, Rome, Milan, Tallinn, and Santiago, Chile. He has received the Global Citizen Award from GIC for his efforts.

Mr. Kotok is a member of the National Business Economics Issues Council (NBEIC), the National Association for Business Economics (NABE), serves on the Research Advisory Board of BCA Research, and is also a member of the Philadelphia Council for Business Economics (PCBE).

Mr. Kotok has served as a Commissioner of the Delaware River Port Authority (DRPA) and on the Treasury Transition Teams for New Jersey Governors Kean and Whitman. He has also served as a board member of the New Jersey Economic Development Authority and as Chairman of the New Jersey Casino Reinvestment Development Authority.

Mr. Kotok hosts an annual Maine fishing trip, where, it is rumored, most of the nation’s important financial and economic decisions are actually made.

Visit: Cumberland Advisors

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