Take One Step and Look Ahead

Lets discuss a curious disconnect inside the market’s logic right now.

The U.S. 10-year Treasury rate started 2014 at 3.0% and change. Right now, it is at a 2.2% rate and change. That’s an 80 basis-point fall. Along with that fall, in tandem, came a fall in stocks in 2014. Nobody called for a falling long rate this year in January. Nobody.

How can we make sense of this? Central banks look ahead, much like stock markets do. They set an interest rate knowing its real economic effects don’t hit until 12 months later, perhaps less, perhaps 6 months more.

But the point is this: Is this current GDP slowdown in Europe a feature of an overvalued euro, which followed from a relatively high 3% U.S. rate on the 10-year? Partly. Russia’s bellicosity hurt a lot. The rest seems to be an issue of Germany not wanting to let the purse strings out on its budget.

My problem with the deep stock market pessimism on a looming German recession is that a lack of fiscal spending also means, from a fiscal balance sheet perspective, the Germans have very little debt. If it comes to pass that Germany actually does have a private recession in 2015, there is no country better prepared to spend out of its public budget.

The way the Finance Minister of Germany thinks is that he is taking the slow torpor in today’s national income accounts as the price of national balance sheet prudence. The benefit of balance sheet prudence, at least in part, is the ability to spend out of his budget if necessary, down the road. He also likes the price stability implied by the low inflation rate that follows from running balanced budgets.

I think market participants should step back and ask what happens to an economy, even a European and German economy piled up with pessimism, when rates fall to historic lows.

That’s Macroeconomics 101. It means there is loads of excess liquidity, lots of refinancing, and a great incentive to invest, or pay down existing debts, public or private. Attached real activity stimulus from the public and private balance sheet re-positioning comes in 12 months or so. That means mid to late 2015 is going to be witness to private income growth from this year’s European rate stimulus.

Then there is a cheaper euro; then there is a cheaper price of oil.

If the stock markets take another step forward in time, and price this trifecta in, isn’t now the time to realize this?
Want the latest recommendations from Zacks Investment Research? Today, you can download 7 Best Stocks for the Next 30 Days. Click to get this free report

To read this article on Zacks.com click here.

Get all Zacks Research Reports and be alerted to fast-breaking buy and sell opportunities every trading day.