Saga of Financial Markets


Last updateSat, 29 Jul 2017 12am

Back You are here: Home Market Market Update Insight Why it is time to buy US equities on pull back?

Why it is time to buy US equities on pull back?

The Fed’s role is to ensure  price stability and full employment.  With unemployment rate of more than 9%, and five-year expectations for US inflation of below 1.5%, the Fed’s primary objective would be to reduce the unemployment rate.  As the inflation rate is low, it implied that the current economic climate might be perfect for the Fed to carry out a Phillipian experiment – the notion that higher levels of inflation can reduce unemployment.

According to William Phillips, an economist that published research on the relationship between unemployment and the rate of change of wages, in 1958 found that a burst of inflation brought higher nominal wages.  When nominal wages rose faster than producers increased prices, consumers felt wealthier.  The wealth effect spurred near-term consumption and higher nominal gross domestic product, leading to a decline in unemployment.

What does this mean?  This implied that as the Fed objective is to lower unemployment, the Fed is likely to leverage on Phillips-curve trade off, i.e. printing more monies with the launch of QE3.  The Fed had indicated QE3 is still possible if the economy weakens further and that the lunch of QE3 is likely to be in 2012.   Don't fight against the Fed - if the Fed wants a little more inflation so as to reduce the unemployment, it will get it one way or another.  The bottom line, with the rising tide of liquidity due to QE3, it will buoy asset prices such as US equities.

English: Relationship between the inflation ra...

English: Relationship between the inflation rate and the unemployment rate (Philips Curve) in the US 1960-1969. Data from the U.S. Bureau Of Labor Statistics. Each dot is one year. Français : Relation entre le taux d'inflation et le taux de chômage (courbe de Philips) aux Etats-Unis entre 1960 et 1969. Données du Bureau of Labor Statistics. Inflation et chômage en moyenne annuelle. Chaque point représente une année. (Photo credit: Wikipedia)

It is also worth noting that:

  1. Berkshire Hathaway as of September 2011, had invested $20bn of which $6.7bn in US stocks.  Buffet had also invested $8.7bn to acquire Lubrizol Corp and $5bn of preference shares of Bank of America.
  2. Despite all the negativity, weak confidence and volatility coming out of Europe, there has been pretty good resilience in consumption in October.
  3. Corporate earnings have continued to be strong, and high corporate profitability could provide one of the anchors for at least decent U.S. economic activity.  Also, there has been a recent drawdown in inventories, not just in the U.S., but globally as well, which may provide a potential catalyst for growth going forward.

Last but not least, Robin Griffiths, a technical analysts who tracks a variety of different cycles, placed most weight to four-year cycle (known as the US presidential cycle) and a longer 10-year that encompasses the modern phenomenon of start-of-decade recessions.  His view is that the equity markets, while still in a decade-long phase of multiple compression, are heading in the short term for a new peak early next year, followed by a sharp decline, possibly well towards their 2009 lows, in the middle of the year.  They will then surge to a new peak at the end of 2012, around the time of the US presidential election, when markets are traditionally strong.

As such, we believe that the next 6 to 12 months is a period where we should buy US equities on pull back.