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European Stocks at Seven Year Highs on ECB Quantitative Easing

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It’s true, foreign equity markets have rallied – the problem for US investors is that the strong dollar has eaten into returns earned in other currencies. For example the Euro Stoxx Index is up 7.5% ytd in euros, but is flat in dollars owing to depreciation in the euro. The euro has slid from $1.39 at the peak last year to only $1.12 today. I have said it before – time to take a European vacation!

The S&P 500 closed Friday at 2052, up 1.6% for the week and is now roughly flat for the year.

The 10 year Treasury yield was unchanged over the week at 1.80%. The yield on 10 year BBB rated US corporate bonds has fallen to 4.42%, its lowest level in 57 years.

Release the Kraken! Mario Draghi and the ECB surprised investors with a much bigger than expected QE bond buying package on Thursday which will be pretty much open ended until the ECB hits an inflation target of 2%. Inflation y/y (actually deflation!) in the Eurozone is -0.2%.

European stocks surged and the euro fell further (to an 11 year low) on prospects for lower rates – can they go any lower in Europe? It is not at all clear that this will be enough to revive the Eurozone economy which has long term structural/cultural/dependency problems. And then there is Greece…

Greek voters go to the polls this Sunday. The far-left Syriza party is in the lead and is promising a partial write-down of the country’s debt. In a sense the elections are a referendum on the “tough love” austerity measures currently in place to solve the European debt crisis. A win by Syriza would suggest that the way policymakers have dealt with this crisis is no longer acceptable politically and could foreshadow a Greek exit from the euro. Would others (Spain or Portugal) join Greece?

Gallup: On top of record-high unemployment (29%), Greece also had the lowest workforce participation rate for any EU country, at 53%. Across the entire adult population, only 37% were doing any kind of work in 2014.

Canada surprisingly cut its interest rates as well, which weakened the Canadian dollar. At some point the strong US dollar will hurt US manufacturing companies by making US goods more expensive on foreign markets.

ISI Evercore: “President Obama is proposing more tax increases for the richest Americans to pay for tax breaks for the middle class. They include raising the capital gains and dividend tax rates to 28%, hiking the estate tax, taxing college saving 529 plans, and imposing a 7 basis point fee on the liabilities of the largest financial institutions. This would bring in about $300 billion, and would fund new proposals including an expanded child-care tax credit, initiatives to expand paid parental leave and make community college free. These proposals are designed to support Obama’s “expanding middle class” rhetorical arguments.”

China’s 2014 gross domestic product expanded 7.4%, down from 7.7% growth a year earlier. Because China’s real GDP has doubled over the past seven years, +7.4% real GDP growth today generates a bigger unit increase than +14.2% did in 2007.

Moody’s has lowered Russia’s credit rating to Baa3, just one notch above junk status, citing the collapse of oil prices. The rating matches what S&P and Fitch have assigned already.

Next week we get another Federal Reserve FOMC meeting on Wednesday and Q4 GDP will be out Friday. It is expected to be solid at +3.2% but down from the scorching +5.0% in Q3.

Click here for our 2015 annual letter.

Have a great weekend everyone. Enjoy the snow!

Jeff Pantages, CFA®
Chief Investment Officer

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