Market Perceptive for August 23rd, 2018
Famous hedge fund investor Stanley Druckenmiller is known for his assertion that it is liquidity that moves markets, not earnings. If that is the case, the current debacle in Turkey should be watched carefully. Turkish President Erdogan’s efforts to control rising inflation have blown up in his face. The Turkish lira has declined sharply over the past two weeks. Whenever you see major losses like this, you should ask yourself “who else is exposed?” Obviously Turkish consumers are hurt by a plunging currency because that will lead to soaring inflation on anything that needs to be imported. Turkish businesses that borrowed in dollars (most of them) are going to have a hard time. German and Italian banks, which are the biggest lenders to Turkey, are also understandably having a very difficult time. The currencies of other emerging market and frontier market countries continue to be hurt because in a crisis, investors tend to prefer the U.S. dollar and the Japanese yen. Even other developed markets have been losing ground over the past few weeks. Despite stabilizing over the past three trading days, we are not out of the woods yet. All eyes are on the Federal Reserve which has repeatedly signaled its intention to raise rates in September. This may very well spark a renewed run in the dollar and out of more vulnerable markets.
So far, the U.S. has by-and-large avoided the contagion that has engulfed most of the rest of the investment world. I cannot predict how long investors will continue to shift assets to the U.S.; I can only say that in the short term it makes sense from a tactical standpoint as both technical and fundamental trends are supportive. Valuations are not, of course, but valuation has never been a good timing tool. You may want to own emerging markets because they are currently priced to return much more than domestic stocks over the longer term, but you have to deal with the fact that every day other advisors and investors are throwing in the towel, depressing your share price. How much pain (underperformance) are you willing to withstand?
I would always rather buy an inexpensive asset with momentum than an expensive asset with momentum, so if I can offer any good news from a valuation/regression-to-the-mean standpoint, it is that growth, with its heavy tilt toward technology, has cooled off a bit lately. Investors have been willing to look at more cyclically driven shares this month, including industrials, transportation, and retailing. On the more defensive side, pharma and real estate are doing better. I feel much better about investing today (at less than 1% below January’s all-time high) knowing there are other pockets of strength outside big tech. I believe the S&P 500 will break the January high this week, for what it’s worth. There is still so much liquidity out there, and it continues to look for a place in U.S. stock and bond markets. That said, I expect a pullback in September because it is a traditionally weak month and there will probably be jitters around the Fed and the midterm elections.
Jeffrey Gundlach of Doubleline recently articulated that there is too much money shorting long-term treasury bonds. I agree. Whenever there is a big speculative imbalance, something has to give. The short speculators in gold were recently proven right, but I agree with Jeffrey that the logic in the case of long bonds is flawed. The Fed can raise short term rates to a point where the yield curve inverts because inflation is still largely contained and because an inversion isn’t as predictive as it was in the days before massive central bank intervention. If you are a bank in Germany or Italy right now and you are concerned about your balance sheet, the 3% you can earn on a 30-year T-Bond is AAA-rated, yields much than 30-year European sovereign debt, and is likely to appreciate (at least near term) versus the euro. I believe demand is going to keep long rates under control unless our economy slows dramatically (and I don’t see that happening in 2018).
This is a good time to remember that when you invest with the American Funds family, your equity funds typically have more international exposure than their peers. Growth Fund of America has 13.3% in foreign stocks, almost exactly double that of large cap growth competitor T. Rowe Price Blue Chip Growth. Not a judgement on either fund, just a heads up for those that might be interested in their total foreign exposure.
The strength in the economy has really helped high yield municipal bonds outperform higher grade munis. The latter offers more inflation risk and less credit risk, but credit has been surprisingly strong this year so investors have been generally rewarded for taking that risk. I believe that will continue.
Mairs and Power, a St. Paul Minnesota based investment management firm focusing on companies in the upper Midwest, got stomped by their peers over the last several years due to their overweight in industrial firms (which are more prevalent in this part of the country). The Growth fund (MPGFX) is putting up some category topping numbers this quarter.[i]
Lastly, you may consider hedging some international exposure by using IHDG (Wisdom Tree Hedged Quality Dividend Growth ETF) in place of a non-hedged international ETF (VEA or SPDW) or a blue chip foreign fund like Europacific Growth.
[i] Source: Morningstar Adviser Workstation
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