It is eye-opening to read the Market Perspective I wrote exactly two months ago. There was a real sense of dread back then as the global economy appeared moving toward recession while the Federal Reserve was still in tightening-to-fight-inflation mode. It is no surprise that December was such a poor month for investors given the near-term outlook at the time. Fortunately, the investment environment has changed considerably since then. The Federal Reserve backed away from its “autopilot” approach to interest rates while global economic indicators have been helped by lower oil prices and reasonably robust consumer demand. Rightly or wrongly, investors aren’t worrying about Brexit or the U.S.-China trade war right now. I can’t help wondering whether the pendulum will have swung back two months from now.
I say this because although the investment climate has gone from aggressively “risk-off” to fairly strongly “risk-on” over that past eight weeks, I’m not sure the big picture has changed all that much. The mental journey from (glass) half-empty to half-full (and vice versa) can happen quite rapidly. I believe it will be important this year to keep a big picture framework in mind so as not to tempted by market swings to rapidly toggle between aggressive and defensive portfolio positions. As we see it, the outlook is mixed with the following pros and cons:
- Interest rates are still fairly low by post WW2 standards, and there is current no significant upward pressure from either materials scarcity or labor (wages)
- Oil prices have come down worldwide, putting downward pressure on inflation
- The tax and regulatory framework in the United States is very business-friendly
- The Federal Reserve is still taking cues from the stock market, suggesting it will be pro-active in any serious market decline
- Valuations of emerging market and international developed market stocks appear to be, for the most part, quite reasonable
- The maximum point of easy credit has been passed. However slowly, credit is being reined in.
- The U.S. dollar remains strong, which removes liquidity from global economies
- Economic inequality globally is at post WW2 highs, and this is fueling populism. At some point, perhaps sooner than later, tax policies are going to be less business-friendly
- There does not appear to be a structural way out of the U.S.-China trade impasse. China can offer to buy soybeans, etc. but the bigger issue is intellectual property and China is extremely unlikely to give in on that issue. Its been the linchpin of their economic ascent over the last 35 years.
- Corporate debt levels are very high, which stems from the attractiveness of boosting earnings by borrowing money at low rates to buy back stock. This (higher debt and less cash) reduces flexibility during a recession. A corporate treasurer focused on the long-term health of their business would ISSUE stock when valuations were high, not buy it back!
With all this in mind, I intend to manage in what I believe is a neutral manner across portfolios as I don’t see any major valuation driven opportunities, long or short, to be exploited right now. That said, I believe:
- An opportunity will exist later in the year to buy non-dollar denominated securities as the dollar peaks and heads lower.
- Credit (lower quality, higher yielding debt) is doing well now as investors seek higher yields, but this is a window for traders (as opposed to a long-term alpha opportunity).
- Gold will have a good year. Not because of inflation, but because by year-end most currencies will appear unattractive because of debt and poor economic policies. The dollar would already be falling due to our dramatically increasing deficit and capricious policy stances were it not for the even worse prospects for the Euro.
I’ve been giving a lot of thought to why growth has out-performed value for such a long time. I’m going to expand on that topic in my next post.
-Mark A. Carlton, CFA
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