Is This the End?
The markets are set to open Thursday under significant distress, following a 150 point drop in the Dow yesterday. Commodities continue to be in free fall, especially crude oil which sits at $41 per barrel, a low not seen since the financial crisis. The Dow is now down about 3% on the year and the S&P is right around the even mark if not slightly down. More significant than where the total index lies, though, is this painful reality: 252 of the 500 stocks in the S&P are already down over 10% from their highs; and 120 of them are down over 20%. Yes, we are not yet at that technical “correction”, but functionally it is already happening.
The common question we face in times of turmoil is, “Where will the bottom be?” The answer is, “We do not know.” The follow-up question is, “What’s your guess?” The answer is, “We don’t believe in guesswork.” The response to the sigh that those two answers generate is for us to proactively say, “We are blessed with not needing to know exactly where the bottom will be, because we are generating an investment outcome that is agnostic about these types of things.” As a broad macro consideration which is applicable to how we allocate client capital, we have a point of view about global markets. Our points of consideration are:
1) U.S. economic growth is positive but tepid, as it has been for several years, and barring any surprises is likely to remain as such. This means we do not believe impressive 3.5% growth is coming, and it means we do not believe negative growth – actual recessionary contractions are forthcoming. The tepid, lukewarm, chug-along economy we forecast is a by-product of what we believe to be uncertainty in monetary policy, low growth fiscal policy, excessive regulation, and missed opportunities in national energy policy.
2) Global economic growth is slower than U.S. economic growth – the growth we just called “tepid” in paragraph #1. We see Europe as a 0% growth zone, and China as a 5-6% growth zone where 7%+ has been the norm. Many emerging markets not run by Communists or incompetents offer better growth but those rates of growth are declining at present (particularly where such growth was dependent on commodity prices). Japan is a zero or even negative growth zone. In other words, we do not see a global recession, but we see very little international growth to excite us in the very short term. To the extent certain emerging economies offer better than average growth, and simply face short-term headwinds around: a) Currency, and b) Sentiment, we are extremely happy to continue investing here and accept short-term volatility for the sake of the longer term result.
3) We do not believe the Fed will hike rates in September and we do not think it will matter much. We expect slow, coddling activity from the Fed which is boxed in by a rising dollar which is doing its tightening for it. Additionally, the Fed has committed itself to a path (in error, in our opinion) that says, “We want to create 2% inflation.” Essentially, the fact that this inflation has not (yet) surfaced indicates to us their far, far greater fear (deflation) will continue to win out. When pressed with the risks that inflation legitimately represent vs. the risks that deflation legitimately represent, central banks will always, always, always choose the side of deflation as the fear they feel most culpable to address.
4) We are already in a balanced, somewhat “neutral” allocation positioning, and do not yet plan to change that. A recovery or sentiment reversal of note (to the upside) may cause us to become slightly more conservative, and a further drop in markets (5% more downside in the S&P 500) would likely cause us to increase risk assets, but overall we think our present allocations represent an appropriate positioning for these volatile times.
5) Oil prices are very important right now. Markets are pricing in all the negativity in the world, and crude oil may very well break $40 soon enough. I cannot emphasize enough how one-sided this trade is: All the money is on a strong dollar, weak oil viewpoint. We feel that when Mr. Market tilts the other way it will happen with force and speed and violence. We do not want to invest with the crowd. Our viewpoint is not one of, “If the Saudis capitulate … ” but rather, “When the Saudis capitulate … ” We have no idea when that may be, but our viewpoint is that oil prices belong in the $60-75 range within the next year, and the investment implications of that are substantial.
We are watching oil prices. We are tactically maximizing the opportunity in MLP space. We are prepared for an increase in the present negative sentiment that is ruling the day. And we are convinced that this is a transitory period ruled more by sentiment than fundamentals. Investors are wise to focus on the only things that have ever mattered to a successful portfolio outcome: The avoidance of big mistakes.