The Globalist and How to Best Play a Frothy Market

By Aline Wealth Management on October 28, 2016

I would like to introduce a friend of mine to you – a fellow who I will call “The Globalist” for he is a native of a EU (still part of the EU!) country and while he has lived in the states for decades has a well-worn passport and thinks very much globally.  The Globalist and I shared a lovely lunch recently overlooking Huntington Bay on Long Island’s North Shore, and over iced teas and sandwiches, discussed the interesting state –of –affairs we find ourselves in right now globally.

The Globalist feels that the world has a problem – a growth problem where global growth has fallen below its historical trend—from a long run growth rate of 3.4% to 2.1%.  This, he believes, can and will cause issues to come to light—issues in the political realm as a rise in populism is taking hold in nation’s around the world (i.e. Br-Exit).  Many investors have the false belief or comfort that monetary authorities and their agents could keep economies structurally efficient for an extended period of time; that the management of the business cycle essentially becomes the work of central bankers. That ever increasing levels of debt and leverage are sustainable indefinitely.  Italy is the next flash point says the Globalist with Renzi in a bit of a delicate situation with the banking crisis and a potential exit referendum.  The Eurozone needs to be more integrated with its own treasury and budget to serve as a fiscal authority as well as a monetary one.  My friend suggests as citizens around the globe begin to better rationalize these issues that uncertainty and volatility are likely to rise.

Consider:  that between 2008 and 2015, U.S. public debt swelled from $5.8 trillion to $13.1 trillion, yet Uncle Sam’s interest payments actually shrank over that time, from $253 billion to $223 billion, note Laurence Siegel of the CFA Institute Research Foundation and Stephen Sexauer of the San Diego County Employees Retirement Association. Yes, controlling a central bank can prove very convenient.  However, while depressed rates let corporations borrow freely, individuals may feel compelled to save more just to afford the same retirement, notes Deutsche. Low rates boost housing, but they do so at the expense of other sectors, like banking, where weak profits weaken the resolve to lend. Then there’s that old saw that low rates are good for market confidence. Well, look around you now: Stocks are at record highs and rates are lower for longer. How confident do you feel? 

On the debt side—the diagram below should give you (as it has me) some pause.  Debt is increasing!  That is worrisome on many fronts and plays into this notion of a “secular stagnation” for our economy. 

Valuations –what you pay when you enter into an investment—has been proven time and again to be the most important determinant of investment success. The table below speaks to valuations—using the Shiller (Yale Professor and Nobel laureate) CAPE (cyclically adjusted PE) ratio – which is currently 25.5x—that suggests a future return glide path that is likely to be pretty challenging (hence our decision to be more tactical, flexible, nimble and opportunistic in our management of portfolios). 

However the biggest “Canary in the Coal mine” has to be the 30%+ outstanding global bonds that are now yielding negative rates:

From an investment management point of view,  I like the idea of maintaining a hefty amount of cash/dry powder (tactical allocation –NOT market timing!) – but then again that’s a lot of capital to have sitting idle.  So that begs the question: With stocks and bonds at highs where can a value minded investor find opportunities?  Answer:  Very few places—need to do some heavy lifting in the analysis area and dig, dig, dig. We believe that we have found a few ideas (happy to share them, in detail,  with you in a one-on-one discussion).  Though just get you thinking consider the following two themes:

Market Neutral Funds— these are solid funds that have low correlations with equity and bond markets.  A fixed income proxy in my view – a place to hide—steady Eddie kind of investing.

 Value style investing – as the graph below indicates, the value style of investing has been losing to growth/momentum for a while now—we believe value is overdue for a long lasting rally (plus by their very nature, value stocks have greater margins of safety).

Enjoy the weekend and know that we are here for you – to review your comprehensive wealth management plan, to review your portfolio or to discuss interesting investment theses going forward.

PS  Please see the following article from the Economist that speaks about the current global economy.

http://www.economist.com/news/business/21702492-investors-may-be-too-sanguine-populism-and-profits