I have written for weeks that there was too much bearishness in the marketplace and cash on the sidelines; that Brexit would NOT be the big negative assumed by everyone; that economic growth was on the horizon; that second quarter and full year earnings would beat expectations and that markets were statistically undervalued. The financial markets continued to vex the pundits last week rising on a wall of worry hitting major new highs while the bond market, an indication of risk off, fell. Did you happen to notice the Japanese and European bourses, including London? Up, up and up!
So what happened to turn the glass from half empty to mostly full? First it was the vote in Japan giving Prime Minister Abe a larger majority and a green light for more fiscal and monetary stimulus; second it was the continued positive reaction to the June U.S. employment data; third it was a change in leadership in Britain and the belief that an agreement between England and the ECB would occur amicably being beneficial to both sides (even my former partner, George Soros, is more sanguine about the Brexit outcome now); fourth, Alcoa's earnings which was a huge beat combined with optimistic comments by Klaus Kleinfeld, its chairman, that global growth is accelerating; fifth, the U.S economic data points showed an improving trend; and sixth the surprisingly strong earnings out of the banks despite such low interest rates and a relatively flat yield curve.
The market has a way of fooling the consensus and affords little opportunity; i.e, time, to adjust your capital allocation and investment selection once it turns. It was fitting that materials and cyclical stocks led the way last week while utilities and bonds lagged dramatically.
We hit it right and our performance was twice the market this past week as we continue to significantly outperform all indices for the year. Our advantage is that we look forward-not in the rear view mirror as done by most pundits and investors. Did you happen to listen to Cramer last week? He is now bullish and pro-growth. Funny-he was not that way the week before!
We maintain our global perspective and a systematic approach reviewing all variables and their impact on all countries and all markets. We are very much like chess players looking two or three moves down the board but cognizant on the next one. We understand all markets and all asset classes. What I am trying to say is there is a huge difference between asset managers and it begins with management.
The week ended with tragic news out of Nice and an attempted coup in Turkey. We live in a VUCA world and must always be on the alert for the unexpected possibility of these types of events. That is why maintaining excess liquidity and having risk controls is a necessity at all times. Fortunately, we sold some futures Thursday afternoon to reduce our net exposure, which had gained so much this past week.
Our hearts are in solidarity with our French global citizens as well as the families of those killed or injured in this tragedy.
So what are we watching?
Naturally we are watching earnings season very closely and will listen to as many quarterly conference call as possible and/or read their transcripts. I'd rather hear what is happening real time in the world from those on the front lines rather than economists/pundits; second, I will pay close attention to both the Republican and Democratic platforms as their blueprints for running this country over the next four years; third, I will be listening closely to policy changes out of Japan and whether helicopter money is used; fifth, I will watch the first days of Theresa May's leadership as the new Prime Minister in Britain; sixth, I will see if any new policy changes are enacted in China in reaction to the second quarter GNP numbers and rising debt levels; and seventh, finally I will be looking at all economic, financial and regulatory data points in each major industrialized nation in the world.
So where do we currently stand?
Quite frankly I get nervous when our view becomes or is becoming the consensus. I tend to sell early, as I tend to buy early too. I aim for singles and doubles rarely waiting for that last tick. Hence I sold some futures this past week. Was it the right move? I doubt it as this market is unique. Never have I seen so much bearishness, so much cash and so equities so low as a percentage of portfolios at this point in time. Managers and investors face a dilemma....be wrong for the fourth year in a row or hedge their bets and commit some of their cash. I am betting on the latter which will lift the market big time. I might add that corporations bought in record levels of stock last quarter further reducing supply. Could this market blow off on the upside? Absolutely and I will sell as stocks become fully valued in my mind. I may sell early too as I did in 2008 but it has generally served my investors well. Rather than letting market psychology dictate my actions, it is my valuation work and perception of the future.
Stay the course for the moment.
While investing for change is one of my core beliefs, I also look for investable themes. Growth is one of them now therefore I have increased my cyclical exposure by adding to industrials, materials including energy, and financial stocks. Here again, I am choosing best in breed with superior managements, balance sheets and dividend yields. On the other side, I reduced my exposure to consumer nondurables and healthcare. It is difficult to short a rising market at it tends to lift everything therefore I will be shorting market futures as a hedge when desirable as our stock selection will outperform the averages.
So remember to review all the facts, step back and reflect, consider mindset changes, maintain excess liquidity at all times and control risk, do independent research on each investable idea and...
William A. Ehrman is managing partner at Paix et Prosperite LLC.