What is Your Investment Philosophy Based On?
Do you want the global economies to improve, stagnate or decline?
What you choose has direct bearing on your asset allocation, regional exposure and specific investments. Step back to reflect on the facts and then, formulate a sustainable plan to invest that will earn a significant positive rate of return.
I have maintained a positive bias over the last eighteen months, making slight changes along the way to respond to minor shifts in my macro and micro economic outlooks. I combine a top down analysis with a bottom up approach. My investment process works. It has been time tested over 35 years in managing hedge funds and earning significant positive rates of return. I have done particularly well over the last eighteen months by looking through the up-and-down volatility and sticking to my guns, naturally making those slight changes, as needed.
Last week's blog, "The 10 Year Bond Yield Broke 2.20% --- Panic?" came out after U.S rates hit 2.27 percent last week. The stock markets here and abroad declined severely, rates were rising overseas, the dollar was especially weak against the euro and fear was everywhere. The key point was to put all of this in proper historical perspective: When have rates been this low and when has the dollar been this strong? Profits were at an all time high, the Fed deficit was at a multi-year low, capital and liquidity ratios were at highs, inflation was running well beneath 2.0%, etc.
I went on to say that it is a joke for the pundits to claim that the market, which has sold at an average multiple of 16 times over the last twenty years, is fairly to overly valued today selling at 18 times earnings when all the variables used to analyze multiples have improved so much. I also commented that the economies are range-bound with lower highs and higher lows. Putting all of this into perspective, I concluded that this remains a good time to invest, not trade, and those investors who cannot recognize change, like companies, would fall behind and fail.
We all know what happened over the remainder of the week. Economic stats weakened somewhat in the U.S., interest rates fell back to 2.15 percent, the dollar continued to weaken against the euro as the interest rate differential narrowed and the U.S stock markets hit an all-time high. Traders got whipsawed once again. There is a lesson here to be learned and something that we preach week after week. Invest, don't trade.
Now, let's see where we are and, more importantly, where we are going economically (top down) and how best to position your portfolios (bottoms up) to make money while controlling risk.
1. The majority of economic statistics reported in the United States last week were surprisingly weak, putting the strength of the spring snapback in question: Consumer sentiment fell to 88.6, the lowest level in 5 months; industrial production fell for the fifth straight month due almost entirely to weakness in the energy, mining and utility sectors; capacity utilization fell to 78.2 percent; the consumer comfort index declined for the fifth straight week; wholesale prices (PPI) fell 0.4 percent; retail sales continue below plan (Macy's and Kohl's) and were unchanged last month; business optimism is building; hiring plans are increasing; the Federal deficit fell dramatically; overall debt levels continued to improve; the fast-tracked trade bill is moving forward; economies overseas are improving; and the dollar fell further, boosting the outlook for exports. It is clear that second quarter GNP will not be as strong as previously anticipated but still will show a large improvement over the first quarter. The Fed is on hold until data points confirm sustained higher growth. Finally, overall corporate first-quarter reports continued to beat forecasts.
2. The spotlight is on Greece. It is unfortunate as it takes attention away from the bigger picture, which is that the European economies appear to be gaining more traction and the outlook for the remainder of the year continues to improve. The euro continued to gain last week as rates continued to increase in Europe while falling here. The euro finished the week at 1.145 to the dollar and the European stock markets, not surprisingly, were hit hard, impacted by rising rates and the higher euro. The outlook for the ECB and Greece to reach a sustainable, workable agreement remains in limbo. I still find it hard to believe that Tsipras can backtrack on his election promises to the Greek people to restore former cuts and maintain long term benefits. Both are budget breakers and run counter to former agreements between Greece and the ECB. It is hard for me not to believe that a Plan B is ready to go for Greece to exit the euro. Again, if Greece exits the euro now or in the future, expect an initial hit to the euro followed by a sharp move upwards. By the way, the financial system has the capital base to take the hit of writing down Greek debt, so don't worry about contagion.
3. The economic outlooks for China, India and Japan have not changed much, if at all, over the last week. Numbers seem to support that growth in China will fall between 6.5-7.0 percent, Japan at around 0.5-0.75 percent, and India around 7.5 percent. These countries will benefit tremendously from an acceleration of growth elsewhere, the decline in energy prices and by internal changes by their governments to build a strong foundation for their futures. Take particular note of Japan's current account surplus hitting a seven-year high and the premier of China ordering faster implementation of policy changes and local bank financing replacing shadow lending. All good for the longer term.
4. The Middle East and energy remain key areas of focus. I have stated in the past that American influence in the region was waning and that view was certainly reinforced by the Saudi king's refusal to attend a conference in Washington pertaining to the proposed nuclear agreement with Iran. Don't listen to what the spin may be in the media, just watch the actions of the rulers in the Middle East, which is not supportive of the U.S actions in the region. Oil prices stabilized last week at around $60 per barrel. I continue to believe that the price of oil will vacillate around this level, depending mostly on demand growth as production, especially shale oil producers, can ramp up quickly if prices increase much more from these levels. Expect a sharp, quick break in prices, if sanctions are reduced or removed against Iran permitting another 1.5 million or more barrels on the market.
When I step back after all the news, I conclude that things really have not changed that much in my overall economic and investment outlook. The key facts to chew on include global economic growth that is improving, albeit slowly by historical standards; low interest rates and inflation; high liquidity and capital ratios are high, reducing systemic risk; surprisingly strong corporate profits despite many headwinds; improving employment and wages; a Fed that is on hold while monetary authorities elsewhere are still easing; credit creation that exceeds the demand for money; a dollar that has corrected but will remain the currency of choice longer term and energy/industrial commodity prices that are stabilizing at low levels.
I can't over emphasize how deep a conservative bias permeates at every level: Governments cannot overspend and are reducing their deficits, corporations continue to reduce operating costs and leverage while increasing free cash flow; and individuals improve their financial position rather than overspending.
The backdrop for investing certainly has changed for the better. I would appreciate your comments about this and any of my blogs as it helps me review my facts and assumptions, reflect on the investment landscape, make sound capital allocation decisions and to search for the best investment ideas to earn the highest rate of return while minimizing and controlling risk.