Note March 13,2019: Contrary Core Developments – Contrary to our expectations for better balance, intense interplay remains between quantitative ease driven central bank policy and capital market activity. For instance and as often in this cycle, when concern builds on equities or elsewhere, major sovereign country benchmark fixed income yields decline, even flirting with zero or less in Europe and Japan. It is constructive that the major central banks appear cohesive, unlike famously in the late 1980s. Still and despite enormous collective and individual size, asset managers appear reluctant to counter central bank assumptions. It contrasts with late 1980s hedge funds versus monetary and fiscal policy and which in this cycle, does occur about individual company securities.
Softness in ongoing corrective checks and balances could make capital markets now especially vulnerable to external shocks. For instance even as global growth appears slowing to 3 ½% in annual GDP and dissonance more limited in monetary policy, it exists in fiscal policy, in global politics and trade relations. Political misunderstandings could arise. For instance and amid key trade talks, the U.S. President appeared to summon the leader of China to his Florida golf resort for a second time but went twice to Asia to only meet the North Korean leader. In Europe, issues amid elections are more entangled from Brexit to French yellow vests. Tight elections appear in India even as South Asian tensions rise. Levant tensions now stretch from Algeria to Iran amid Israeli elections.
Such market realities make diversification essential, including above benchmark cash and shorter duration fixed income to be supplemented by precious metals in asset and equity mix. Within underweight fixed income, in addition to shorter duration, we favor emphasis on high quality corporate paper. With practically universal heavy weightings in indices, developments in many financials underscore their crucial role for equities.
On core growth and defensiveness dependent on meeting business challenges, we favor Information Technology over Consumer Staples. These aspects also hold the U.S. markets in good stead compared to Europe, for instance. Despite recent prominence being given divestment of Energy, we overweight it. We recall that Energy majors were long attuned to managing business risk and prospering even when crude oil was mandated at $2.50-3/Bbl. for two decades to 1970.
The recent ECB funding proposals entitled Targeted Long Term Refinancing Operations (LTRO), the Federal Reserve signaling an interregnum in Fed Funds increases, the emphasis on monetary policy at the NPC of China as well as from indications as disparate as from the Bank of England amid Brexit, the Bank of Canada with weakening growth but overheated real estate and the Reserve Bank India amid both credit stress and now an election, central banks appear more in consonance on monetary policy than compared to the late 1980s when dissonance seemed to contribute to capital market stress. Clearing of inflation based assumptions after the 1970s, the restructurings of the rust bowls in advanced and emerging economies alike took time into the 1990s as did that subsequently savings and loans in the U.S., information technology and credit excess into the 2000s. Even for managed economies, market based businesses do depend on restructuring for rejuvenation. However and when looking at the massive continued quantitative ease of today, distortion of capital markets does remain of concern to us as a corollary of current monetary policy.
Lacking strong ongoing corrective checks and balances could make capital markets now especially vulnerable to external shocks were they to occur. For instance, while dissonance may be more limited in monetary policy, it is very much present in fiscal policy, in global politics and trade relations even as global growth appears slowing to 3 ½% in annual GDP. There has been the odd spectacle of the President of the United States being willing to travel twice to Asia to meet the leader of North Korea but appearing to want to summon the leader of China to his Florida golf resort a second time. Such differences could easily become a source of misunderstanding amid crucial trade talks and a slight in Asian sensibilities. In Europe, issues amid elections are more entangled from Brexit to French yellow vests. Even at this late hour of a March end deadline, a clear Brexit strategy seems absent in Britain. With European Union elections due in May 2019, the continuing French yellow vest protests underscore broader continent wide tensions about basic opportunities. Tight elections appear in India from mid-April to mid-May 2019. Meanwhile, South Asian tensions rise from Afghanistan amid talks with the Taliban to expanded shooting war fears over terrorism between India and Pakistan. Levant tensions now stretch from Algeria to Iran. A tense period has already developed in snap Israeli elections. They all appear in one way or another to the role of authoritarianism and the still unsettled issues of land division.
At best, fixed income and equity markets have seemed to be range bound over recent quarters and more specifically to be still in momentum driven probing in either direction. At this stage of the cycle, such capital market behavior signals indecision. We believe that these market realities make portfolio diversification to be essential at present, including above benchmark cash and shorter duration fixed income, supplemented by precious metals in asset and equity mix. Within underweight fixed income, in addition to preferring shorter durations, we would put more emphasis in holdings on high quality corporate paper. Spreads reflecting more stringent risk assessments did appear earlier on in late 2018/early 2019 but seem lesser currently with respect to lower quality or junk CCC corporate and emerging markets fixed income. Compared to alternates like U.S Treasuries, yields at close to zero for German Bunds and Japanese Government Bonds do raise the potential for heightened currency volatility even in the most liquid markets.
Within equities as the company reporting season tapers, market leadership appears U.S. driven. However, we regard S&P 500 P/E levels of 16x as hardly inexpensive. Thus, markets seem still momentum sensitive, irrespective of geography or sector. With their practically universal heavy weightings in equity indices worldwide, collective and individual developments for many financials underscore their crucial role in equity markets. From markets as disparate as Germany and India and even in the United States where the restructuring of the Financials was earliest, recent events demonstrate it to still be strong over a decade after the unveiling of credit crisis in 2007/8.
On core growth and defensiveness based on management skills in meeting business challenges as opposed to historical precedence, we favor Information Technology (especially software and hardware) over Consumer Staples. We see these aspects as holding the U.S. markets in good stead versus those of Europe, for instance. Last but not least and despite the recent prominence being given divestment of Energy, we overweight it. Energy majors were long attuned to prospering even when crude oil was mandated at $2.50-3/Bbl. for decades from 1948 to 1970 and to managing business risk. StrategeInvest’s independent consultancy operates as Subodh Kumar & Associates. The views represented are those of the analyst at the date noted. They do not represent investment advice for which the reader should consult their investment and/or tax advisers. Any hyperlinks are for information only and not represented as accurate. E.o.e.