On Friday, June 26th, I was on Bloomberg Market Makers with Olivia Sterns and Pimm Fox to spend a few minutes talking about the news of the day and the markets. In a short period of time one tries to respond to some of the issues that may not have been covered or where the on-air personalities are looking for a little more color on previously discussed issues. As usual, the day before, the producers ask for a few thoughts on some topics that could be covered during the session. The questions for the day were Grexit—will it happen and what if it does; Brexit—lots of talk from Britain about leaving the Eurozone—could it happen; China and its tech stocks—is this market a bubble; and the US Markets—are we at the end. As you can see from the video, as is always the case, there isn’t enough time to go into all the topics, certainly not in depth. Below are the notes sent over on Thursday of last week on the various questions. This gives you some sense of the making of the sausage in preparation for the brief appearances on the screen. I admire the amount of work that goes into the creation of these brief segments, and the maintenance of coherence and continuity achieved by the folks in front of the camera for the full two hours. (I also appreciate the opportunity to wear the makeup all day). Appearances do matter (in a different sense of that expression), because they force one to crystallize immediate thoughts affecting the markets, much as our managers have to do every day. Some trends being reestablished and volatility can lead to opportunity.
Please read the notes on Grexit written for the moment of appearance, but I have some further thoughts, subsequent to Tsipras’ decision to put the idea to a referendum:
Depending on how the referendum is positioned, odds could favor a majority vote from the closet Eurozonistas to accept a form of what is proposed, stay inside the Zone and within the Euro. This can give Tsipras cover to cut a deal grudgingly acceptable to the various players including Germany. An unusual approach to reaching this goal, and it carries huge risks. For Tsipras to be pushing for a “No” vote really makes it a vote on his continuation in office. A “Yes” vote would likely lead to the forming of a new government. This next week, particularly with the banks closed, won’t come close to representing the end of the drama. Sartre must have had a vision of the Eurozone when he wrote “No Exit” in 1943. Garcin may be Greece. The door is open. Hell is other members of the Eurozone. We are somewhere near the end of this existential one-act play. And, we are all in it… Make sure you know your lines. Pay Attention to the cues. This is moving in various directions every moment.
The Friday Notes
Grexit: It is not to Germany’s benefit to have the Euro structure collapse. This has been a boon for the country in terms of employment and trade balances combined with cheap credit. So the most likely outcome is some extension of the problem with the first steps toward reform and some manner of debt forgiveness, either through major extensions of maturities or some defined workout period. Tsipras is popular within Greece and has fought the good fight, which politically puts him in a better place. If he’s smart he has already written his speech to the Greek populace about what he has achieved and where he has had to compromise to produce what is best for the majority of the people. On that path, I don’t think this will lead to political turmoil. The biggest risk is a continued run on the banks. If you had money in the banks why would you leave it there under any circumstance? To me the ultimate “solution” is a creation of a Northern and Southern Euro. This will have a negative impact on trade for the Northern countries as the NEuro would be stronger while the SEuro (or maybe the Franc) would be significantly weaker. This would take time, but the path would likely result in a weaker single currency until the two Euros are established. It would be interesting if we start to see trading in a when-issued SEuro and NEuro. I know this sounds far-fetched, but the situation we find ourselves in is a bit far-fetched as well.
Britain and the talk of exiting the EU, I don’t have any knowledge or thoughts on that. Just seems like talk.
China and technology, I have written a chapter in a new book on China edited and produced by John Mauldin and Worth Wray, “A Great Leap Forward?” My chapter is on Invention, Innovation and Implementation in China and its impact on the pace of technological change globally as well as in country. China is great on Invention. They have work to do on Innovation, and lots to do on Implementation. But we are seeing continuing signs of success. China is already filing more patents than either Japan or the US and soon they will be issuing more. They have created a legal system (heaven forbid!) for the defense of intellectual property. What’s interesting is only 15% of the patent lawsuits being filed are against non-Chinese companies. 85% are Chinese companies against Chinese companies. My view has always been that once a country has intellectual property to defend the pace of creation accelerates. China has almost 5 times our population. They most likely have an IQ distribution that is not different from the rest of the world. That means they actually have a population of very smart people—their top quartile—equal to more than the total population of the United States. We better watch out. Regarding their stock prices, particularly technology stocks, there are some specific factors that have led to very significant elements of speculation. I believe one should leave this market to the professionals. At the same time, they do have a domestic market for their technology significantly larger than anyone else’s, and a growing global market. I do see some shades of the dotcom boom with some differences. I actually ran a venture capital portfolio during that period and managed others doing the same. It was fun and amazing. And, at the end, if the valuations put on the companies accurately represented the present value of a future stream of revenues and profits, a small number of companies would have equaled the total GDP of the US in a measurable period. But, recognize that today we are dealing with technologies where processing speeds are more than 2000 times faster than they were at the end of the dotcom boom and the networking effect is similar. This is a revolution involving user bases multiples larger than that period: 413mm internet users in 2000 and 3,150mm today growing at 8 users per second. 214 Billion emails sent every day. 4 ¼ Billion Google searches every day. Are multiples really high for the ultimate winners? Maybe not, but one just has to figure out which are the winners, from which countries and deal with the fact that new disruptors are disrupting the old disruptors as we speak.
The US markets. Given the lower pace of top line growth, peak profit margins, the likelihood that credit will become more expensive, and the current multiples it is hard to optimistically put a growth on the stock market of more than 5-7% per annum, sort of in line with nominal GDP growth. If inflation stays low, 5-7% may prove to be high. 4-5% may be more like it. That means, on balance the equity markets will slowly grind their way up over the next decade and we will be talking about new highs. Yes, accidents can cause significant corrections, but probably not a bear market for awhile, unless we get way overvalued–which I don’t expect. In fixed income it’s another story. I don’t see the credit risk—yet–that Carl Icahn may see, but I do see rates rising, at least in North America. I think traditional fixed income is not necessarily the risk mitigator and return generator it has been for the last thirty years.
A further note: It doesn’t appear that the beta play on the stock market or a traditional weighting to the bond market are the ways to generate returns necessary for meeting one’s retirement or other family goals. One may have to look for active management, unconventional strategies and maybe some form of illiquidity premium to achieve those long-term goals. It is not clear that history is rhyming, much less repeating itself. Past performance is not indicative of future results. We continue to Pay Attention to the clues and cues as we work toward creating an Act II of this play. Where is Sartre when we need him?