Commodities at a Crossroads

Our CEO, Jack Rivkin, recently revisited his thus far prescient view of economic issues facing “The Rest of the Americas.” There are several key drivers one should pay attention to when evaluating the Americas, most of which ultimately lead to the commodity markets.

From the Fed’s decision on interest rates (which is highly data dependent), currencies, the dependence of Chinese demand for commodity exports out of Canada and Latin American countries, and nearly ubiquitous political disharmony, commodities are at an inflection point. Here is why:


US Economic Data and the Fed
April retail sales were up 1.3%. Job creation is improving and wages are starting to improve as well. Economic data is getting better, but it’s not necessarily good enough for the Fed to take action. What are the possible scenarios and impacts on commodities?

  • Good Data: If we continue to see decent economic data, it could spur the Fed to raise interest rates at the upcoming meeting in June. An increase in the Fed Funds rate generally leads to strength in the US dollar (USD) relative to other currencies. Conventional wisdom stipulates that a strong USD is typically a negative for commodity markets; the two are negatively correlated since commodities are priced in USD. If the USD strengthens, commodities tend to suffer because it will take more dollars to buy the commodities. While that’s been true the majority of the time, it’s not always the case as one can see below:


  • Great Data: That said, if the data out of the US is very positive—one could view this as a growth theme. In this case, the Fed will almost definitely raise rates in June; the USD will rise; but if the US is consuming more, spending more, and on an improved economic growth trajectory, that could spur increased demand, which could actually push commodity prices higher.
  • Bad Data: The last scenario is if the US data gets worse. We don’t think this is all that likely, but low inflation could make the Fed blink. Where we may see bad data is globally. With global markets more intertwined than ever, it would be bold for the Fed to ignore any further and significant global weakness. Moreover, the big Brexit vote shortly after the June Fed meeting could give Yellen pause, ultimately postponing a hike until July.


According to both the World Economic Forum and the Wall Street Journal (WSJ), in 2015, China consumed “roughly an eighth of the world’s oil, a quarter of its gold, almost a third of its cotton and up to a half of all the major base metals.” In addition, as Jack pointed out in his Perspectives piece, China also produces about half the major base metals. One cannot discuss commodities without discussing China.


All eyes are on Chinese growth to continue fueling this impressive demand. Chinese growth is less than it was in prior years but their growth target remains between 6.5%-7.5%. While momentum has slowed, 6.5%-7.5% is not insignificant. To give some obvious context, the U.S. economy grew 0.5% on an annualized basis for the first quarter of 2016.

As Chinese demand for and production of commodities vacillates and its growth moderates, we could see more idiosyncratic Chinese market movements. For example, during September of 2015, China’s National Administration provided new standards for the use of aluminum cables. Aluminum is significantly cheaper than copper and China is rich in aluminum resources—substituting aluminum for copper allows for lower costs and less importing. Prior to September of last year, copper and aluminum prices moved fairly closely together. Since this time, however, we’ve seen more dispersion, periods in which aluminum rallied and copper declined. Thus demand may be increasing right now for base metals, but one may continue to see more substitution versus base metals moving in concert.

The remainder of 2016 should be interesting. If China backs off stimulus or increases local production, it could spell trouble for commodities given their significant share of commodity consumption. We tend to agree with the team from Gavekal Research, who recently stated the following:



“Since GDP growth in 1Q16 remained above the 6.5% target, it seems likely
that policymakers will now focus more on averting a major bubble and
dialing back leverage, than adding fresh stimulus. This is not to say that
the central bank will cause another interbank liquidity crunch, but it will instead
focus on keeping rates low and stable. Hence, do not expect more easing
policies in the next 3-6 months; after accelerating for the last year credit growth
is likely to stabilize at the current level.”

Gavekal Research, Chen Long, The Daily—“No More Easing Likely,” May 15, 2016;


If this is true, we may not see more stimulus from the Chinese central bank. Yet, a complete economic slowdown followed by stunted commodity demand seems unlikely.

Political Unrest
With the exception of Trudeau’s white knight status in Canada, much of the rest of the Americas’ leadership remains on shaky ground. Democracy in its raw form is coming to the USA, Rouseff is on her way out of Brazil, while Mauricio Macri is still sorting out the pieces in Argentina—and he’ll be doing that for a long time. Any perceived weakness in leadership could be viewed by investors as a sign of a weak economy. This too matters because as faith in these governments declines, so may their currency as we witnessed several times last year. For example, one of Brazil’s largest exports is coffee. A weak Brazilian real led to lower coffee prices. In fleeting moments of real strength, coffee rallied alongside.

Fig3of3_Charts_Brazil Real+CoffeePrices_051916

For countries that rely heavily on commodities for exports, a weak currency is not necessarily a positive. Therefore the impact of political unrest on commodities could make for a bumpy ride, at least in the short-term.

Commodities Now?

One may ask, is this a good time to get into commodities? The reality is, it depends on what sector, what commodity, and when. The question also assumes that investors only have the option to go long commodities. Imagine if you could have been short crude oil over the last two years? Our preference is to invest in strategies that can go long and short, such as trend following managed futures strategies. These strategies are systematic in nature with the goal of following price trends. If gold continues to rally, trend following systems will likely add more and more long gold exposure. In fact, most managers we follow are positioned long after gold’s rally this year. If the trend abates, these systems will typically reduce exposure and if the trend reverses strongly, these systems will follow the price trend in the other direction. Investing in systematic trend following strategies allows for long and short investing while taking out the discretionary judgement of trying to time these often volatile markets.

Commodities are indeed at a crossroads with some dispersion likely. Much of what can move individual commodity markets for the remainder of 2016 remains to be seen, as various other cross currents make it difficult to predict. In other words, even if we get Fed clarity, China and other variables could remain uncertain. Investors may want to look for trend following managed futures strategies that have the ability to follow commodity markets directionally once the fog clears.

The Rest of the Americas: Reprise

We are continuing our review of what has happened since we laid out our expectations in our Perspectives at the beginning of the year. We had a view that one could find all manner of investment opportunities, long and short, without moving beyond the continents of the Americas. Given the volatility of the markets and the currency and commodity movements since then it is time to take a fresh look—particularly at the rest of the Americas. Below is a reprise of our expectations and our update of how the expectations have changed. Commodity and Currency movements as well as specific governance issues may cause a greater dispersion in results for the rest of the year.



The Rest of the Americas: Still some Economic Issues but an Improving Picture as One Moves from North to South 

Canada, in many ways, is a large natural resource company. Until the energy picture improves, there remain issues as a new and different government starts to grapple with the current environment. In addition, while the Canadian banks avoided much of the turbulence experienced in the US from the mortgage fiascos, their housing market has gotten somewhat extended from growth that occurred under the umbrella of high energy prices in the early part of this decade.

On the other hand, we see elements of reform and a better competitive environment globally in Mexico. Lower energy prices have slowed development and reform in this sector, but other sectors continue to move forward. This remains a good story of growth, reform and development.

Moving further south, if the project stays on schedule, by mid-year the expanded Panama Canal should be in operation with the ability to receive the Post-Panamax cargo ships that carry two to three times the previous loads that could make it through the canal. This will change patterns of traffic to the east and west coast ports of the US from East Asia, reduce transportation costs, and, most likely, produce a shift of traffic via the Suez Canal back to Panama. It could likely result in some increased infrastructure spending for some of the US ports as well as the supporting rail and truck traffic from these new patterns of shipping. An under-the-radar change that could have some unintended consequences positive and negative.

With the Argentina election leading to major change combined with elections in Venezuela and pressure on Brazil to change, the center of gravity on reform and a better investment environment in South America may be moving in the right direction. There is no question that the overall economic situation in South America is quite dependent on exports of hard and soft commodities. Until the commodity supply/demand picture improves, it may be difficult for the overall investment environment to improve significantly. We may be entering an environment where some prices are falling below operating breakeven. Let’s keep in mind, though, that energy is a big part of the cost of extraction and refining for most hard commodities. Miners and refiners will keep producing if there is a dollar contribution toward fixed costs. With the metals priced in dollars for the most part, the currency weakness many of these countries have seen is a further reduction in costs. It is possible as we get later into the year modest increases in demand combined with reductions in supply may shift the patterns. At the same time, it is highly unlikely that we will see major improvements in governance and economic results early in the year in these three countries mentioned. However, the tone has shifted. This is an opportunity for the US to affect the rate and quality of change in these three important South American countries with an impact on the whole continent.

While the change in our relations with Cuba gets media attention, a similar reaching out by the current administration to change relationships with the three countries is a real possibility. One will be able to find all of the varieties of investment opportunities within the Americas with similar risk characteristics as exist throughout the rest of the world. This is a slight overstatement, of course, but just saying…

One does have to be careful of what is going on with capital flows. The countries in South America are dependent on export growth primarily tied to commodities. While Argentina may be coming out the other side of its ability to access the capital markets, it is not clear that other countries can make it through this period without some degree of financial stress. But, the Americas represent an unusual somewhat isolated set of investment opportunities across the equity, fixed income, and fixed asset markets, both public and private.



Commodity Movements push much of the Americas to Unsustainable Levels—too Fast, too Soon

 Below are three bar charts showing returns in local currency and dollar-based YTD for most of the capital markets worldwide as well as a specific focus on the Americas and commodities.





In part, the commodity run has to do with the weakness of the dollar against many currencies. Gold and possibly other precious metals are primarily moving because of the dollar, but also because they can act as sources of real returns against an expectation of rising inflation, low interest rates, and, maybe low equity returns. Our expectation had been a likely shift occurring on the commodity front as we moved into the second half of the year. In part, this was based on a step-up by China on the fiscal side which would increase demand and prices for a variety of commodities as infrastructure and support of inventory building took place. It would appear that China has already started that process. Unfortunately, I think this could lead to some disappointment later as China backs away from this fiscal push, much as they did after the 2008-2009 debacle. China did keep things going with prices peaking in 2011. There has been some slowdown on the supply front, with much uncertainty about OPEC and Saudi Arabia, specifically regarding oil, but other supply slowdowns elsewhere including the fires that rage in the Canadian oil sands region. Of course, the rise in prices could reflect concern about the Cushing Fault—one of our cocktail conversation expectations. Even 60 Minutes is now talking about earthquakes in Oklahoma.

That aside, as we pointed out in our Perspectives piece, China is the biggest source of supply and demand in the hard commodities, and effectively, controls the markets. Higher prices may lead to bad economic decisions regarding maintaining or even increasing production in response to the prices. These increases will likely end when China stops supporting the price and/or the dollar begins strengthening as it becomes clearer that a recession is unlikely—slow growth, but growth, wage increases and hiring pushing up consumption but not necessarily profits. Last month, for example, total compensation for all those employed was actually up 0.7% March to April. That’s a pretty healthy annual rate.

So what does one do now? The Americas look a bit ahead of themselves. While we are seeing change in Latin America, there will be some major hurdles for the major countries on governance and fiscal budgets. Commodity prices could continue to provide a lift if what is going on in China continues. I think we will start seeing more dispersion in the results in Latin America as the year unfolds.

We have already indicated that we expect the slower growth of the global economy to produce dispersion among country and company results. Below are two tables that show what has happened in the US specifically by industry with the energy industry as a poster child.




This does require a broader and more specific look across more asset classes and more managers to take advantage of the dispersion and the spread we could likely see between the liquid markets and those with an ability to buy into less liquid sectors. The opportunity set is getting broader and requiring a real understanding of risk and a real understanding of liquidity requirements.

Lastly, so much of what I discussed depends on what happens here in the US as well. As my colleague, Lara Magnusen, recently pointed out in Bloomberg, any positive economic data out of the US may convince investors that the Fed will indeed raise rates at their next meeting. The knock on effect here is that you could see some real strength in the dollar, and thus reversals in commodity markets generally.[1] The rest of the Americas are thus dependent on a highly correlated set of variables affecting commodity markets, and, ultimately, the broader economic landscape.

[1], May 1, 2016, Gold Keeps Shining as Funds Miss Out on the Best Rally in Two Months

Beginning the Look Back at What We Expected for 2016 (and Beyond)

At the beginning of the year we wrote a Perspective on “What to Expect in 2016 (and Beyond).” There were several expectations of which many were not likely to play out until later in the year. For example, our views on commodities staying flat were based on dollar strength and China not beginning its full-fledged fiscal response to its growth until later this year. Dollar weakness and the steps China has taken already have pushed the timing up with gold being the poster child for this change along with the major industrial commodities. Stay tuned on this one. This could be temporary.

It is our plan to comment in “Outside the Boxes” on various of these expectations as differences unfold along with a complete review at mid-year. Below, is the first of these reviews.

This update, having to do with the Presidential race, was in our “…cocktail conversations…” section along with an earthquake prediction and a view on dietary habits and their impact on historically defensive stocks. While this would ordinarily be a part of cocktail hour, it is my view that what is happening in our electorate as witnessed by the Trump phenomenon, could reinforce elements of volatility and dispersion in the investment markets, particularly in a slow growth environment. The thoughts reference the markets, but also raise some questions about the 230-year experiment this country has been having with democracy.

The blog starts with a reprise of what we said at the beginning of the year followed by the “update.”
Worth paying attention.


The January 2016 Reprise

Screenshot of What to Expect in 2016 for 5-5-16 blog


The May 2016 Update


“I’m sentimental, if you know what I mean,
I love the country, but I can’t stand the scene.
And I’m neither left or right,
I’m just staying home tonight,
Getting lost in that hopeless little screen.
…I’m still holding up,
This little wild bouquet,
Democracy is coming to the USA.”

—Leonard Cohen  

Democracy lyrics © Sony/ATV Music Publishing LLC


The Winning Ticket 

It certainly looks like it will be Trump and somebody on the Republican ticket. It is still critical for the ticket to have the highest odds of winning Ohio and Florida. One would think that a reconciliation with Kasich would have been the answer. Hillary Clinton, the presumptive Democratic candidate, has to consider a similar logic. While history suggests that Vice Presidential candidates are selected more for their contribution subsequent to the election, this year could be different. It has certainly been a different primary season.


Democracy: Head, Heart or Gut

I started this update with the lines from one of Leonard Cohen’s many great songs, “Democracy.”
These thoughts express my sentiments pretty precisely. This may be one of the most democratic elections we have had in a long time. The constituencies have been motivated by non-establishment candidates on both sides to vote as they feel in terms of their innate fears and beliefs coming from the gut and the heart. This is in contrast to the more “enlightened” fears that would come from the head, calling for preservation of the system. This is what, historically, has been presented by the “Establishment.”

There have always been differences in the views between the two major parties of what really is important in the system, but the outcomes have been conventional and, ultimately, supportive of global commerce, finance, and an expanding role of government. In this election, the anti-establishment elements may end up determining what will appear to be a different path. Although, I would expect that the ultimate differences will not be long-lasting.

The historical evidence suggests this uncontrolled versus enlightened democracy was not envisioned by the forefathers of this 230 year experiment. Democracy in its raw form is coming to the USA.


Pay Attention

Nevertheless, the uncertainty that may come out of the conventions and then, the election outcome, combined with what will be a slow growth period globally will likely lead to continued volatility and wider dispersion in financial and investment results. This does require a fresh look at allocations and investment strategies for the near-term as well as the next several years.

A Flat Market Year-to-date

If one was fortunate enough to avoid the noise of the first three months of the year, one could point to a flat equity market for the year-to-date (YTD) with the 10-year treasury yield declining from 2.24% to 1.91% as the yield curve flattened. Most were not fortunate enough to avoid the noise and the liquidity trap that led to some selling at the wrong time and not much buying. The poor macro guys were making all kinds of bets, while the hedge funds tried to make the most of the dispersion amongst individual securities.

We have written about greater volatility and greater dispersion as a characteristic of a slow growth economy, which produces increased differentiation of earnings performance and a generally slower growth in overall equity performance. We believe this condition will be with us for some time to come as the global economy works its way through industrial overcapacity and the recession produced in the global industrial sector. In the meantime, service sectors around the world and disruptive information technology have been the primary source of jobs. Ultimately, IT will change the mix of talent needed. That is already showing up in the JOLTS reports with quits and job openings at high levels. While one can see the dispersion in individual stocks, we also see dispersion in the pace and the drivers of economic growth in both developed and developing markets. It is worth looking at the dispersion by industry within the US, and we have included a table showing what has happened YTD in the energy sector featuring the 10 best and worst performers year-to-date.


The US is, in our view, rightfully, on a path back toward normality led by Fed action without much fiscal help. Odds are if the economy continues to produce job growth and, ultimately, wage increases, we will see additional increases in the Fed funds rate this year (See Altegris Perspectives, “What to Expect in 2016 (And Beyond)” for some specific forecasts made as the year began on Fed rate hikes, oil prices, the markets, and a few other variables).

There are two variables at work, which would appear to be affecting the timing and magnitude of the Fed funds rate increases. One of them is bogus in my view, but the other one is a bit more troubling. The bogus element is the excuse of what is happening outside the US as a reason to both delay and reduce the likely Fed funds rate increases for this year. The second variable, which has not been made explicit, but, in my view, is a driver of the move away from being data-driven, has to do with the elections in November. The noise coming from both major parties—to the extent we still have two major parties—has, as a part of their message, been looking to what has really gone on at the Fed with finger-pointing blame for the rate of growth perceived to be lower than it should have been; and making sure that the next president makes it “right.”

There has always been a political consideration that the Fed has been required to acknowledge, even in Paul Volcker’s day. However, with the rhetoric coming from the candidates, I believe the Fed is taking a very cautious approach with a willingness to err on the side of not doing anything that could, in hindsight, be viewed as disrupting the growth path we are on. This likely means fewer increases than were originally anticipated this year and later in the year, unless the employment data forces the Fed’s hand. Our expectation as expressed in our Perspectives piece was for two increases this year. That is now appearing to be the general view (which likely means it’s wrong). If the general view proves to be wrong, I would think we would see more than two increases as opposed to a reduction. As I said in the Perspectives piece, the second half of the year may be very different from the first half—and that’s without the Cushing quake.

As long as we are dealing with unspoken strategies, one could take this even further into the world of strategic interlinkage of actions with an unexpected outcome: The lack of a Fed funds rate increase has had a negative impact on the dollar, and, along with some elements on the supply/demand front, has been a factor in pushing the WTI (Cushing) oil price up from a low of $26.68/barrel on January 20 to around $40/bbl now, while the spread has narrowed with Brent, which hit a low of $28.58/bbl on January 13, and is at the same price as WTI now. The $11/bbl increase in Brent is a huge benefit to Russia, which is pumping out a recent high of over 10.3 million barrels of oil a day. At the same time, the ruble has declined over the last two years relative to the dollar by 50% making every dollar received worth twice as much to the economy and reserves than it might otherwise. The sudden withdrawal of the Russian military’s support of the Syrian government, “mission accomplished” combined with noises about reaching some type of settlement desired by many of the significant Middle East oil producers seems coincident with the interesting move of oil prices off their lows. We will see how long these prices hold, but every day is a huge benefit to Mr. Putin, and some belief or hinted commitment that oil prices may stay a bit higher is reason enough to move toward being a part of a cease-fire and potential settlement. This is not a benefit to the US economy away from the oil and gas industry. It simply reinforces our view that growth will be slow and profit dispersion will be significant, and things happen in this world that are more complex than the pundits think. It continues to require a relook at allocations and a realistic view of what kind of returns one can expect from the traditional liquid markets overall for some time to come.

The dispersion will lead to moments in time when the value proposition is overwhelmingly positive. Those are the most difficult times to make the buy decisions as opposed to selling at the bottom. We have written and “webinared” before about the illiquidity premium that is available and may be necessary to achieve one’s financial goals, as well as the increasing value of pattern recognition as Moore’s Law continues to increase the ability of those who know how to use the technology to the benefit of their clients. We will continue to see these unusual volatile moves as we work our way through this long low return environment. It is a different investing environment.

In the short term, I still believe we need to PAY ATTENTION to the employment reports as a major factor for the Fed, the economy, and, most likely, the elections. We will be getting the March report this coming Friday.

As one can see from the table of historical seasonally-adjusted and not seasonally-adjusted employment numbers, February, March and April typically make up for the actual declines in the employment rolls in January. However, this January’s decline—larger than many of the previous Januaries—along with the numbers of late last year, seem to indicate a changing pattern that is not necessarily being picked up in the seasonally-adjusted numbers. If the make-up actually occurs in February through April, the seasonally-adjusted numbers could be explosive.

Fig2_TBL_Blog_OTM Change_Jan11-Feb16_032816

This will make for interesting media responses. Of more importance will be what is actually happening to wage and weekly payroll increases and what that means for total wages, including additions to the payrolls. This does get pretty technical, and the changing pattern could lead to just the opposite of what I am describing. The wage numbers will be of more importance to the Fed and will likely become the topic that could drive the Fed’s decisions on timing and magnitude of funds rate increases against the backdrop of an adversarial political environment. The confusion that comes with these seasonally-adjusted numbers will add to the volatility and uncertainty about what the Fed will actually do.

To some extent it is noise; to another extent it is a signal, reinforcing the view that we are in a different, slow growth environment that will call for some real decisions on asset allocations and the choices of strategies to meet one’s goals. We can help with some of those solutions. They are not blanket solutions that apply to all investors, but instead do require some real understanding of what an investor or her advisor is trying to achieve over a specific time frame.

A Tale of Two Stocks

A tale of two stocks and a tale of two investors that, we believe, demonstrate the sometimes illogical nature of perceptions and how those perceptions can drive valuation.

The stocks are BioMed Realty Trust (BMR) and Alexandria Real Estate Equities (ARE). They appear to be the only two companies currently focused on ownership of lab/life science space in the US. For the last two decades, they have had a duopoly in this real estate sector. Alexandria effectively gave birth to the industry in 1994, and Biomed’s executives (who were former Alexandria executives) later followed suit. For many institutional investors they were interchangeable, although, as one would expect, both companies would be keen to point out differences and advantages. While lab/life science is a niche, it is a relatively sizable one. Biomed, at the time of its purchase by Blackstone in January 2016, was valued at $8 billion and Alexandria is currently valued at about $10 billion.

The two investors in our tale are: the stock market at large and Blackstone; and the crux of the story essentially revolves around valuation perception of these two.

Blackstone purchased Biomed and the deal closed at the end of January this year (the deal was announced October 8, 2015). They paid $23.75/share, which was 103.6% of the last consensus estimate of net asset value (NAV) published by SNL Financial. The characteristics of the companies are duopolistic with a limited supply of new space, cluster markets (all US inventory of this type of space is in six markets), barriers to tenants moving out, and secular demand drivers. So Blackstone’s calculation that it was worthwhile to pay a slight premium for BioMed to enter the business was very logical, in our opinion.

Blackstone is currently among the largest buyers of real estate in the US, and, based on our experience (they purchased Excel Trust, a public shopping center company with whom I served as an independent director), we believe Blackstone is both sophisticated and thoughtful, thinks for the long-term, and is not prone to overreaction.

Flash forward to February 29, 2016 (the time of this writing) from last October when the BioMed deal was announced. As shown in the chart below, the remaining public company, Alexandria, is now trading at 76% of consensus NAV, which is approximately 1.6 standard deviations cheap. The market price of the shares have tracked closer to NAV more than 95% of the time over the last 10 years (the average valuation over the last 10 years—including the Great Recession—is 97% of NAV). Also, if we remove the Great Recession, the shares have never traded this cheaply. So Blackstone thought Biomed was worth 104% of NAV but the stock market thinks Alexandria was worth 76% of NAV. Between the two companies, in our opinion, Alexandria has the better portfolio as evidenced by the fact that Alexandria’s average same-store net operating income growth has been about 33% greater per year than BioMed’s for the past 10 years of reported data (40 quarters Q4-2005 to Q3-2015; the average annual same-store net operating income growth for ARE was 5.39% and BioMed was 4.06%). This makes no sense to us that Alexandria would trade about 28% cheaper than BioMed.

The public markets seem to have become caught up in a hailstorm of short-term, confusing and frequently false data reads. China, the Fed, interest rates, et cetera, have caused a significant disconnect in public market perception. Given the discrepancies between what Blackstone thinks about value and what the market seems to think, we think Blackstone is more likely correct.

ARE Market Price/Estimated NAV per Share
February 28, 2006 – February 29, 2016

In the last 10 years, 95% of the time, shares have traded above Feb 29th’s price to net asset value.


Source: SNL Financial


The opinions expressed reflect the views of American Assets Capital Advisers, LLC’s (“AACA”) and not the views of Altegris. The information provided is not a complete analysis of the market, industry, sector, or securities discussed. While the statements reflect the author’s good faith beliefs, assumptions and expectations, they are not guarantees of future or actual performance. Furthermore, AACA disclaims any obligation to publicly update or revise any statement to reflect changes in underlying assumptions or factors, or new information, data or methods, future events or other changes.

The author’s assessment of a particular security is not intended as research. This commentary and the information contained herein, is not, and does not constitute, directly or indirectly, a public or retail offer to buy or sell, or a public or retail solicitation of an offer to buy or sell, any fund, units or shares of any fund, security or other instrument, or to participate in any investment strategy. All data in this document, including that used to compile performance, is obtained from sources believed to be reliable but is unaudited and not guaranteed as to accuracy. The performance data cited represents past performance, which does not guarantee future results. The securities discussed are for illustrative purposes only and do not represent all of the securities purchased, sold or recommended for advisory clients. The reader should not assume that any securities discussed were or will be profitable.

Markets are Macro Right Now, but the Details Don’t Support Those Bets

Just a few observations:


I was waiting for the numbers this morning. As one can see, the US consumer seems to be doing just fine. They are actually buying real goods and services, taking advantage of increased income, transportation costs are down, and there is a generally okay outlook.

I think we are seeing some major macro bets being made and pressed, which is pushing up volatility. The big macro bet seems to be that we are heading toward a global recession. I just don’t see it at this stage. We are clearly in a global industrial recession already with oversupply relative to demand and an inability or unwillingness of countries to spend on infrastructure as an offset to the lack of corporate expansion. But this is in a global economy that is more and more services oriented of which the US is a poster child and China is on an accelerating path in that direction. China may also be one of the few countries that has a major infrastructure initiative around the Silk Road.

In addition, as I have said before, given the low prices of oil and other commodities, I believe we are seeing liquidations of sovereign wealth portfolios from those countries dependent on revenues from these commodities, in order to meet fiscal budgets. Oil prices at these levels are not a company problem away from the oil patch, but they are a country problem, which will add to volatility globally.  The volatility is actually opening up some very interesting investment opportunities for those investment managers who actually look at individual companies on both the credit side and the equity side. When we get into these slow growth, but volatile periods, we begin seeing real dispersion. Look at last year: 250 of the S&P 500 stocks up on average 18% and 254 down on average 17%. I suspect we will see the same this year and for many years to come as we work our way out of the overcapacity on the industrial side and the heavy debt burden that has been accrued during this low interest rate environment. WE have started off this year with less dispersion. Anytime you see the market move up or down in double digits you do get less dispersion, although it doesn’t totally disappear. There are close to 100 stocks up this year—even 25% of the energy stocks.  It’s a different environment and we are somewhat captive to a very heavy bet being made that the world is collapsing. I don’t think that is the case.



This is a very thin market and therefore, should show greater volatility than broader markets. The Chinese have tried to manage the market similar to the Limit Up/Limit Down rules that we have on our markets, but theirs is much smaller and can expect to see high volatility given the lack of transparency. I think the Chinese stock market is a side show; what is actually going on in their economy is not. China is on a path to slower growth. The mechanics are complex, but the objective is achieving a high enough level of employment against a decline in the savings rate, which by itself, should be a stimulant for growth. The rest of the world, which has been dependent on this high rate of growth, will have to adjust. That is what we are going through now globally. This is complex and my level of knowledge (frankly, most people’s level of knowledge) is very superficial. It is an important driver for the global economy, but folks cannot count on it being the super driver and it is not the only one.


A Side Comment

I don’t quite get Janet Yellen’s remarks regarding the “surprise” low oil prices and how low negative rates have gotten in Europe. I also do not understand her giving any weight to the possibility of the US moving to negative rates. This is not good for the markets. We are in a slow growth environment that could go on for a long time, and without much fiscal help, the Fed has managed to get the employment numbers back up to a decent level. We need to get into the spring to really see how the numbers look given the bizarre seasonal adjustments that take place in December and January. I am looking forward to the spring. It might take a little longer for us to understand exactly where we are, but I don’t see us in a bad spot. I think the second half of the year could be very different from the first half if we can get the macro bets under control. We just have to Pay Attention.



High yield: Opportunity amid the carnage?

High yield debt sure does look scary today. After recording its worst annual performance in a non-recession year during 2015, it realized another milestone earlier this year. The asset class, as measured by the Barclays US High Yield Index, reached its third largest drawdown in history, matching its performance during the 2001-2002 recession. Only the losses in 2008 and 1990 have been larger when compared to the recent period.

Given the steep declines, should investors brace themselves for further losses and liquidate their high yield portfolio en masse? In short, we think not. In fact, we believe this is the best time since early 2009 to be a selective investor in short-duration high yield bonds. Prices have overshot fundamentals in most sectors, and it is precisely these overreactions that sow the seeds for the potential to outperform in the future.

Three key reasons underpin our view:


  1. This is not 2008

Nearly a decade after the financial crisis, the scars of 2008 remain fresh in investors’ minds. Fears of another crisis have led many investors to run for the exits with little regard for fundamentals. The fact that high yield recently matched its third largest drawdown in history despite any hint of recession or material change to the default rate environment underscores today’s disconnect between prices and fundamentals. Moreover, the conditions that drove the 2008 crisis—highly leveraged financial institutions and a faltering economy—are not present today.

Financial regulation has resulted in much stronger balance sheets across the financial system, and we believe the risk of a recession is low as job growth continues apace and the services sector—which accounts for 80% of the US economy—has been growing solidly.


  1. Current yields compensate the patient investor, even if spreads widen further

For the first time in several years, the math of owning high yield bonds is strongly in the investor’s favor. Why? Both spreads and current yields have increased to multi-year highs and adequately compensate investors to take credit risk at today’s price levels. Annual coupon payments now average nearly 8%[1] at the index level, and bond prices have declined from over par in mid-2015 to 85 in early 2016.

Investors now have the potential for both income generation and capital appreciation over the coming year for the first time since 2011. In the event that the “risk-off” sentiment continues over the near-term and credit spreads widen another 2%, investors could still realize positive returns over the next year based on today’s yield levels, and that may help to provide a relative cushion in the event that prices continue to decline.

[1] Source: Barclays




  1. Look beyond the indices

As we enter the late stages of the credit cycle, sector and security selection now take center stage. In today’s market environment, avoiding the losers is paramount to picking the winners. Index investors are likely at a disadvantage because they assume concentrated exposures to the sectors that have issued the most debt—telecom in 2000 and energy in more recent years, for example—which may be a formula for future underperformance.

Investors that take an active, security-focused approach with a sharp focus on sector and company-specific fundamentals have the ability to identify idiosyncratic risks and opportunities—and therefore may benefit from the price noise—in what is likely to be an increasingly unstable environment ahead.

While caution is needed in this volatile environment, we believe there are outstanding risk-adjusted investment opportunities present in today’s markets. Why now, and not after default rates have spiked? Investors should note the cautionary tale of 2009: default rates peaked at 10.3%, while the ML High Yield Index returned 57.5% that year and 15.2% in 2010. So instead of waiting for the “all clear” signal—which may likely coincide with lower potential returns—investors that have been underweight high yield debt should consider increasing their allocations to the sector today.