Preparing for the Unemployment Numbers in December and January.

Don’t expect much help reading the economy or the markets or the Fed

The initial weekly claims data for the week ending December 26th showed a seasonally-adjusted increase of 20,000 from the previous week and raised the 4-week moving average by 4,500 to 277,000. The Department of Labor did note the instability of seasonal factors around the holidays. These numbers still suggest a tight labor market as we find ourselves with one of the lowest 4-week moving averages in history, certainly relative to the total labor population.


Reproduced with permission from Doug Short, PhD. Copyright 2015. Advisor Perspectives, Inc.

This coming Friday we will see what happens to the employment numbers for the month of December. More importantly, we will see what happens to hourly earnings and other measures of wages. I have already made the point that one has to take any forecast estimates for 2016 with a grain of salt. One will actually have to take the reported labor numbers for December and January with several grains of salt. “Grain of salt” is an appropriate expression for the labor statistics. The use of Pliny’s phrase regarding a seasoning to reduce the effect of poison or, in modern terms, to imply a bit of skepticism, has to do, for these months, with the seasonal adjustment factors. As the table below shows, the not-seasonally-adjusted numbers in December and January, have historically been negative. January, in particular, has been a big month for layoffs following the holiday season and general corporate timing on staffing decisions. The employment rolls go down by two-and-a-half to three million real people. The sizable negative numbers have typically produced a positive seasonally-adjusted number when the economy is not in free fall. We tend to focus on the seasonally-adjusted number making profound statements about the direction and degree of change. If someone can show me the consistency in the formulae to produce these seasonally-adjusted numbers, particularly given the impact of holidays and weather, I will be happy to remove a few of the grains of salt when discussing the data. As I have said before I have never met a seasonally-adjusted person.


Our focus will be on the wage data as we move through the year. The numbers for December may produce a reinforcement that wages are rising. The year-over-year numbers may have more value than the monthly changes. We believe this will be a focus for the Fed. However, given the issues around first quarter data, among other variables, it will likely lead to no further action on their part until well into the year. This should also be a focus for investors relative to expectations for corporate earnings and, possibly, inflation away from the impact of lower energy prices.

As I said, one has to take all of these numbers with a grain of salt, certainly until we get through what has so far been a mild but disruptively wet winter. We won’t get much help in figuring out what securities to buy from the macro data such as employment. This will be a year when focus on the micro becomes critical. Pay attention.

Employment Triggers a Green Light for a Fed Rate Hike, but…

It’s still a slow growth environment. Inflation is low. Investors can expect continued performance dispersion.

Employment is off the table for the Fed

As mentioned in our earlier video blog the November employment gain of 211,000 combined with the upward revisions totaling 35,000 for September and October certainly took the employment issue off the table as a showstopper for a Fed Funds target rate hike this month. There are very few categories where the actual unemployment rate is above the 5.0% rate for the overall workforce: teenagers at 15.7%, blacks at 9.4%, Hispanics at 6.4%, those with less than a high school diploma at 6.9%, those with only a high school diploma at 5.4%, and I would highlight mining at 8.5% (versus 2.8% a year ago). I would posit that these levels are not the responsibility of the Federal Reserve to deal with. And, what is going on in the mining sector, which includes oil and gas extraction, may have added to the employment roles in other categories as lower energy prices increased both consumption and most companies’ (ex-energy’s) profit margins. The November beige book and the latest JOLTS report point to a tighter labor market with increased difficulty filling jobs and quit rates high, which point toward an increase in wage rates. The Fed does have to look at a tight labor market and make some judgments regarding this ultimate impact on inflation and the pace at which its 2% target is achieved.

So what about inflation?

The Fed’s preferred measure of inflation is the core personal consumption expenditure (PCE) index. That index is up only 1.3% year-over-year and was actually flat month-over-month in October. The general belief is that the US inflation rate may stay lower longer given the expected slow pace of global economic growth, the strong dollar and continued technological innovation. One cannot ignore the tragic events in Paris and San Bernardino as having an impact—on the margin, of patterns of consumer spending and, possibly, levels. This is likely to keep the Fed on a very slow path of target rate increases extending the runway for slow but steady real and nominal growth. I think this path will be followed until inflation actually picks up. I have some views on the timing of this, which I have been saving for this year’s Perspectives piece “What to Expect in 2016 (and Beyond),” but will provide a preview in a separate blog as a wild card to watch for.

And what about the markets?

In turn, these economic and financial results will likely produce slow growth–matching nominal GDP–in the US stock market if valuations stay close to current levels.

The fixed income markets, on the surface, could also appear somewhat benign with a moderate increase in overall rates. No doubt, the slower pace of growth will produce specific credit issues—certainly in energy, but likely some other entities—but credit overall, may hold up reasonably well. The credit markets, at the moment, would appear to be pricing a broader disaster, particularly in the high yield markets. I think we will see some specific disasters—credit issues, but decent credit analysis can eliminate or reduce the impact. An actively managed portfolio in high yield could be a logical allocation to a portfolio.

Odds are some of the longer term trends in currency, commodities, and relative market performance will continue for awhile with some bumps along the way when markets misread central bank actions or statements (à la Draghi) or geopolitical events cause temporary disruptions.

So, how should one invest?

In the table below, which looks at performance of the S&P500 over the last several years, an interesting pattern emerges:

WEB_S&P-Dispersion_Chart_640px-wide_120715When the market has been up or down double digits all one really had to do was either own or sell the whole market. However, when we have experienced single digit performance for the overall market, much as we are seeing this year, there has been significantly greater dispersion among stocks. This is an environment we expect to continue for some time—slow nominal growth in the economy and the equity markets, leading to dispersion of performance tied to active company management and active investment management. Why do we expect slow nominal growth to persist for several years making active management more important? There are at least four reasons (and I am sure some others):

  1. As Eric Peters of One River Asset Management recently reminded us, when the Fed takes action, which is typically designed to reduce the magnitude of an economic decline or surge, it has an effect on future patterns of growth. Easing pulls growth forward, while tightening pushes growth out, reducing the depth of the valleys and the height of the peaks and the distortions in employment and inflation those produce. We have been through an extraordinary pulling forward of future growth and it will take time for us to return to normal.
  2. The debt burden incurred by sovereign nations has been and continues to be enormous. If nothing else this will affect fiscal policy as the tool it could be to add to growth opportunities.
  3. China’s transition from a global engine for industrial production and consumption to a more internally focused services economy, combined with the reversal of its own extraordinary steps to offset the impact of the western world recession—just look at the production and pricing of hard commodities beginning in 2009—will be a damper on global growth for the foreseeable future. This bears watching to see how closely the yuan continues to track the dollar, or if its inclusion by the IMF as a reserve currency leads to a tracking of a basket of currencies and a different interest rate regime.
  4. Without putting too much weight on it, the “Buffett Rule”—future equity growth is problematic for a number of years when the total market value of equities exceeds the value of GDP—is operative. I discussed this anecdotally in a recent post.

In a slower growth environment the likely dispersion of equity returns would push one away from index-hugging strategies toward active managers both long only and long/short managers. We have been suggesting this for a while. We would include private equity allocations in the active long only category if immediate liquidity is less of a need and the attractiveness of a potential illiquidity premium in a lower growth environment is magnified. We have these more active managers in our stable of funds, but others do as well. The key message is to adjust allocations to include more of these active strategies in the portfolio as one looks at the environment ahead.

In the fixed income space, while there is risk of rate volatility affecting all debt classes, as big a risk would appear to be more specific credit issues. Does that mean one should be moving up the credit curve? I think the answer is in part, “yes.” But, the preferred way to do that would be similar to the approach on equities: Look for active managers—not benchmark huggers—who are analyzing specific credits and taking advantage of the homogenization of yields that comes from index buying and selling. The high yield index is offering a fairly significant yield spread over treasuries—very tempting as a category. But, just remember that around 18% of that index is in energy and hard commodity bonds. As shown below, the rest of the index, while at lower yields, is at spreads we haven’t seen for almost three and a half years. Historically, in a different energy regime, the rest of the index used to trade at higher spreads than oil and metals.WEB_Metals+Energy_HYIndex_Chart_640px-wide_thru093015_120715

At this stage, I would rather have someone looking at individual securities making up a diversified portfolio where the detailed analyses show relatively lower credit risks in the environment we foresee. Who knows? There may even be some energy credits that are worth holding but have been tarred by association. We see that in our own portfolios. There are certainly some credits in both high yield and investment grade where the credit default swaps don’t fully reflect the degree of risk at this stage. I want managers who are running portfolios where they can tell me the precise nature of the balance sheets of their individual holdings and the risks associated with the businesses. This is different from what has been required previously.

One should not ignore the uncorrelated strategies, particularly systematic trend following. There are some long-term trends in place. While there are likely to be occasional reversals—some of which could turn into more permanent moves, I would rather use these managers to recognize the patterns and determine which foreign exchange, commodity, equity and fixed income indices should be included, negatively or positively, in the portfolio at any given moment in time given the environment we are facing.

Allocations need to change

It is hard to determine in isolation what the allocations in a specific portfolio should be. That requires a discussion. I know the allocations to active strategies should be higher. As I have been saying, past performance may not be the best guide for the future as opposed to a realization of a different pattern of future returns and an understanding of the volatilities and risks that exist in the environment we foresee. It is a less easy environment, with lower overall returns, but possibly a broader set of opportunities to meet one’s specific goals.


Paris, China, Russia and the Impact on Risk

The tragic events in Paris on Friday have not only raised the global risk levels of further terrorist actions, but will also produce behavioral changes geopolitically and locally. This will affect markets beginning now.

We are already seeing the pulling together of a more coordinated global action against ISIS by the western world. Europe, of course, may bear the brunt of change and would appear to be the most vulnerable to the impact of the increased risk levels on the broad economy, country politics, and societal reaction within the diverse elements of the population. Kim Wallace of RenMac made the observation this past weekend that 3% of the 7.3 billion people in the world are emigrating from developing countries to more developed environs. With the turmoil in the Middle East in particular, but also other closer areas, Europe, with a more open door policy—at least until now—is bearing the brunt of the disruptive emigration on its economies, its existing population and the social issues surrounding the clash of cultures.

In the meantime:

  • Russia is holding back from supporting what is likely to be a western world coordinated effort around ISIS, and will likely be a continued troublemaker relative to its own perceived interests.
  • The IMF staff is recommending the inclusion of the Renminbi in the basket of reserve currencies. The actual adoption or rejection occurs at the end of this month.
  • Commodities, including oil, have taken another downturn.
  • While US employment data looks reasonably strong, it certainly didn’t translate into strength in retailing.
  • The technicians don’t see much cause for recovery in the markets, at least through the data that was available through last Friday.
  • And, the probabilities regarding a Fed hike in December will likely move down.

There is much more that could be said regarding what has happened this past week and certainly opinions that could be expressed. I leave that to the op-ed contributors. It is hard enough trying to make sense about what this means for the markets. Let’s try to address some of the possibilities, starting with the effects on economies.

Almost all of these actions would tend to support a slowdown in activity in the euro region from a combination of the disruption caused by the terrorist action within Europe, the political dysfunction that may occur, and the actual reduction of incoming travel to the region. This is against a backdrop of the possibility that the decline in commodities is an indication of even slower global growth as opposed to simply an oversupply situation caused by the continued production of various hard commodities and oil as long as the operating economics provide cash flow to service debt and cover other costs. I have said this before, but it’s worth reiterating, that energy is a significant input cost to the extraction and refining of most hard commodities, as well as oil itself. As the breakeven drops, production can continue longer than one might expect. We recently discussed this point relative to the Bakken oil fields in North Dakota. We will need to look for other signals to determine whether this is a global growth problem or something more specific. The offset in Europe to the impact of the terrorist activity is the likelihood of continued, and possibly increased, QE or QE-like central banking activity as well as fiscal activity. In addition, the currencies of China and the US are likely to remain stronger than the euro as a result of the IMF action, and some signs of growth stability in China, combined with a possible flight of capital to the two large countries that are somewhat—I say somewhat—more isolated, with lower probability, from the possibility of terrorist action internally. Relatively speaking, these markets may do better for some period as a result of these flows and growth patterns than what we see from Europe. It specifically may hold down rates as money flows into US government securities. Ultimately, the euro currency weakness could begin to mollify that spread in performance.

So what does this say about the likelihood of a Fed move in December? I think that depends a lot on the November employment reports where the Fed will have another set of data before a decision is made. The October numbers were certainly robust as we have pointed out in some of our recent Altegris video and audio broadcasts. If there is actual evidence of a further global slowdown combined with weaker employment data—not our expectation—the Fed could delay. That puts them into next year with all of the uncertainties that entails. If the US numbers are good, combined with no significant deterioration globally, the odds are the Fed will pull the trigger and get started. The markets are to some extent reflecting this, although we will see what the Paris incidents do to the dollar, flows and, ultimately, market rates. As I have said, I don’t think December is a good time to change the rate picture—even modestly—while there are significant end-of-year activities around balance sheets and inventories of securities in the financial markets.

All of this reinforces our view that there will be increased dispersion within and among asset classes, combined with some financial accidents, away from a fluid geopolitical environment. Active management and less-correlated solutions are the likely better performers in the aforementioned economic climate that may be with us for some time to come. I don’t really have to ask, given recent events, for everyone to pay attention.

Employment, China and Other Fed Funds Factors—Redux

September or October or next year

Employment Numbers below Consensus, but…

 The first seasonally-adjusted employment number for August was well below consensus at 173,000, and well below where we would expect the revised numbers to end up for the month. On the positive side, the unemployment rate declined to 5.1%. Hourly wages are up 2.2% versus a year ago and rose 0.3% month-over-month. Average weekly earnings are up 2.49% from a year ago. The mixed news in the weekly earnings numbers was a rise of only 1.89% year-over-year for non-supervisory and production workers. Backing into the number for supervisory and more skilled labor, the weekly earnings increase appears to be closer to 5.5% year-over-year. That would indicate the pressure for more highly skilled workers may be pushing wages up faster among that segment of the labor force—wage inequality at work.

Employment numbers for June and July were revised up as shown in our “geek table”
below of the seasonally-adjusted and not-seasonally-adjusted numbers for this year
and last.

TBL_Blog_OTM Change_Jan14-Aug15_090915

We would expect to see further revisions up for the July and August numbers, but that will come after the September Fed meeting. I do have some concern that the not-seasonally-adjusted number for August is starting out lower than last year, while the seasonally-adjusted number is higher. As I have said before, I have yet to be able to understand the seasonal adjustment factors. That’s one reason why I refer to this as the “geek table.”

The Overall Employment Picture could Support a Rate Move, but…

The employment picture by itself could support a Fed funds rate move in September or certainly October. However, market turmoil, China, the dollar, and the lack of inflation provide an excuse to delay a rate rise. It is our view that if there is no rate rise in September or October, we will likely not see a rate rise until early 2016. While the futures number and pundits put higher odds on a December increase, let’s remember that December is a month of significant rebalancing of cash positions among financial institutions and corporations. The last thing the market needs is another variable such as a change in the Fed funds rate target thrown into the mix. A change in the target rate this month or next would allow some time for the markets to adjust and for the Fed to continue testing its reverse repurchase (RRP) facility as a control mechanism for the effective Fed funds rate. I also think an increase in the fall would be an indication from the Fed that they have confidence the US economy is actually on a decent path of growth. While this would be a disappointment for those looking for support of financial assets away from the fundamentals, in my view it would be the start of a positive path to “normality.” The volatility in the financial markets would likely continue, but against a backdrop of the US, at least, coming out of the abnormalities of the QE period which produced a rising tide for most financial assets. As this tide dissipates, we will begin to see who is actually wearing a bathing suit. We have entered into a period of active management of corporate and financial assets. Accidents will happen on what will still be an accommodative path to “normality,” but this will open up opportunities for those actually paying attention to fundamentals. It will be a slower growth path over the next several years than we have historically seen, with a premium likely for management talent within companies and asset managers—a different mix compared to the last six years or more.

China and Emerging Markets in the News, but…

The wild card in all this would still appear to emanate from what is going on in China; although the emerging markets, Europe, Russia, and the Middle East bear watching. I am pretty solidly in the camp of those who don’t believe there will be a hard landing for China. I think the growth rate is slowing and actually wrote last December that I thought China growth would fall to 5%. I could be low (or not). It is true that the industrial and fixed capital investment side of China is in a major slump. This is the source of the lower demand and oversupply for a variety of the hard commodities as well as oil. That, in part, is caused by the slower growth in the rest of the world, which will continue. China over built and it will take many years for the country to grow into the capacity it has created. Unfortunately, the capacity will likely be less efficient than newer factories and transportation systems available at that time. In the near-term, this has a major impact on a number of China’s emerging markets suppliers who have historically been big exporters to China. However, it continues to look like the services sector—a big employer—in the Chinese economy is continuing to grow. Depending on the source, it appears that at least 50% of the population is employed in the services sector now, up from 35% 10 years ago, with the shift coming from the agricultural sector. China still has 29% of its population employed in agriculture. That compares with 1.2% in the US and similar numbers in other developed economies (the US had 29% of its population employed in the agricultural sector in 1915, 100 years ago). Services accounted for 46% of the Chinese GDP in 2013—it’s probably closer to 50% this year, because it is growing at a fast rate as industry is falling. Industry was 44% in 2013 with agriculture at 10%. By the way, construction, which seems to be a big topic, was only 7% of GDP (a part of the industry number).



As indicated, while China itself can weather this shift, the impact on a variety of the emerging markets can be severe—both for those countries exporting raw materials as well as intermediate goods. There will be credit issues, particularly for countries that have taken on USD-denominated debt. Away from the emerging markets, we will see credit issues as well, which open up some interesting opportunities in the illiquid space and the liquid markets. We have seen major dislocations in currencies and relative market performance. The tables below give some sense of year-to-date moves as well as the increased volatility:


Volatility and Dispersion to Continue…but…

We expect the volatility and dispersion in performance by markets, sectors, and individual securities to continue against a backdrop of slower global growth. This is regardless of whether the Fed moves this fall. There are significant opportunities being created on the positive and negative side. It requires making some judgments regarding relative risk that may have less to do with recent history and more to do with some decisions about how the financial markets may operate differently in a more disparate idiosyncratic world. We are paying attention to what we believe are the best active, less-correlated managers across the investment spectrum.

Note: Some of what we have discussed can get a bit technical, and, by the time these thoughts are published, the world has moved on. We try to condense our thoughts in regular short videos, and, fortunately, do get an occasional chance to express our views on various media. Viewing or listening to these thoughts is a good shorthand way to get slightly more current views. Here’s an exampleYou can also click on “Updated Video Commentary” for 2- to 3-minute videos of our views.

Employment, China, and Other Fed Funds Factors: How will it all add up?

We still believe the employment numbers, as reflected in the monthly BLS release and the JOLTS reports, are among the more significant factors in the timing and pace of a Fed decision on raising rates. However, the weakening of the yuan in the short term has overwhelmed other factors affecting the global economy and central bank decisions—at least in the minds’ of the media. There are other factors that come into play as well, including the actual pace of both US and global economic growth, productivity, and commodity prices. Let’s try to put these in perspective.


The Labor Department reported employment increased by 215,000 jobs in July. This seasonally adjusted number was close to consensus, and kept the unemployment rate at 5.3%. While we expected the rate to remain unchanged, 215,000 was below our expectations. July is typically a layoff month as one can see in the tables below comparing seasonally adjusted results with the unadjusted numbers.

TBL_Blog_OTM Change_Jan14-Jul15_081815

Factories often close down for maintenance, the educational systems close down for the summer, and many service organizations adjust to different patterns of activity for the summer months. Based on the unemployment claims and other evidence that companies were having a hard time finding qualified workers, thus holding onto employees, our expectation was for a larger seasonally adjusted number. We will see what the next two revisions bring. Note that last year in July, the unadjusted number, which was a bigger loss than this year, ultimately resulted in a significantly higher seasonally adjusted number. In the meantime, the workweek was up 2.7% over a year ago, and hourly wages were up 2.1%. That puts weekly wages up 4.9% from last year. July is a strange month because of the seasonal adjustments required to make a negative number into a positive number. This has to be a tough month for the BLS to estimate. This is a number the Fed can interpret any way it wants to.


China’s “floating” of the yuan (renminbi) and the subsequent weakening of the currency have added new elements to the view of growth in China and the state of currency relationships, particularly in the emerging markets. It has put additional pressure on hard commodity prices and raised issues around the time it would take for central bank inflation targets to be met. The timing of the move was interesting. Clearly, it is to China’s benefit to have a weaker currency in terms of its export markets. On the other hand, it does raise import prices and has an impact on both the Chinese consumer and company profit margins. As significantly, a freer floating renminbi is consistent with the desires of the IMF in considering the renminbi as a reserve currency. It is our view that while growth is slower in China, it is likely faster than growth in most of the developed world. It is not clear that a freer floating renminbi would produce a major weakening once the speculators are removed from the picture. This will bear watching—particularly as it relates to China’s economic growth. Let’s understand that, while the focus is on China’s major slowdown in industrial growth, services—which are more internally relevant—now represents close to 50% of the economy and continues to grow. I would urge readers to take a look at the recent macro outlook webinar we did with Henry McVey and Dave McNellis of KKR where China growth was discussed.

The Fed and Interest Rates

The Fed will have one more look at the employment numbers before its meeting on September 17. This will include the JOLTS report for July as well as the August employment numbers and revisions to earlier months.  If these numbers are, at worst, neutral, odds are the Fed will start down the path of raising the Funds rate. Let’s also understand that the effective Funds rate will be the rate at which banks lend to each other to meet reserve requirements. For example, the Fed could raise the targeted Funds rate by 25 basis points, but the rate at which banks are prepared to borrow or lend could vary. We are entering an unusual period where results may be inconsistent with history, regardless of the timing of Fed rate increases. Odds are, once the Fed actually does raise the target rate, we will start hearing more about the Reverse Repurchase facility that has been set up to provide better control of the actual rate. All of this depends on what other data we see on the US and global economies. How much attention will be paid to what is happening in the rest of the world remains to be seen. Our view is the US data will be the driver of timing for the Fed. And, our view, shared by others is that the Fed will begin the process sooner than the futures would indicate.  Whenever the process starts, it will be a gradual undertaking with some elements of experimenting and observing the data before additional rate increases take place. Getting us to this point has been an experiment. This will continue as we work ourselves back to “normal.”  Experiments can lead to accidents. The combination of the variable global economic picture, low oil prices and related low commodity prices in general, systemic foreign exchange fluctuations, high valuations, low top-line revenue growth, and some wage pressure, will lead to larger variations in performance geographically, by sector and by individual company. It is a time to Pay Attention to more active managers on both the equity and fixed income side of the markets. Not only would I be looking for managers with lower correlations to the patterns we have seen in the last several years, I would also look for managers who can offer a measure of downside protection against the accidents we may see.

South America, PE, and the Fed

Watch Friday’s Employment Numbers

Last Friday, July 30th, I was invited back to Bloomberg Market Makers with hosts Matt Miller and Scarlet Fu. Katia Porzecanski, who follows the emerging markets, and Tracy Alloway, executive markets editor, joined the sessions. As usual the producers provide some topics a day or so before the appearances to prime the discussions. The questions were “What are you watching in South America?” “Hedge funds and Private Equity assets—what kind of strategies are you looking at?” and “What’s up with the Fed?” As in the past, below are the notes I sent to the producers in preparation for the segment.


South America: I’m watching three countries: Brazil, Argentina, and Mexico.

I don’t think we are close to a turning point on the negative GDP in Brazil. This is important as Brazil is critical to the rest of South America and accidents can happen on the corporate credit side and within the government. They don’t have a lot of levers.

Argentina, may look like a disaster, but is moving closer to an election which will bring in one of a couple of logical, policy oriented candidates, and Argentina will begin its every two decades cycle of recovery. I think the issue on their sovereign debt will get resolved. But, coming out of it may be a change in the covenants of sovereign debt in the future. For example, the ability to hold out from what a majority of creditors agree to on a settlement is likely to vanish.  This makes sovereign debt more expensive but hastens returns to the capital markets for renegers.  In addition, Argentina has phenomenal Shale-based hydrocarbon reserves, which it will be able to exploit once there are adults in the government.  A big part of the shale reserves are in the same area where Argentina’s conventional gas reserves existed. The gathering facilities and movement of the resources are already in place. This could happen quickly and economically.  Unfortunately, in the process, some of the best fishing areas in the Neuquén Province (where I used to fish!) may be destroyed. I hope not. Economically, shale extraction is a big plus. Let’s understand this will add significantly to global energy supply, and put more pressure on prices.

Mexico is, as I said on air, a shining star. The natural growth rate is 2 ½-3%. If Telecom and Energy reform happens, another 1 ½% would be added to the rate. Henry McVey, KKR’s Global Macro Head, discussed this recently on our webinar, “Investing in an Idiosyncratic World.”  Mexico could become one of the faster growing economies in the world with sustainable demographics. Energy reform there would also add to global oil and gas supply. I am pretty optimistic for Mexico.

In general, I like the Americas for opportunities—long and short. Canada is a little problematic right now given the oil patch and commodity producers may have a problem. If global growth picks up at some point, there is a cycle yet to come.


Hedge Funds and Private Equity: In general, given the market environment I expect over the next several years, I am in favor of active managers—non-benchmark-huggers, whether that is long-only or hedge funds that can generate alpha on both sides of the market.

Today, the best Private Equity firms have the most active managers among all managers. That’s because these managers can do more analysis and have more companies to choose from (than those operating in the public markets) in making their decisions. In addition, they are typically heavily involved after the investment is made and do not have to worry about specific quarterly earnings. There is truly an illiquidity premium, which could very well be widening.

I am more nervous about the Venture portion of Private Equity. It is reminiscent of the Dotcom Era. (BTW, when I first typed “dotcom,” spellcheck changed it to “sitcom.” In retrospect, that may have been appropriate.) My guess is that, as always, the top quartile performers in that space will remain at the top. One has to make sure they are investing with a top quartile performer.

I think that the five years after 2008 were hardest for hedge funds, in general.  Now we are entering into a period of low global growth but high dispersion.  One can’t count on beta to meet return requirements, and there is risk on the fixed income side—low yields, but principal risk and credit risk if rates rise. I would look for equity hedge fund managers that run a lower net long position most of the time, fixed income absolute return or long/short managers that fundamentally analyze credits. I also think while one can own real estate, I would like to have a hedger there, as well. The macro strategies may start working and uncorrelated strategies like managed futures do belong in a portfolio. I would actually like to create the core of a portfolio around all the alternative strategies and active management strategies that have been on the periphery for the last several years. On the edges, I would play around with passive strategies, hopefully moving in and out at the right time.


The Fed: In response to the Fed’s news this week, I think the Fed is saying that they will be data driven, but they really want to start raising rates. I would be surprised if the raise actually takes place before the Fed’s dots and the future’s markets get a little closer to each other. Right now the differences are more than a quarter point apart on where rates will be in December. When will the increase happen? If the employment number surprises on the upside next Friday that may move the dots and the market closer to each other and push the odds up on a September increase.

It could surprise. I would bet it will. Why? July is actually a lay-off month, with plant shutdowns and other changes. Unseasonally adjusted, the employment numbers go down by about a million people; seasonally adjusted ends up as a positive number. The unemployment claims, the job openings numbers, and anecdotal info say that there aren’t as many layoffs taking place. Companies are having trouble finding qualified workers and hanging on to the ones they’ve got and perhaps, they are starting to raise wages on the margin. I can’t make heads or tails of the seasonal adjustment factors, which always seem to be adjusted themselves.  If someone gave me some odds on a bet on the number, I think it could just as easily be 275,000 to 300,000 seasonally adjusted, but certainly above the 218,000 consensus estimate. I’ve never met a seasonally adjusted worker, but this could be a surprising month. If the number doesn’t surprise to the upside, then it’s December. Whatever and whenever it is, it really depends on what happens from there in terms of the size and how often the rates continue to rise. I have even said that maybe the first rise or subsequent increases are at 1/8 of a point instead of ¼.

As an added bonus, as I mentioned, Executive Markets Editor Tracy Alloway joined us in a second segment. At 6:30 am that morning Tracy sent over the three topics of the day that we would be discussing: the emerging markets pain, bad month for commodities, and a good month for Italian bonds. We did cover those topics as well. This link takes one to the Bloomberg clip.

Tracy pointed out that the emerging markets as a group experienced major currency declines in the month and some are actually raising rates. My view was that they should be focusing on growth and raising rates was not the way to do it. It was also a bad month for commodities with many blaming the dollar. There are many causes for low commodity prices—slower global growth and the strength of the dollar don’t help. My view is that lower commodity prices may stay that way because of the oversupply and low prices of oil/energy. Energy is a major input to mining and refining costs. As those costs fall the marginal cost of production may fall enough for extraction and refining to make a contribution to overhead, thus keeping the supply higher than it otherwise might be and prices lower. If mining assets actually change hands at wholesale prices (a coal property was described as selling for a dollar), that also lowers the bar on what the price of the commodity needs to be to produce a return on investment. That will certainly be happening in the energy space, and may occur elsewhere.

I didn’t have much to say about Italian bonds other than QE in Europe is likely to continue pushing yields lower than they otherwise might be. Investors are following the money.

Life may not turn out to be quite that simple. I do believe we will see significant dispersion in economic results, sector results and individual company results over the next few years. Active management will have its day. Pay Attention.