Macro, Markets, and Malarkey

Stocks and Bonds
It feels like forever ago, but back in February, the S&P 500 hit its lowest level since 2014 as global growth fears spooked investors, leading to liquidations and deleveraging—most notably for sovereign wealth funds.

Fast forward to now…as of the end of July 2016, the S&P 500 closed at 2,173.60—up 7.5% from the beginning of the year. And, 10-year treasury yields started the year at 2.24%; as of the end of July 2016, rates were at 1.46%—a 35% decline in yield from the beginning of the year. These are big movements in both domestic stock and bond markets which investors shouldn’t take lightly.

Fig1_S&P+10yrTreasury

Also, more than $11 trillion in negative yielding bonds are outstanding, largely in Europe and Japan. The Financial Times wrote a great piece recently highlighting the post-Brexit surge in investor bond purchases.[1]

Fig2_GlobalNegYieldSovDebt

This means that if an investor holds one of these bonds until maturity, they actually lose money. They are also paying the issuer for the right to own these bonds, versus receiving some sort of payment in return—as Finance 101 teaches us should be the case. Governments with massive stimulus policies (ECB, Bank of Japan, and now the Bank of England) are buying up bonds, bidding up the price of these bonds and thus sending yields negative. Accelerating the decline in yields is the fact that the supply of such bonds is not ample enough to meet this demand. Negative yields are supposed to entice investors to invest in other assets, since they clearly lose money by investing in such bonds. This hasn’t happened. And yes, this is completely backwards and deflationary.

Currencies and Commodities
Currency markets have not been immune to this storyline; as Europe and Japan use monetary policy to help grow their economies, foreign investments flow to the US for its higher yields. Since May, foreign buying coupled with more hawkish Fed speak has strengthened the US dollar versus other currencies.

Fig3_USDollarIndex

If the US dollar continues to strengthen or simply stays strong on a relative basis, this has the potential effect of placing a lid on US inflation. The stronger the US economy gets versus its global counterparts, the stronger the dollar looks versus other currencies.

A strong dollar is usually a negative for commodities. And in fact, the strong dollar has kept commodity markets mostly in check since early May, as we wrote about in Commodities at a Crossroads. Of note, crude oil fell to under $30 a barrel earlier this year, sliding alongside the S&P 500, touching its lowest levels since May of 2002. It then spiked to above $50, and now hovers just north of $40 due to dollar related price pressure—nearly 20% below its peak in June of $50.11.

The US Economy and Election
That’s not all. We’ve barely discussed the domestic economy. Here at home, despite anemic GDP growth of 1.2% for Q2, economic growth is indeed expanding as evidenced by the latest payroll and hiring figures. Non-farm payrolls increased by 255,000 in July on a seasonally-adjusted basis, with the unemployment rate at a very healthy 4.9%. Wage growth and labor market improvements here in the US makes a strong case for the Fed to raise rates. Our view is they should raise rates in September, ahead of the election. Whether they will or not remains another question.

Lastly, and as an homage to Vice President Biden’s favorite saying, “malarkey,” rhetoric around the US election has truly captured the American public, including ourselves. We are seeing raw democracy at work here and elsewhere. People are voting against the establishment; it’s a small segment of the human race, but it affects us all. In the meantime, it may become clearer that at extremes, when enough of the populace is truly feeling disadvantaged, capitalism has to make some changes. Otherwise capitalism and democracy are not going to work when the rule of law favors a few as opposed to the many. While this line of thinking may be too philosophical for a financial markets blog, it merits consideration because it does affect one’s view on investing.

Thus far financial markets have not reacted to the election news melee, but investors should pay attention. Should the Republicans lose their majority in the House and Senate, and Hillary Clinton is elected, this could have a dramatic impact on GDP as government spending will very likely increase…then again, it will also increase if Trump builds his wall.

What Should Investors Do?
Stocks can be at record highs throughout the year. The reality is that it doesn’t take much of a move to set a new record high when you have just made one. Odds are we will see low growth for the rest of the year, maybe the rest of the decade. One should expect dispersion by country and company with thoughtful, well analyzed decisions to make on what to own. This is going to take real professionals who are either doing real fundamental analysis or machine learning or can take advantage of the volatility and the anomalies. It’s going to be a different market. We all know that global and country growth comes from demographics and technology (of which productivity is a subset if you can measure it). But, there is a payback when the easy money goes away, causing slower growth than the demographics and technology would suggest.

In light of this, our view is that investors should have two areas of their portfolio well covered. First, there are downside risks to the market right now. Ignoring this fact would potentially leave one’s portfolio without a buffer, and we believe every portfolio needs uncorrelated assets. While it is self-serving to advocate for managed futures, Altegris has a focus on managed futures because time and time again they have performed during some of the worst periods for traditional equity markets.
Fig4_PR_ManagedFuturesPerfDuringEquityMarketStress_1288-NLD-882016

Equity markets could continue to push for new highs, but we believe they are also susceptible to periods of steep losses. Managed futures performance has historically been uncorrelated to the performance of the broad stock market, and we strongly believe all investors with risk capital should consider this diversifying return stream, given the current macro picture.

The second bookend to investors’ portfolios, given the market environment, is private equity. Private equity was one of the few areas that didn’t sell off when investors panicked earlier this year, and whose returns can be orthogonal to the returns of traditional markets. Now, private equity is not a liquid investment option, so investors must be thoughtful in terms of just how much they allocate. But it is the forgoing of frequent liquidity that makes private equity attractive in our opinion. This is what is commonly referred to as the illiquidity premium, which is essentially the potential reward of enhanced returns—over time. This potential for enhanced returns may be particularly attractive for investors given the uncertainty in traditional equities at present.

The bottom line is that investors should aim to diversify portfolios. Look for ways to grow and preserve capital in your portfolio and seek returns in areas where investment managers have a real edge and understanding of the underlying investments. Pay attention, and invest for the future of your portfolios.

 

Data sourced from Bloomberg unless otherwise specified.

[1] Financial Times, June 29, 2016: http://www.ft.com/fastft/2016/06/29/negative-yielding-sovereign-debt-rises-to-11-7tn-globally/

Argentine Elections, Other Elections and the Markets

Por fin, un elección importante y idiosincrásico rompe una cadena

Mauricio Macri, the conservative mayor of Buenos Aires, defeated Daniel Scioli, the ruling party’s candidate, in the runoff election in Argentina held on Sunday.  So, given everything else that is going on in the world, why does an election in a country that represents less than 1% of global GDP deserve any space? At least, wouldn’t it make more sense to write about the gubernatorial election in Louisiana which represents 1 ½% of the US GDP?

Actually, both elections represent significant changes. Louisiana hasn’t elected a Democrat in any statewide election since 2008, and certainly not a centrist candidate. Argentina has been in the hands of a Kirchner since 2003 during which time there has been a steady deterioration in the economy, understated high inflation, a currency collapse and, ultimately, an inability to access the global debt markets. In the end, populist policies did not overcome the finally recognized impact of corrupt and incompetent governance of a beautiful country with abundant resources and a reasonably well-educated population.

Argentina takes on some level of importance as a possible indicator of a broader shift of governance in the rest of South America. In addition, the country has resources to exploit under a more normal relationship between the producers and the government. This would include shale gas reserves that may represent the second largest known fields on the planet. A portion of these reserves lies in the same region as earlier conventional gas where gathering systems and other infrastructure still exist. Under a different and friendlier government, the technology that would be necessary to access the fields may be more readily available to YPF or in other business combinations. Finally, we will likely see some settlement of the remaining debt that is preventing Argentina from accessing the global credit markets.

None of these elements will occur overnight, but the markets will likely reflect positively the possibility of the ultimate outcomes as suggested above. Macri will have his work cut out for him to reverse the path that Argentina has been on for some time. While he won the election, almost 47% of the voters did support Scioli. Macri will have to take some hard steps in a problematic economy, similar to what Carlos Menem had to do some 26 years ago. There will likely be some ups and downs domestically, including some steps that would appear to be more like the populist actions of the Kirchner administrations. But, the chain of bad governance would appear to be broken.

What may happen more quickly is resolution of the debt situation in order to get access to the global markets, and have funding for whatever actions Macri may need to take to turn the economic situation around. That means that the holdouts from the earlier settlements will see some kind of positive conclusion to their battles. There is the possibility that the settlements will be accompanied by some changes in the covenant structure of sovereign debt in order to avoid a future situation where a small number of holdouts can prevent full closure and access to the capital markets. This will likely raise the cost of debt for other global issuers. This is a speculative observation, but it is hard to imagine a country willingly putting itself in the position of denied access to the capital markets caused by a minority subset of its original creditors, much less the purchasers of the debt on the open markets.

There are many other variables in motion in the markets these days. It remains to be seen if increased QE in Europe will have the same positive effect on the capital markets as it has been having previously. The geopolitical issues and the impact of the terrorist actions on local growth may not be passing events as most such actions have been subsequent to 9/11.  There are questions about growth in the US. The employment reports in early December may provide some answers and determine whether the Fed proceeds with raising the Funds rate.  We expect that the numbers will be supportive of a Fed move.  In general, though, with some exceptions, one could make the case that active management confined to the Americas, North and South, could produce as good a set of returns in 2016 as a more diversified portfolio. We are seeing dispersion among US stocks. The same may apply to Canada as it most likely experiences continuing problems in the energy sector and spreading in the housing and banking sector. With the Argentine election as a backdrop, we may see some interesting but dispersed opportunities developing elsewhere south of the United States. More to come.