As experienced investors we know the markets are complex, but it is helpful to pause and remind ourselves and our clients that action for the sake of action is usually folly. We believe that the long tepid U.S. and to a degree "Rest of World" economic expansions, truly gargantuan central bank and government stimulus as well as liquidity and concomitant Bull markets for assets are becoming fatigued under their own weight. This does not mean economies must recede and markets must decline, but it does mean the next phase is much more likely to be slower growth and returns and late market cycle volatility and rotation as all that liquidity seeks the marginal opportunity – that is until the policy makers do something to remove at least some of the excess liquidity. Typically, in a classic “real” economy cycle, by now stimulus has been sopped up with productive undertakings that grow jobs, consumer paychecks, investment in property, plant and equipment (PP&E), and consumer spending.
This was never that classic Real Economy cycle, but instead the newer (and now much more common) variety of the Financial Economy cycle, which morphed or spilled over as they do, into the Real Economy. So the initial policy prescription was right, dump money on assets because that was the source of injury and pain, but a funny thing happened despite all the political talk, the policy never actually shifted as the pain moved from the Financial to the Real economy, and this is the crux of the problem.
We have been saying for about 2 years now that if the Fed is waiting for classic real economy signals for when to begin withdrawing the stimulus, they are making a big mistake because this is not that cycle, and never was. So Fed table pounding for 5.5% unemployment (taken to be the boundary below which you get wage inflation), and 2.5% -ish CPI – taken to be the markets way of saying there are too many dollars chasing too few goods, was misguided. Low and behold, in the FOMC briefing of about a week ago, when the Fed held steady on rates. Chairperson Yellen said it, finally, "There is growing realization amongst Fed Governors that there the NAIRU (that Unemployment barrier rate) is not 5.5% but may be closer to 4.9% - again with the "-ish), and the equilibrium CPI policy point may be "significantly less than 2.5%", that was it.
In two sentences this Fed just trashed their holy policy grails of the past 2 years plus. Then they went absolutely silent for 55 days and counting. So with all the global challenges and no Fed compass, and no Fed or other meaningful central bank guidance, what else are markets to do but gyrate round looking for a new direction?
What do we know?
We have been here before and are "all over it" as the young people say, this translates into heightened vigilance, daily rebalancing reviews, but we are not going to let the market ratchet us down by rebalancing into a downward spiral.
We know that the markets will find a stabilizing point and then recover. We know the only ones who lose are those that sell at low points. We know that we went into this with what we believe to be a better portfolio design, better build, and a bit of better operation. So far we have fared modestly better for it. Most importantly we know out of this will come very attractive opportunities for seemingly contrarian moves that have the potential to generate large "make-up gains".
If we can be of service to you in this environment, please call us.