Global markets swooned yesterday as nervous investors sold off every asset class (even gold) in a lemming-like rush for the (perceived) safety of US Treasuries. The Greek debt drama, and Europe’s fumbling and bumbling response to it, has once again taken center stage. US policymakers have fared little better, as the US Federal Reserve’s announcement of “Operation Twist,” intended to drive US Treasury holders into riskier assets, produced the exact opposite outcome. Investor demand for US Treasuries pushed yields to a record low of 1.67% and the dividend yield on the S&P 500 (2.15%) is now higher than the yield on a 10-year US Government Bond.
When markets yo-yo, BSW strives to immediately communicate our outlook, actions, and positioning to our clients, colleagues, and friends. That charge has become increasingly challenging as volatility within the markets has dramatically surged. Markets are up, down, back up, back down – well, you get the picture. The most important question, though, is not really, “What’s happening in the markets/economy?” Instead, it is, “What is happening in MY portfolio?” To answer that, we ran the numbers on BSW’s Growth Portfolio — so below please find a concise summary of BSW’s recent performance, along with our outlook, positioning, and “news you can use.”
BSW Economic Outlook:
Theme #1: We are still feeling the aftershocks of the “Great Recession.”
If the financial crisis of 2008 had been a normal, garden-variety recession, the economy should be absolutely roaring after so much monetary, fiscal and bailout stimulus. But, as we have been consistently saying, the 2008 financial crisis is/was closer to a depression than a recession. Looking at the past 800 years of financial history, recovering from a financial crisis typically takes about 7 years. This would suggest that we won’t be back to “normal” until 2015 or 2016 – and the ongoing sluggishness in employment, growth, and housing evidences this.
So, BSW expects weaker, “new normal” growth to continue for a while. Consumers and governments need time to retrench, pay down debt, and rebuild their balance sheets. Further, the overhang of housing and the specter of the long-term unemployed will continue to dampen bright spots along the way.
Finally, although it is certainly possible that we will revisit the lows of 2008, we don’t believe it is probable. The wild card is Europe. If the Europeans cannot agree to coordinated efforts to stem their debt crisis and a dis-orderly “Euroquake” default of Greece occurs, it could produce a Lehman-like contagion spreading to Italy, Spain, and Portugal that would plunge the world into a Japan-like lost decade (or two).
Theme #2: Two-tier recovery.
The recovery from the 2008 Great Recession is bifurcated at many levels: developed vs. emerging, high end vs. low end, and Inflation vs. Deflation.
First, the emerging markets are recovering (they never really recessed) at a much faster rate than their developed market peers because their financial houses are, largely, in order.
Second, companies that sell high value goods (Apple, Whole Foods, etc.) and companies that sell low end goods (consumer staples) are both still doing well. Companies that market to the mid-range consumer (such as non-staple items at Wal-Mart) however, are badly hurting. That’s because the middle class is getting squeezed and is trading down. Their primary “asset” (their home) is still losing value, companies are hesitant to hire (especially middle management), and wages are stagnant. As such, the “class warfare” rhetoric has returned to our political dialogues – and looking historically, class warfare dampens economic growth even further.
Finally, the dichotomy of inflation versus deflation. Certain items (food, fuel, healthcare, insurance premiums) are rising in price, while other items (houses, wages, etc.) are falling in price. The forces cancel each other out and keep the Consumer Price Index (CPI) measure of inflation low — precise but not accurate.
Theme #3: Keynesian “Race to the bottom.”
As my favorite Swiss-rabble rouser, Marc Faber, likes to say, “Everyone has become a Keynesian.” He’s referring to the economist John Maynard Keynes who advocated that the government use monetary and fiscal policy to “manage” the economy. For me, Keynes has always been like Marx. Both were absolutely brilliant, but practically speaking, their policies are disastrous and remind me of oxymoronic “forest management” that tends to result in both: a) Massive wildfires; and b) Ridiculously expensive fire-fighting techniques. Dropping a bucket of water on a wildfire with a helicopter is reminiscent of “Operation Twist.” Forests have had fires as long as forests have been around. And banks/countries/companies have been going bankrupt since they originated as well. Most often, the “system” manages itself best without interference from well-intentioned bureaucrats.
In essence, all Central Banks are in a race to devalue their currencies and all countries are bent on trying to export their way out of their current predicament. But as another of my favorite economists, Ken Rogoff, cogently argued in the Financial Times recently, traditional economic analysis leads to traditional policy prescriptions, which are useless and inappropriate in a “Great Recession.” Far from being a stabilizing force on markets, Central Banks have simply amplified volatility, with their influence and actions serving as the ultimate uncertainty – and markets hate uncertainty.
We hope this summary provides you with better insight into your portfolio and BSW’s outlook. If you have any questions regarding out positioning or would like to discuss your portfolio in greater detail, please don’t hesitate to contact BSW. As always, we are happy to help.
-David Wolf, Chief Investment Officer