Trend Management’s Second Quarter Report 2016
Global stock markets were having a good year . . . until an election in Britain, the financial markets didn’t like. Our managed accounts are up for the year, but the last week of June was quite the roller-coaster.
The financial community is trying to figure out what it means for Britain to leave the EU. We do not feel Brexit is the start of another 2008 stock market debacle, similar to the result of Lehman Brothers’ bankruptcy. Unlike eight years ago, the system is awash in cash, growing $150 billion a month, as Japan and Europe continue printing a lot of money. Cash will temper the fear spreading in the market since the last week of June.
Brexit has caused a huge decline in bank stocks in Europe. Investors are debating whether another country will leave the Euro. We have always viewed England’s exit from the EU as not a huge deal to the world financial system. British banks borrow in pounds, and lend in pounds, and Brexit will not change it. That fact makes it easier for the banks to manage their balance sheets and limit systemic risk. British banks can weather a change in bank regulation from Brussels to London, because the currency will remain consistent.
Some may remember, during the last crisis, we predicted Greece would leave the Euro. So far, it has not, but we do believe Greece will be first to follow Britain’s lead, before the vote in Italy and Spain. Short-term, these elections will cause problems for investors to work through, but we foresee the end of the Euro is inevitable. In the past two-thousand years, there is no instance where a group of countries survived, who shared a currency, but did not share the money.
European bank investors fear Greece, Italy, or Spain, leaving the EU. If so, any money remaining in those banks will convert to new, respective Greek, Italian, or Spanish currencies. What each would be worth is a guess. For example, Euros now deposited in an Italian bank may convert to lira, when withdrawn. Would one theoretical lira be worth one Euro? Half a Euro? Less?
The last run on European banks was 2010-2012, and caused very sharp swings in U.S. stock markets. In 2010, three corrections of ten-percent or more related to Europe. We don’t anticipate an encore, but it probably won’t be a boring summer, either.
We own three, U.S. bank stocks. All have passed the Fed’s economic stress test, designed after 2009 to help identify financial system risk. Our largest bank stock position is Wells Fargo. It is not a large player in Europe, and we view their decline this year as a stock-buying opportunity. We also own positions in USB and PNC banks, which we also feel are minimally affected by what’s going on in Europe.
The world economy has suffered since 2010, when Europe’s problems surfaced. We project the Euro’s break-up as a good thing for world growth, once the shock wears off. Unemployment across much of Europe remains over 10%, with youth unemployment above 50%. In our view, one currency to deal with the problem is the wrong approach. Smaller countries rejecting the Euro will allow them to spend more on their people, thus increasing economic growth. This will help our investments in commodities and Latin America, as well.
We continue to predict Latin America as a beneficiary of rising commodity prices, due to the end of the U.S. oil production bubble. Our first purchase was made this quarter in Latin America, and it’s possible we will buy more assets in the next. We find it interesting, so far this year, Latin American stocks are up 23% on average, while commodities are up 15%. (The S&P 500 is up 2%.) We think that trend will continue.
We did not add any new companies to your portfolio this quarter. We like what we own, and will continue holding them through the Brexit and Euro volatility.
We wanted to leave you with observations made during cocktail parties, social events, and casual meetings where investments were discussed. A common theme has been lumping all stocks into one pile, as though they are an asset class, like commodities. The assumption is all stocks are alike, and trade together. It’s further assumed, if negative on stocks, then go to one- hundred-percent cash, because no stock can withstand a market decline.
Except inside the S&P 500, numerous stocks do not correlate with the market. If the market goes up, some stocks have a better than seventy-percent chance of going down. And vice- versa. Prevailing wisdom aside, not all stocks are the same. Nor do they trade the same.
As an example, in our managed accounts, we now have over twenty-percent of your account in stocks that will more than likely rise, if the dollar declines. The direction of the dollar matters more than the Dow or the S&P increase. On down days in the overall stock market, it’s possible your account may be up, if the dollar is also down that day.
We are doing this, because we consider the dollar overvalued. Three years ago, your account was fully invested in stocks. Since then, as the S&P 500 rallied, we have gradually hedged your account by betting against our currency--which is somewhat a bet against the S&P 500. Today, the account is almost 100% invested in stocks, but the portfolio’s economic driver is the dollar going down. In other words, we are trying to protect your account from a decline in the S&P 500 and the dollar, without the unenviable decision to be 100% in or out of the market.
We wanted to let you know, your account will track less with the S&P 500, than it has in the past. This is by design. We would prefer to have bought bonds, were interest rates at normal levels, but bonds are in a bubble, and we don’t want to own them. Hence, we have invested more in stocks that rise when “stuff” does, and decline when it doesn’t. If the dollar rises, we think the stock market will do okay, but your account will probably under-perform the S&P 500. If the dollar declines, we think your account will more than likely out-perform it.
Feel free to call us, if you have any questions (417-882-5746). Sincerely,
Mark Brueggemann IAR Kelly Smith IAR Brandon Robinson IAR