My Presence is a Present

I struggled this week with how to convey my message to you.

I thought about dropping a little Eckhart Tolle and telling you that “the past has no power over the present moment” so you don’t manage your portfolio looking at past returns or focused on old economic data. 

I also considered busting out some 2,500 year-old wisdom from Lao Tzu and hitting you with “the further one goes, the less one knows” as a way to say that forecasting is a complete waste of time and the only reason it exists is so that Wall Street can rationalize its own existence. But let’s be honest, that’s some pretty heady stuff. So instead, I turn to a present day sage, Kayne. “My presence is a present, kiss my ass.”

Don’t get me wrong, it’s important to periodically check the rear view; just don’t try to see 2 miles back and around a corner. It’s also important to look through the windshield several car lengths ahead but don’t look for the Cracker Barrel 14 exits away.

Unless you have a time traveling phone booth like Bill S. Preston, Esquire or you’re a direct descendant of Nostradamus, expend your energy on better understanding what’s happening right now. Kayne nailed it. If you focus on the present, the gift that it gives you is a huge edge over other investors.

I’ve talked before about the virtual monopoly that the US has on positive yielding debt now with the ECB and the BOJ going full tilt negative. Emerging markets are also benefiting from the insatiable appetite for positive yields. There are so few places to find positive yields that the bum rush into EM debt is being done while overlooking the real problem at the core of EM, growth.

I’m no fan of rating agencies because they are typically the last to recognize and respond to shifting dynamics. That said, so far this year, S&P has downgraded 16 economies and Moody’s has downgraded 24 economies. The last time this many economies were downgraded in a 6-month time period was during the peak of the Eurozone crisis back in 2011. The number of downgrades has also accelerated quite a bit compared to just 10 at this same point last year. 

If ratings agencies are the last to switch their bias on an economy, then the deluge of downgrades is well overdue and indicates that these economies have been deteriorating for a while. It’s just that now not even the ratings agencies can ignore them.

No Growth Prospects, Just More Bad Decisions 

The lack of growth means that Investors are piling into emerging market debt as leverage is increasing and credit quality is deteriorating. Unless EM growth picks up soon, investors are running into the equivalent of a burning building because it’s the only shelter from the rain of negative rates.

Speaking of ignoring reality, investors’ reaction to central banking action, or rather, inaction, reminds me of trying to explain to a toddler why eating all of their Halloween candy in one sitting is a bad idea.

Little Johnny throws a tantrum because to him, if 1 Kit Kat is good, 35 is better. But Johnny’s parents know better. 

For 2 weeks in a row, the ECB and then the BOJ stayed in a holding pattern rather than upping the easing policy ante. Investors responded by throwing a Halloween candy tantrum. 

Sometimes I feel like I’m taking crazy pills. What do people really expect? Do they actually think central banks are just going to blow their wad meeting after meeting?

Even central bankers are smart enough to smoke a cigarette and see if their stimulus is having a positive impact before deciding on further action.

Channeling Miss Cleo, 80% of economists expected the BOJ to expand its current program last Friday. Spoiler Alert! The majority was wrong. 

In fact, Japan’s prime minister came out earlier in the week and tried to force the BOJ’s hand by announcing a $265B stimulus package aimed a “supporting domestic demand and putting the economy on a firmer recovery path.” But the BOJ didn’t bite.

Central Bank Spending Isn't Helping 

The staggering thing is that central banks are currently buying $180B worth of assets every month. I know, big numbers get thrown around a lot so here is some perspective. $180B a month is the most monthly asset purchases EVER! That’s even more than the $150B that was being purchased each month immediately after the Crisis.

Oh, and don’t forget, the US isn’t even participating in this spending spree…yet. This is all being done by just the ECB and the BOJ. I don’t know what investors think more money is going to do because not even this historic amount of monthly purchases is moving the economic meter. 

Japan’s annual GDP growth rate looks like a blind man’s attempt at using an Etch a Sketch, it’s all over the damn place. The net result is a solid downtrend that started after the economy peaked in 2012. Hell, Japan gets giddy when they post a GDP growth rate with a “+” sign. Over the last 8 quarters, Japan’s economy has been in outright contraction half the time and Q2’s growth rate came in at Hulk-ish +0.1%. 

As for the Eurozone, it never even got back to its pre-Financial Crisis GDP growth rate high and peaked post-Crisis back in 2011. For the last 18 months it has been hard to tell the difference between EU growth and a dead man’s EKG. Growth has flatlined until recently when it actually slid lower from Q1 to Q2 2016. 

Speaking of Q2 GDP, the US growth rate decelerated for the 5th straight quarter and now the slope of US growth officially looks like the 17-story downhill drop on The Verruckt in Kansas City. 

It’s very early in the Q3 grudge match but the initial manufacturing and service sector data from July point to a sub-1% GDP growth rate. If this holds for the next couple of months, it would mean a 6th consecutive quarterly decline.

Since 1990, the US has had only 3 other occasions where GDP growth slid for 5 consecutive quarters or more.

1.      Blowing Nasdaq Bubble: Slid for 6 straight quarters. The S&P lost 29% during the first 5 quarters and gained 7% in the last quarter. It went on to decline another 23% in the following 12 months.

2.      During the Big Short: the economy slid for 7 straight quarters and the S&P lost 42% during the first 5 quarters but rallied 2% in the final 2 quarters. It gained an additional 11% over the next 12 months.

3.      From Q2 2012 to Q2 2013: the economy slid for 5 consecutive quarters. The S&P gained 13% during those 5 quarters. It gained an additional 22% over the following year.

4.      And now, from Q1 2015 through Q2 2016: the economy has slid for 5 consecutive quarters and the S&P has gained 5.5%.

The first 2 events had quarterly contractions in growth leading to a recession, which the 2012 economy didn’t experience. If history is any guide, it would appear that as long as the US doesn’t slip into a recession; the probabilities favor a US equity rally of some magnitude over the next 12 months. 

This is why it’s important to better understand what’s happening right now. You now have context by which you can judge US growth during Q3. This context will allow you to proactively manage your portfolio, in real time, rather than managing investments like Bill and Ted or Miss Cleo.