Thursday, May 16, 2013

Upcoming Global Macro Forces ( 3 to 5 years)

Jack, from Merrill Lynch sent me a document to read saying it was written by one of the brightest analysts out there. I did my best to get through it, but it was slow slogging at best.

This is my best effort to write down my interpretation of what they said.

Concept 1 is the idea of a three speed world. China and other successful emerging economies are high speed. America, at 2% growth is an example of medium speed. Japan ( if Abenomics is not able to pull them out of stagflation) and some of the poorer European countries are low speed.

Concept 2 is the observation of very active central banks. I have noticed this myself and wondered how it would all work out. The report refers to the central bank activity as experimental. It does say it has been beneficial for banks, but less clear for investors in the future. The observation is made multiple times that a result of central bank activity is that the price of certain investments may not be tied to the true reality of the market ( I think that means potential for bubble, but they did not say that). In order not to get totally blown away when the qualitative easing free ride ends, make sure to carefully consider the fundamentals of any investments. The authors talk about Whatever It Takes (WIT), which is what the Fed did to avoid disaster as described in Too Big To Fail and toning it down to avoid Moral Hazard ( doing whatever you can to save your country at the expense of the global economy).
6/20/13 The Fed, Ben Bernanke, gave a speech about winding down quantitative easing and caused the markets to drop a bit over 2% the next day.

Concept 3 is the branch. The author of the report believes we are headed towards a branch, or fork in the road. Either the system heals itself, focuses on deleveraging and political stability ( come on US Congress, work together), or we reach a period of even slower growth which would be devastating to the economies that are already in trouble such as certain countries in Europe. Some countries are much closer to this branch than others, the ones already in trouble (Spain, Portugal, Greece, etc).

Concept 4, this is the scary one, unless we can increase growth, haircuts are almost certain. To quote Wikipedia, "Private sector involvement (PSI) refers to the participation of the private sector in projects of the government. It has come mostly to mean financial affairs, and specifically the participation of the private sector in the write downs of sovereign debt in instances of haircut." Haircuts are bad things in this context, if you have 100k invested and there is a write down, you may end up with 60k or some such.

Concept 5 was Zombification. Be warned that different people use the word Zombie in economics differently. Yesterday, the Bank of Canada warned of Zombie banks, banks and companies that really are not alive, but are able to survive in the current era due to central bank policy of very low interest rates. The problem is these are consuming these resources that are meant to restart the Canadian economy and when reality emerges will probably fail at that time. This makes me feel very good about our strategy of avoiding buying stock in companies that have a lot of debt. The document seems to use Zombification a bit differently, but if they define exactly what they mean, I missed it.
7/10/13 Edward Hadas argues that an aging population is the major driver of Zombification in a blog post.

There were several recommendations, here is one that jumped out at me.  "Look more intensely for opportunities away from the central bank wave." This is one of those easily said, but hard to execute pieces of advice. I smiled because the document implies they have people on staff that can do exactly that and if so, I am happy for them. I am guessing the secret is to look for other macro trends such as:
- Aging population in USA, look for health care wins, electric wheel chairs, home elevators, nursing homes etc.
- Declining Caucasion influence in USA, look for international restaurant chains, Latin, Indian, Asian.
- Technology game changers such as 3D printing, surgical robots, etc.

Another suggestion is to increase defensive positioning. I think this is the idea that people are going to have to buy soap and shampoo regardless of how the economy does. That did not seem to be a super workable strategy in the great recession. I can see moving my portfolio a percent or two to defensive, mostly by increasing mega-cap stock positions and either holding the line or profit taking on some small cap and medium cap positions. On the other hand, if what they mean by defensive is putting some cash on the sidelines, I am all in. The document says, "Do not give up liquidity cheaply." Amen, I suggested to Hunter, Harry and Trey, to put some money on the sidelines and keep some powder dry about six months ago. Granted, the market continued to go up, but there should be some buying opportunities in the months ahead.