2016 was quite a year! Growth worries out of China took stocks down into February until the world’s central banks coordinated a clandestine rescue by providing liquidity to the system and backing away from any measures that might cause market angst. OPEC talked about crude production cuts and that multi-month jawboning process stabilized oil. Equity markets liked that as well. The rollercoaster ride that was provided during the first half of the year gave way to amazing calm for a few months until the November election.
Since the Trump win, a stunning amount of money has been thrown at markets as investors and traders became enamored with a lot of unsubstantiated theories and bold predictions. The size of some of the moves in stocks, bonds, commodities, and currencies were huge outliers based on historical standard deviation measures. A lot of trades have become incredibly crowded. The consensus is massively long dollars and short bonds. In equities, all the “cool kids” are now long small caps, cyclicals and banks in a big way and are fearful of being caught short anything even in a remarkably expensive market.
Importantly, the flat treasury yield curve continues to be a key market-driven barometer that contradicts the recent reflation and growth narrative that has been the common theme of recent months. Yet, just about everyone expects yields to rise because of growth initiatives from the new leadership in D.C., seemingly forgetting that so many policies have been tried for years to no avail. The positioning in treasuries suggests huge bets against bonds have been placed. Any respectable contrarian should take notice of the uniformity of opinion here.
Many measures of business sentiment and soft surveys are jumping, but economic activity has yet to follow. None of the major issues that have concerned us for years were dealt with in 2016 in a productive way. We strongly suspect the secular nature of automation trends, debt deflation, and demographics will continue to be powerful forces difficult to overcome.
All the credit issues we talk about (too often) were simply papered over with more enormous debt growth and QE last year. It is important to remember that every single one of these problems would have historically caused enormous investor discomfort and risk reduction before the central banks went completely berserk a few years ago. Yet, somehow we are all supposed to forget just how bad things must be to make the insanity of massive QE and central bank domination an accepted course of action for so long.
We cannot recall a year when weak revenues and earnings were ignored to such an astounding degree. Numerous companies reduced earnings guidance or missed estimates only to see their stocks hit all-time highs. Often, forced short covering was to blame for the price action. It was quite strange to say the least. Our negative views on the earnings path of a number of short positions were frequently correct, but we were not rewarded in most cases as fundamental considerations were tossed aside. Faith in the central bankers was tested at various times in 2016, but their rhetoric came to the rescue at all the key junctures.
Investor hope remains extremely high without much justification other than stories being spun on Wall Street and active imaginations. It is quite possible that the whimsical Trump may simply change his mind on some key issues or be sucked into “the swamp” he is supposedly set on draining. The benefits of proposed tax cuts are likely being overstated and Congress still needs to be brought on board to bring them to fruition.
Less regulation will be clear plus, but a number of industries have gotten pretty bubbly already in spite of the more stringent regime of recent years. As for massive infrastructure spending, for now that appears to depend on private sector participation that may not come to pass. Besides, this cycle is long in the tooth, so the marginal benefit of such a program is not what it would be coming out of recession when it might make a bit more sense.
In general, it seems the new chatter from the pundits is, as usual, meant to make paying ever higher prices for baskets of pedestrian companies through ETF’s seem like a smart thing to do. Another giant wave of passive investors has entered the markets in a rebuke of active management. We have seen this before and we do not imagine that it can end well this time either. Blindly buying and “holding your nose” is not a wise investment strategy especially if what you are buying is absurdly expensive.
The views expressed on this blog are the opinions of the authors. This information is not intended as investment advice or to recommend the purchase or sale of securities. More information on Strategic Balance, LLC may be obtained by contacting investor relations.