Most markets and asset classes have struggled YTD, with most Bond and many Equity indices down for the year. The emerging markets have taken a hit this year with the EEM ETF down some 9% YTD, with Turkey and Argentina dragging the index down.The outlier remains the USA, where the S&P500 and Nasdaq have continued to move higher on the back of the corporate tax deductions and an improved earnings outlook.
- High Yield Bond TR (HYG ETF): 1.87%
- US 10yr bond index: -1.45%
- Global Emerging Markets (EEM ETF)= -9%
- European Equities (MSCI Eurozone –EZU – ETF): -2.8%
- Global Equities (MSCI AC World – ACWI – ETF): 2.8%
- S&P 500 TR (SPY ETF): 9.0%
Our core Fund of Fund account is up 2.3% YTD, as at end of August. This is ahead most balanced products and comparable asset classes and compares favorably with funds such as the PIMCO Total Income Fund and Templeton Global Return Fund, which were both down YTD. The account has also performed reasonable well against the hedge fund indices, with the HFRX Global HF Index down -55bps and the HFR Absolute Return Index up 1.36%.
The FoF account is predominantly allocated to Fixed Income and equity long-short managers. A large allocation in Fixed Income is to risk arbitrage. Fortunate, as most long bond managers are down YTD.
Our Equity top picks have also performed well, outperforming the S&P on average, since we incepted the product earlier in the year. One stock is up over 100%, since we included it on our preferred list in Q2’18. We are in the midst of finalizing our equity selections, which will be run as an internal account. This can be run pari-passu for clients. It will be limited to 30 names, with strict stop loss parameters.
While the current bull market in the US is certainly long in the tooth, we are still finding some interesting stock picks, primarily across the Technology and Healthcare space. Some of our healthcare names have been long neglected which is reflected in their valuation and we feel comfortable holding them, given the sector’s relatively defensive nature.
Having exposure in relatively defensive sectors and stocks is appropriate in our view in this late cycle market.
Indicators such as Goldman’s Bull/Bear market Risk indicator, should make investors cautious at these levels, particularly given the impact the strong USD is having in the Emerging markets, should there be an EM debt crisis.
So caution is warranted.
Another factor that deserves our attention, is the increasing socioeconomic divide in the US. This is more of a longer term factor but will be increasingly relevant in the next downturn, as it will influence the policy response.
On a recent trip, I was fortunate to spend some time in the US and spent the time taking a few anecdotal notes, to check what I read ties up with what one can see at ground level. The findings are concerning.
There is an enormous amount of literature on the perilous state of the US middle class, having not benefitted from a decade of growth since the recession of 2008. The research points to the skewed gini coefficient, showing an enormous disparity between what the top 0.1% earn and that of the average working, let alone a blue-collar worker.
The effect of policy benefitted the few over the many is clearly indicated in the graph below.
Source: A Template for understanding big debt crises by Ray Dalio
Other concerns that get raised are:
- Median baby boomers having less than 250k in assets, way below the level required to maintain their current spending patterns.
- Food stamp usage at record highs, an indication of increasing poverty in the world’s largest economy.
- Student debt is at all-time highs and the value of a degree becoming increasingly questionable.
- Opioid usage and related suicide reaching endemic proportions.
- Obesity levels are endemic and will have a health and economic fallout.
Reading about all these issues and looking at charts and data is one thing. Getting out and seeing it on the ground is another.
Walk around San Francisco or Los Angeles and one can’t escape the fact that the US has a major issue on its hands. The number of homeless on the streets of both cities is shocking.
On every block one would encounter homeless folk, sleeping rough or passing the time until night. Walk at night along Hollywood Boulevard, a block away from the mansions of the stars, and you will come across absolute poverty. Beyond anything I have seen in the developed world.
It was so shocking and sad that my wife and I felt compelled to package up a few food parcels at the end of our dinner, which we then passed over to a few of them on the street. What was compelling, was that one of the recipients, a woman, explained how blessed she was compared to most. Such human emotions in such a sea of hopelessness.
This is only a small sample though, of the larger problem at hand. Unless steps are taken to reverse the trend the rate of poverty in the US is likely to rise.
Some 43 million people in the US were officially living in poverty in 2017, 14% of the population. If this is not shocking, consider the number that suffer from food insecurity, a number well north of 46m. When using the OECD relative measure of poverty, those living on half of the median income of their country, the US has one of the highest rate of poverty of the member countries at 17.8%.
The chart below shows the rate of poverty across various age groups after tax and transfers.
These statistics are likely to get worse as the flood of baby boomers retiring escalates.
Another issue is obesity. Obesity levels and the burden they place on economy are another issue worth being aware of. The statistics are pretty concerning. Per the CDC, 40% of the US adult population is obese. https://www.cdc.gov/nchs/data/databriefs/db288.pdf.
What was shocking though was that shopping, as we once knew it, has changed to account for it. In the Walmart stores I went to, there were scooters provided for extra-large shoppers. You’d think there would be just a few going around, but I saw dozens. Shopping isles have been widened to cater for it. Closer to the beaches of California you see none of this, but in middle America there is a major storm brewing. The impact of obesity on health is severe, but the problems take a while to surface.
The opiod crisis is well known. https://www.drugabuse.gov/related-topics/trends-statistics/overdose-death-rates.
Prescription drug usage though, is another issue of concern. 23% or so of all Americans have used 3 or more therapeutic drugs in the last 30 days. https://www.cdc.gov/nchs/fastats/drug-use-therapeutic.htm.
Pharma drugs are constantly being marketed on all media, for all ailments. And believe me it’s all ailments, some I’ve never even heard of. The populous is constantly being bombarded with reasons to take pills. Obesity drugs are the next big sales hit, be it too much to focus on diet as a start. And if people don’t have the money to spend on food, obesity will get that much worse.
Another anecdote I took away was how everything is leased. The media is constantly marketing houses and cars for lease. Interest free for the first few years! The savings rate in the US is low for good reason.
i could go on, but enough already.
The socioeconomic divide must get the attention it deserves.
The US is a rich nation. It has the capability to avoid a potential social economic disaster but until the 0.1% and the lobby groups understand the consequences of their lack of action, the issue will be ignored. Trump is a markets man and has focused on reducing corporate tax rates. Advantageous for the short term, but not on the longer term.
There doesn’t seem to be any energy or desire to change the current trajectory of rising deficits and worsening a socio-economic landscape.
My bet is that, during the next recession, the Fed will again be expected to ride to the rescue, providing more ‘free money’ in the hope that this will once again filter through to the man on the street. More of the same, ‘easy money’ policies.
Eventually, a massive initiative will likely be made to provide a larger social security net. This will most likely, unless budgets are cut elsewhere, have to be funded by the Fed, through its asset purchases. Like the prior recession in ’08 the Fed and Treasury may be effective in balancing the decline in the velocity of money, but eventually such policy may have implications for the dollar.
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