Global Allocation Fund commentary for the month ended November 30, 2017.
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Last month, I ended my monthly comment stating that equities had a good upright margin based on their relative valuation in comparison to the rest of assets. Restating that both government bonds and corporate debt are in an absolute bubble zone.
This fact is even more true in Europe, where we can say that the main stock exchanges are still relatively cheap in comparison to the rest of assets, than in the US, where the bond bubbles are not so speculative, but the stocks valuations, depending on the criteria used, currently as of a date today, overpass the valuation not only the last two bubble periods, but also the ones staged in 1929.
One of the best ways of checking if we are “in danger” is, as Mark Twain said, analyse the opinion and the positioning of others. This way, we find ourselves in optimism levels, consumer confidence and corporate confidence levels only witnessed before 2000 and 2008. The funds’ liquidity is in historical lows from long time ago. The hedge funds are the main representatives of active management, as they have the biggest exposure to the principal stock exchanges of the last 10 years. In general, there is a feeling of urgency, not only with the Bitcoin, but with the possibility of missing out on the “great rise” of the stock exchanges.
It is true, as a matter of fact that in the last stages of economic cycles some indices might experience strong upturns, but the truth shall be said, we prefer to miss them or even miss something, that find ourselves trapped in a downfall that can be important and without previous notice, as the one staged in 1987.
The positioning in all types of bets that imply winning money thanks to “stability” or lack of volatility has gone pass any kind of unimaginable limit. The apparent lack of risk acts as feedback in this sense.
We can say that we can expect 70% chance of increases on the middle-run and a 30% chance of decreases. Nevertheless, probability does not work alone, but it instead looks at what we can gain or lose in these scenarios. The potential losses can be 4,5,10 times bigger, depending on the type of asset, than the potential gains. The biggest gain is sitting right next to the lower probabilities.
We are especially worried about the abrupt movement that the interest rate curves have had in the US, in which long-term rates have been considerably low when compared to short ones. Therefore, the 30-year bonds barely are worth more than the 2-year bonds. This indicator points to the fact that we will find ourselves very close to what real economy is capable to cope with before suffering a meltdown if interest rates rise. This scenario is already taking place in the US and bigger accruals are expected for next year.
In the case of inflation making its appearance, as some indicators are already presuming, central banks will have a difficult task in resisting market complaints regarding a policy heading towards inflation control, which can cause a downfall on all assets at the same time. For the time being, inflation is present in all the financial assets, even hyperinflation in some cases. We will see if with the infinite wealth printing machines of the central banks do we not suffer it again.
Even if our bet is on this inflationist variable as the main cause, it could also be due to geopolitical tensions (sanctions to Russia, non-agreements in the OPEC, North Korea, Saudi Arabia, Lebanon…) or to the deleverage – credit crisis in China, etc…
After the credit crisis in 2008, we have witnessed a shocking rise of the debt numbers of some countries and sectors, companies in the US (especially those who have bought their own shares, which motivated in large part, the increases), emerging countries and public debt in general, China’s in particular.
After all stated, we have decided to position ourselves slightly to the downside, both in equities and bonds. We will also buy options, to limit the possible losses and take advantage of this possible scenario. Although is does not seen imminent, is seems rather unavoidable.
I hope that you can have the patience that thinking that we are missing the party implies. Some hangovers are horrible. After analysing the exposure which we have had in the last few months, I can only remember a similar occasion to the one staged in late 2007.
This time may be different, but markets have gone from the investor stage to the speculative. What we can obtain immediately, by waiting, are the possible gains when someone else comes to buy higher.
Let’s hope this time is not different “to worse” and that the only things that do not stumble are some real assets as gold and grounds.
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