I’m back from Camp Kotok. As always, it was both rejuvenating and enlightening.
This year, I quickly sensed a more upbeat mood. There were not that many that were wildly bullish, but most were positive or at least neutral. There weren’t nearly as many bears as I expected. “Cautious optimism” seemed to be the theme.
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Q2 hedge fund letters, conference, scoops etc
That led me to refine my own views with a wide variety of participants. Today, I’ll do the same for you.
Two Reasons Optimism Is Growing
At Camp Kotok, I and my associate Patrick Watson had quickly and independently reached the same impression. This crowd was way more optimistic than we expected, and more so than last year or the year before.
So we spent the rest of the time trying to understand why. It boiled down to two things:
- They aren’t nearly as worried about tariffs and a trade war for an odd mix of reasons.
- They think tax cuts and deregulation will postpone recession.
I kind of agree with the second point. My belief is that we are seeing more benefits from deregulations, but we can’t ignore the tax cuts.
You wouldn’t know it by reading mainstream media, but most taxpayers saw a real percentage decrease in their tax rates and an actual increase in take-home income. Yes, corporations did get the biggest part. I wish it was spurring more investment, but we are at least seeing some businesses hire and expand.
The latest GDP and employment data was encouraging this year. And in talking with business owners, I have sensed growing optimism. The tax cuts, deregulation, and other legislation seem to have stoked “animal spirits” in ways we haven’t seen for quite some time.
My worry is that this sentiment is temporary. That the bump will last only a quarter or two. The Camp Kotok consensus was it could extend through 2019 and some saw it going into 2020.
That is hard for me to believe, in part because of the first point. I see significant risk that US trade policy will spark a larger trade war and recession. Camp Kotok was more optimistic there, too, and that launched some lengthy debates.
Why Trade War Fears Might Be Overblown
Trade negotiations are an insanely complex matter. Worse, finding objective and fact-based analysis is hard because people have strong opinions about the subject. But I did find some at Camp Kotok, though with close Washington connections.
Here’s the insider’s expectations I heard from a China trade expert (who is not at all a Trump fan, by the way). This was not the consensus view at Camp Kotok, but it’s not far off.
- The US and Mexico are very close to a bilateral agreement on NAFTA issues. Incoming Mexico President Lopez Obrador is on board, but it will likely be signed before he takes office in November.
- The Trump administration will use the Mexico accord to extract concessions from Canada. Faced with the prospect of NAFTA falling apart otherwise, Canada will agree.
- With NAFTA revisions done, Trump will pivot to China. The current slate of tariffs is starting to bite Beijing, and it looks willing to substantially increase purchases of US goods. A Chinese agreement could come later this year or in early 2019.
- By 2019–2020, the US-China trade deficit will be much lower, giving Trump an accomplishment on which to run for re-election in 2020.
- Europe will be harder to actually get accomplished than seems to be the mainstream belief, but there seems to be a willingness to negotiate tariffs down to zero. Over what timeframe? I guess that is for the negotiators to figure out.
The Camp Kotok bottom line on trade is that:
(a) any serious problems are deep in the future, and
(b) markets and business owners aren’t too worried.
This will be apparent to all by early 2019 and possibly sooner. With that concern off the table, the economic recovery (or “boom,” if you prefer) will intensify and endure into 2020.
So, we should all enjoy the good times while we can.
The Financial Industry Is Changing
The fintech revolution was another focal point of our discussion.
Many warned of a massive move to online account management (especially mobile). This would shift assets away from legacy banks and brokers to lower-cost managers.
For example, Fidelity recently launched some index funds with 0% management fee. They will make money in other ways, but I heard a great deal of concern nonetheless.
Yes, younger investors are shifting away from traditional management. But for now, at least, those are also smaller accounts that cost more to maintain and service.
However, a very well-known asset manager argued that the simple fact is that people are not going to manage a $500,000 or $1 million account or more from their phone. Most are still going to use a financial advisor/broker (or two or three), even if they do take a sharper pencil to the fees (which they should).
Nonetheless, fees are going to fall across the board in the industry.
We’ve Got Time to Prepare
Again, the above forecasts are the consensus I heard. I’m not fully on board with them all, nor was every single Camp Kotok participant.
I talked to others who share my concerns and a few who were even more negative. I am quite concerned about tariffs affecting the recovery sooner rather than later. Protectionism and trade barriers are, in fact, my biggest worries. They will be difficult for businesses to overcome.
Further, one former Federal Reserve official told me the Fed is locked-in on the tightening path and will keep hiking, even if the economy weakens. That’s a scary thought.
That matches my reading, which is that the Fed is pretty much locked into three more rate increases and four if they feel they can get away with it. I think they will keep tightening so long as the economy grows 3% and inflation is a tad over 2%.
How to reconcile this?
Most Camp Kotok attendees have lived through several cycles. They know that big change happens slowly. The global macro forces that could derail this decade-old recovery and bull market are real and will eventually assert themselves. But not this year or next, at least in the consensus opinion.
This is good news because it gives us time. If the Camp Kotok consensus is right, we have another year or two to accumulate capital, prepare our portfolios and businesses for the downturn, and help others do the same.
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