A Long, Hot Summer
By Yiannis G. Mostrous
ATHENS, Greece–I have a friend here in Greece who works as a relationship manager in the private banking (i.e., high net worth individuals; in Greece, that means liquid assets above $1 million) section of a big Greek bank; let’s call him George. Another friend, Nikos, is a client of George. My position as a mutual friend has given me the opportunity to observe the psyche of investors and participants in this uncertain market environment.
Nikos is a trader and is thus quite active. He appreciates updated information and at the same time is willing to listen to George’s take on the market. The problem is that George is quite uncertain these days and consequently not very helpful. A typical day will go like this:
George will call in the morning to inform Nikos about the market action in Europe. Nikos will ask some questions and finally–as always–will ask for George”s personal view of the market. George is generally downbeat, saying things like, “I don’t really like the action.” Given the way markets have behaved this summer, he can”t really be blamed. Then they hang up.
Around 4:30 pm local time, Nikos will phone George again, looking for information about how the US markets have opened. At this point, if the US has opened higher, George is generally upbeat, having forgotten his morning gloom. Nikos is assured that everything is OK, that he shouldn”t change any of his positions, that he should probably buy in the morning (the Greek market is closed by this time). Nikos never does, but his changes of heart always give us a good laugh as we jointly curse George, a friendly Greek tradition.
But a cursory tour around global markets should be enough to prove that the scenario detailed above is a microcosm of prevailing sentiment. Market participants around the world, at every level, are extremely perplexed and unsure as to what the markets have in store. And as everyone knows, markets dislike uncertainty.
It all starts with the Federal Reserve. The current leadership of the US central bank has been unable to provide the forward-looking guidance that markets had become accustomed to in recent years. We can all say that Fed decisions are “data based,” but the fact of the matter is that though there may be transparency regarding the direction of future policy moves, there’s no clarity. The previous Fed chairman, despite his oracle-like speeches, was always able to communicate his next move to the market.
It’s still early for “Gentle Ben” and, even as it’s tested him, the market has been fairly kind. But the minutes of the June Federal Open Market Committee meeting revealed that the policymakers couldn’t even agree on whether the current 5.25 percent level for the funds rate was “modestly restrictive,” or whether it was “somewhat accommodative.”
Global markets have treated central bankers as gods for years. Such indecision naturally evokes fear in market participants–the feeling of life without a protective net. Indicative of the problem, there are a lot of people getting paid while they try to find ways to read the new Fed.
Given the current status of the Fed’s thinking–or my interpretation of it–a pause in the next meeting is possible. In other words, do nothing until the economic data is more certain. On the other hand, the Fed could continue tightening, taking the fed funds rate to the 6.0-to-6.5-percent range and increasing the probability of a 2007 recession. The latter scenario could happen if Fed officials prove to be more confident regarding the economy’s ability to withstand the tightening than the rest of us mortals.
For the short term, the common expectation is that if the Fed pauses in August, the markets will rally. I have no inside information, but a short-term rally, if it happens, will probably prove to be nothing more than a short-lived spark.
Wait for the Fed to start cutting rates before you jump into any high-beta trades. In the meantime, stay with the defensive positions in the SRI Portfolio.
If you want to play the potential rally, Ericsson is your pick. Although it’s a strategic high-beta pick, Ericsson clearly has the potential to rally if the prevailing market expectation materializes; sometimes the consensus is right, and this could be one of those times.
That said, investors remain gloomy, although Europeans seem to be more upbeat than I’d previously thought. (I’ll have more on Europe later this month.) I’m a little more benign than most, still trying to evaluate the situation and make changes, if necessary.
If market action proves as positive as the majority believes, expect Asia–overweighted in the SRI Portfolio–to perform if not well than at least much better than the more developed markets. Emerging markets in general and Asia in particular remain structurally the only real growth game in town. That said, a hard landing in the US will hurt global markets substantially. But the view here remains that Asia will bounce back faster than the rest.
The Portfolio, as currently constructed, will perform in either a bull or bear market scenario. As things stand, when looking at Asia ex-Japan, Taiwan, Thailand and Singapore offer the best of both worlds: upside potential with downside protection. China and Indonesia are on the opposite end of the spectrum.
One last note regarding the short term: In the March 8 issue of SRI, Hedge Your Bets, I presented a chart of a ratio used to assess the forecasting of tactical (i.e., short-term) market moves. As I wrote then, when the ratio falls below the support level of 1.3, the risk of a selloff increases. That ratio recently broke below longer-term support, but hasn’t reached 1.3. Things still aren’t looking very promising.
Source: Bloomberg LP
As a courtesy to new subscribers, here are some of the Rules Of Engagement as published in the first issue of SRI:
ATHENS, Greece–I have a friend here in Greece who works as a relationship manager in the private banking (i.e., high net worth individuals; in Greece, that means liquid assets above $1 million) section of a big Greek bank; let’s call him George. Another friend, Nikos, is a client of George. My position as a mutual friend has given me the opportunity to observe the psyche of investors and participants in this uncertain market environment.
Nikos is a trader and is thus quite active. He appreciates updated information and at the same time is willing to listen to George’s take on the market. The problem is that George is quite uncertain these days and consequently not very helpful. A typical day will go like this:
George will call in the morning to inform Nikos about the market action in Europe. Nikos will ask some questions and finally–as always–will ask for George”s personal view of the market. George is generally downbeat, saying things like, “I don’t really like the action.” Given the way markets have behaved this summer, he can”t really be blamed. Then they hang up.
Around 4:30 pm local time, Nikos will phone George again, looking for information about how the US markets have opened. At this point, if the US has opened higher, George is generally upbeat, having forgotten his morning gloom. Nikos is assured that everything is OK, that he shouldn”t change any of his positions, that he should probably buy in the morning (the Greek market is closed by this time). Nikos never does, but his changes of heart always give us a good laugh as we jointly curse George, a friendly Greek tradition.
But a cursory tour around global markets should be enough to prove that the scenario detailed above is a microcosm of prevailing sentiment. Market participants around the world, at every level, are extremely perplexed and unsure as to what the markets have in store. And as everyone knows, markets dislike uncertainty.
It all starts with the Federal Reserve. The current leadership of the US central bank has been unable to provide the forward-looking guidance that markets had become accustomed to in recent years. We can all say that Fed decisions are “data based,” but the fact of the matter is that though there may be transparency regarding the direction of future policy moves, there’s no clarity. The previous Fed chairman, despite his oracle-like speeches, was always able to communicate his next move to the market.
It’s still early for “Gentle Ben” and, even as it’s tested him, the market has been fairly kind. But the minutes of the June Federal Open Market Committee meeting revealed that the policymakers couldn’t even agree on whether the current 5.25 percent level for the funds rate was “modestly restrictive,” or whether it was “somewhat accommodative.”
Global markets have treated central bankers as gods for years. Such indecision naturally evokes fear in market participants–the feeling of life without a protective net. Indicative of the problem, there are a lot of people getting paid while they try to find ways to read the new Fed.
Given the current status of the Fed’s thinking–or my interpretation of it–a pause in the next meeting is possible. In other words, do nothing until the economic data is more certain. On the other hand, the Fed could continue tightening, taking the fed funds rate to the 6.0-to-6.5-percent range and increasing the probability of a 2007 recession. The latter scenario could happen if Fed officials prove to be more confident regarding the economy’s ability to withstand the tightening than the rest of us mortals.
For the short term, the common expectation is that if the Fed pauses in August, the markets will rally. I have no inside information, but a short-term rally, if it happens, will probably prove to be nothing more than a short-lived spark.
Wait for the Fed to start cutting rates before you jump into any high-beta trades. In the meantime, stay with the defensive positions in the SRI Portfolio.
If you want to play the potential rally, Ericsson is your pick. Although it’s a strategic high-beta pick, Ericsson clearly has the potential to rally if the prevailing market expectation materializes; sometimes the consensus is right, and this could be one of those times.
That said, investors remain gloomy, although Europeans seem to be more upbeat than I’d previously thought. (I’ll have more on Europe later this month.) I’m a little more benign than most, still trying to evaluate the situation and make changes, if necessary.
If market action proves as positive as the majority believes, expect Asia–overweighted in the SRI Portfolio–to perform if not well than at least much better than the more developed markets. Emerging markets in general and Asia in particular remain structurally the only real growth game in town. That said, a hard landing in the US will hurt global markets substantially. But the view here remains that Asia will bounce back faster than the rest.
The Portfolio, as currently constructed, will perform in either a bull or bear market scenario. As things stand, when looking at Asia ex-Japan, Taiwan, Thailand and Singapore offer the best of both worlds: upside potential with downside protection. China and Indonesia are on the opposite end of the spectrum.
One last note regarding the short term: In the March 8 issue of SRI, Hedge Your Bets, I presented a chart of a ratio used to assess the forecasting of tactical (i.e., short-term) market moves. As I wrote then, when the ratio falls below the support level of 1.3, the risk of a selloff increases. That ratio recently broke below longer-term support, but hasn’t reached 1.3. Things still aren’t looking very promising.
Source: Bloomberg LP
As a courtesy to new subscribers, here are some of the Rules Of Engagement as published in the first issue of SRI:
The purpose of this advisory is to help investors navigate the global markets and, in the process, make money. Here then are the rules of engagement for The Silk Road Investor.
The Portfolio won’t cover any US-based companies, but will include companies from all the other regions of the world. US companies benefiting from themes presented here, though, will be suggested periodically.
The Portfolio will be a long-only portfolio with no cash allocation. This is being done so the comparison with world stock indexes can take place on a fair basis–global indexes that investment advisors like to compare themselves against include only stocks and are always long.
Hedging advice will also be offered–starting next week–that will be included in every issue, although not as a part of the Portfolio. Investors will be able to achieve positive returns, while SILK will be fair when comparing its performance to the world’s indexes. Cash–once again–isn’t an option here either.