Capital Ideas Newsletters


Lighting the Fuse

January – February 2016

As if there were not enough concerns to start the year, the falling Yuan precipitated by China’s weakening economy hit the markets hard right out of the gate in 2016. Oh, and then Mr. Kim Jon-un decides to light a bomb – maybe an H-bomb, but maybe “only” the A-bomb……now really is that any better??!!

My, how things change! The House of Saud is considering taking its oil company, Aramco, public. Its value as estimated by The Financial Times is $2.4 trillion compared to Exxon’s $300 billion. Incredible, is it not?

The Saudis are trying to become a modern society and selling shares in Aramco is certainly a good step in the world of commerce. However, their unrelenting pumping of oil has decimated the U.S. emerging energy and exploration companies, as well as much of the shale industry here and in Canada. Was it their plan to make us more dependent on them once again? Should we not be incenting our domestic industry through further tax benefits to retain the “upper hand”?

In this ever-increasing E-world, can we ever feel safe and private again? I would love to see Google, Facebook, Microsoft and Amazon come up with a solution for that question!

The “January Jolt” to the markets woke up those who have been complacent and those who do not respect the power of the Fed. As we said in our year end letter, when the Fed moves, the consequences are not always clear until the markets speak. To us it is apparent that the market weakness is illustrative of general nervousness over where the U.S. currently stands and how fast China is growing.

Earnings multiples, in general, seem to be stretched given the number of disappointments and the markets have reacted by selling off. As usual, the pundits provide a myriad of explanations: China, the strong dollar, the Federal Reserve, the political situation in the U.S. However, at the center is the end of a weak recovery fueled by cheap money.

What needs to happen now in order to progress is for leadership to emerge. Policies must be put in place to stimulate growth. These fiscal policies must invest in our future rather than building debt and creating entitlements.

We believe that the best offense in these volatile markets is a smart defense, and so we have adjusted many portfolios in case there is further weakening.

Bonds have performed well, contrary to what most believed would occur after the Fed announced the rate increase. We were in the minority in believing that rates would remain low and trend downward, particularly on the ten-year U.S. government note.

The forces of “loose money” given to us by Ben Bernanke and Mario Draghi are playing out in such a way that the markets have become addicted to them in the absence of vision and leadership both in executive and legislative branches.

Oil and the stock markets have become correlated as many perceive oil price declines as an indication of weak demand. Gary Cohn, President of Goldman Sachs said at the Davos Economic Conference, that oil demand was up 1.1% last year over 2014. As such, over-supply seems to be the issue. This over-supply, we believe will self-correct as it always does via the market mechanism.

Volatility will be ever-present, particularly because of the emergence of Exchange Traded Funds. Money is moving in large amounts and with great speed. Sometimes, these movements are not based on investing fundamentals, but rather, market dynamics and quantitative black box trading strategies.

We hope to take advantage of these markets, both on the upside and the downside.

Personal balance sheets have greatly improved since 2008. This gives us some comfort. For example, at the end of 2007, household debt equaled 135% of personal income. According to Federal Reserve figures, today that figure has dropped to 103% as of the third quarter of last year. Households are now devoting 15.3% of income to meeting debt payments versus 18.1% in 2007.

On the corporate side, U.S. banks are also in a stronger capital position today with approximately $1.1 trillion in common equity at the end of 2014 versus $459 billion at the start of 2009.
The bigger issue is worldwide government debt. As a prime example, U.S. debt was equal to 101% of gross domestic product in the last year’s third quarter, versus 63% in the late 2007.
We must reduce our government debt. The implications of not doing so is a society which cannot grow and which will choke capitalism with heavier and heavier tax burdens reducing individual incentive.

In closing, we are asking you to evaluate your tolerance for volatility and market swings and to please contact us with your questions and comments. We want you to sleep as well as possible and expect this year to test the mettle of most investors. The proper allocation using different asset classes is the best way to safeguard your portfolios, so please do not hesitate to be in touch.

Voltaire said, “Don’t think money does everything, or you are going to end up doing everything for money”.

Enjoy yourselves!

With Kindest Wishes Always,
Seymour W. Zises

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