“High debt levels, whether in the public or private sector, have historically placed a drag on growth and raised the risk of financial crisis that spark deep economic recessions.”
– The McKinsey Institute
March was an outstanding month for the strategy as the portfolio closed up 1.8% vs -1.7% for the S&P 500. For the quarter, FatAlpha is up 6.5% vs 0.4% for the market. A reader, whom I told the performance to, asked what I did to achieve this result. Simply, just continued doing what I’ve been doing. Yes, KISS principal. Like I’ve always said if your method is solid then the returns will come. The best performers were CTB (+13%), ACCO (+9%) and SANM (+7%). CTB has gained 23% in the last two months. The worst performers were old school tech HPQ (-11%) and XRX (-6%).
During my trip to London I went by a Shake Shack and tried out the burger of this newly listed company. Check out 
the report and view on the stock I wrote for Seeking Alpha here: http://goo.gl/TSQILx
The markets and many investors love to get all worked up during the Fed meetings and when rates will go up. A lot of it is media hype and I don’t think investors should pay much attention. For the simple reason, that any rate hike doesn’t mean diddly-squat! Will 25 bps really make a difference? Theoretically, it’s a meaningless increase to any discount factor investors and analysts use and thus doesn’t really change valuations. And from a debt side, I don’t see many debt deals getting cancelled over 25 bps. On the other hand, there is the issue of perception by the market. Participants may say a rate hike means the economy is strong and thus buy the market. Many investment professionals believe we are out of the woods and need to start normalizing rates.
I have a different view. We are at or very close to normalized rates – the new normalized rates. US economic data has not been as wonderful as some claim, but more importantly people forget how much leverage there is in the world. According to a report by McKinsey (see: http://goo.gl/u2DUQd) since the financial crisis there is $57 trillion more debt in the world. As a percentage of GDP, it has risen to 286% vs 269% in 2007 and 246% in 2000. No deleveraging = no return to normal. This debt drag will result in a low growth world with little at all inflation. Hence interest rates will remain low worldwide. (Special thanks to John Mauldin for highlighting the quote in his March 28th letter which I also have decided to use).
I don’t think this has sunk in yet. I am siding with the Ray Dalio (google Bridgewater for more) and the other doves, as the global conditions mean that the U.S. Fed should remain “patient”. (A rate hike will only make the USD more attractive which will result in an even bigger earnings’ shocks. The majority of guidance given by companies I have looked estimate a weaker dollar. Hence there will be EPS misses even without the hike. So we have weaker earnings and a weak global economy. Can the U.S. rising out of this and be an engine of growth, thus needed a rate hike? While I believe the US will perform better than other economies, the U.S. is not an island and its growth will not be something to write home about. It would be better for the Fed to be late rather than risk a premature rate hike which could push the U.S. economy in reverse. This may not only result in a drop in the S&P but a shift to a global risk off trade. Having said that, the Fed may see all this and hence the delay in the rate hike. Therefore it is likely that we get a 25 bps hike in September or December accompanied by language that there won’t be much in hikes for a while.
Four out of five fund managers said bonds were overvalue (see FT article http://goo.gl/bGP1pL). No arguments here with all the negative yields we are seeing in Europe. Risk is not priced correctly, and as globally rates are benchmarked to the European and US rates, the risk is mispriced globally. The biggest bubble of all is not in equities but in bonds. But didn’t I just say that rates should remain low? Yes, however that does not mean that 2 year Spain should be at 0% and Indonesia at 1.6%. Not to mention the high risk ventures (like biotechs) getting access to free money. Why shouldn’t spreads be wider? More risk, higher yield. But the bond market is now Nasdaq of 2000 with the greater fool theory at full throttle. A shake up in the global markets will result is a magic act – the disappearance of liquidity. No buyers, margin calls, forced sellers. And all these ETFs will only make matters worse.
Now this crash will occur at some point in the near future. I’m not saying a rate hike will trigger it but if combined with some other event, then perhaps. There is always the hope that reforms are put in place and there is a global deleveraging, but the most likely scenario is that at some point a series of events will bring on another crash. This could be a Greek default and/or an escalation of some war. It’s impossible to know in advance, but investors will see blood. The only thing an investor can do is be prepared and have a plan. But at the end of the day this is all just good discussion. I am no genie and I am very happy I am not a macro guy but a simple value investor who goes about his way picking stocks that form a portfolio that beats the market.
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