The U.S. economy continues to grow, but at a slower rate than in earlier 2018. From currency to emer...
Merk's Moves in a Caution Market
12/11/2015 10:00 am EST
Axel Merk sees long-term downside risk in equities along with select upside opportunities in currencies and metals. Here, the money manager for Merk Funds, walks us through his analysis and explains where investors should focus their portfolios in the current environment.
Steven Halpern: Our special guest today is Axel Merk, of Merk Investments and manager of the Merk Funds. How are you doing today, Axel?
Axel Merk: Great to be with you.
Steven Halpern: When we last spoke in August, you had just turned decidedly bearish on the stock market, arguing in large part that there was a lack of fear in risk assets which suggested to you that complacency was too high. Has anything since August changed your view or do you remain cautious on the market outlook?
Axel Merk: I remain very cautious. In the short-term we were right that volatility would surge, but the decline in the market, well, it was short lived. It has recovered most of it.
Having said that, the kind of the environment as to why we’re negative hasn’t changed. Most notably, we said the catalyst is going to be a Federal Reserve that’s trying to extricate itself from the policies, meaning that risk premier will rise.
Before there was complacency keeping volatility down, and now that the Fed is trying to raise rates, volatility is going to go up. That’s going to create headwinds, and since I think many other parameters on the markets are also negative, I do think the negative pressure on the market is going to persist for an extended period.
Most notably, it’s going to take a while because a lot of people have been buying the dips and it’s going to take a while until they’re going to be selling the rallies to look for safety rather than veering out of losing out on a rally.
Steven Halpern: So, in effect, you’re really expecting a long-term change in psychology from where people are convinced that the market is still going up to one where they’re going to start veering. It might continue to go down. Could you expand on that?
Axel Merk: Yes, absolutely. Well, just think about what’s been happening. I think I mentioned it in August in some ways that when the markets go up and up and up and up and volatility is low, investors think, “Well, what can possibly go wrong?” They’re worried about losing out on the rally to buy the dips.
As volatility comes back in—as prices come down—people will be more cautious but not everybody, of course, is going to jump off the fence at the same time.
When we talk to institutional investors, in recent weeks, they don’t like stocks, they don’t like bonds, but they haven’t changed anything. When we talk to investment advisors, they say, "Well, if we don’t buy stocks we’re going to lose our clients because we might be missing a rally."
As volatility goes up, as prices and equities go down, more and more people will say, "Well, wait a second, I haven’t even rebalanced my portfolio as I should’ve probably done in the first place."
If you have a traditional 60/40 portfolio with 60% in equities, odds are that the equity portion has gone up. “Well, let’s at least do the prudent thing and go back to 60%.”
As more and more people do “the prudent things,” the downward pressure is going to increase and more and more people are going to say, “Well, wait a second, I really would like to preserve what I’ve earned in recent years. “
That’s why these things don’t happen overnight. It’s going to play out for a while. The minimum is probably six months. I wouldn’t be surprised if it takes 18 months or three years.
Steven Halpern: Now, as you alluded to earlier, it’s widely expected that the Fed will begin to raise rates shortly. You note in your latest research that this is happening during a slowing economy. What are the risks you see here?
Axel Merk: One of the challenges is that we’ve based this recovery on asset price inflation. Similarly, just as volatility goes up and the Fed trying to raise rates, asset prices might go down. And that’s going to create additional headwinds to recovery.
This isn’t the first time that the Fed would hike into a slowdown. They did it just before the financial crisis as well because they finally are not afraid of hiking rates or they’re late to the game. They’re just human beings trying to make a choice.
Now I’m not suggesting we should stay at zero. I think it’s been a bad policy. What we need is, we need a path. We need to know where we’re going to be heading in and the Yellen Fed is so squarely focused on employment—or by definition—employment is a very backwards-looking indicator.
I see that many businesses are starting to struggle. The tech sector isn’t doing well. Corporations are not reaching their revenue targets and you can blame it on the dollar. There are a lot of underlying currencies that don’t look so good.
With the Fed trying to raise rates I think that’s a lot of wishful thinking, except that translating their wishful thinking into actual policy and that’s going to exacerbate the downdraft.
Steven Halpern: Merk Investments is long known for its expertise in both gold and currencies. Could you tell our listeners a little about the funds you offer and how their positioned for the market environment you see ahead?
Axel Merk: Sure, well, gold is the easy one because we own physical gold and with the special feature that investors can take delivery of the gold. It’s an exchange-traded fund they can take delivery of. The reason we like gold is because, historically, it has a low correlation to the equity markets.
Because of that, if equity markets go down, you want to have something that has a low correlation. The other attribute you want to have, you want to have a positive return expectation. I happen to think that real interest rates—meaning interest rates net of inflation—will continue to be low to negative.
One of the reasons I think so is because I think the Fed is telling us that. If you’ll read the FOMC statement, they say that even as employment inflation goes back to what’s historically considered normal, the rates are going to be less than normal. I think gold as a diversifier notably goes out of fashion.
Beyond that, gold is very easy. People love it or hate it. We deal with it a lot in the currency space. Notably we love our long/short currency strategy. It’s a strategy that’s based on both macro factors, but notably a lot on assessing risk sentiment in the market.
Now, I can explain it to you, but I’ll probably put half the audience to sleep. That’s really the challenge with those sort of strategies.
You want to have a strategy that it doesn’t necessarily need to have performed that great of late, which always hasn’t, but you want to have something that structurally provides something that has a low correlation in a market that might go numb, and with a long/short currency strategy, you can’t guarantee that you make money but you will be almost certain to have something with low correlation.
Then we have two other funds. One is a hard currency strategy with a play on the declining dollar has had an abysmal performance, but hey, if you listened to what Janet Yellen even said in her testimony most recently, where she said there may be a lot of good news and surprise in the dollar. We couldn’t agree more to that. That’s a leap of faith for people to embrace.
Then we have an Asian Fund that’s become mostly a play on the Chinese renminbi. Indeed, we have filed with the SEC to change the name into a fund that squarely focuses on renminbi. We’re still doing a few other things, but late January we’ll shift to that. Again, that’s a very opportunistic play if you believe that the renminbi is going to do well going forward.
Steven Halpern: Again, our guest is Axel Merk of Merk Investments. Thank you so much for your insights today.
Axel Merk: My pleasure.
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