So called experts like to discuss concepts like value and why emerging markets are set to soar, don’t fall into this trap, urges Landon Whaley.
Headline risks are everywhere. As an investor, you must keep human reactions in check so that you’re not drawn into well-written narratives that promise to unveil the mystery of financial markets. This week’s Headline Risk continues our evaluation of the Old Institution and its “experts,” by examining the market calls of contributors to an April article from Bloomberg.
Brian Singer is co-manager of a big boy global macro allocation mutual fund, and he believes you should take your hard-earned $10K and bet on Brazil because, “the Brazilian equity market is cheap on a fundamental basis.”
This cheap talk driven by an argument on valuation makes the dormant rage rhino inside of me come to life.
Now, I’m not picking on Brian (O.K., well maybe a bit) because he’s not the first or the last person that thinks catching falling stocks is a profitable venture because they’re cheap. As regular readers know, I don’t believe valuation has any place in an investment process. I’ve been professionally managing money for 20 years, and on more occasions, than I can count, I’ve seen cheap stocks get cheaper, and expensive stocks get more expensive.
The reason that cheap assets get cheaper and expensive assets gets more expensive is because of the prevailing Fundamental Gravity. Shocking, I know. There’s a reason why stocks in Singapore, Spain, Brazil, and India are getting the woodshed treatment this year. All five of those economies are in a Winter Fundamental Gravity.
The last asset class on Earth you want to own during a Winter Fundamental Gravity is the equity market in that economy, and that goes double for emerging economies. Further, the very last asset class you want to own when the United States is in its own Winter not so wonderland is any emerging market equity.
Why? Because Winter in the United States is the most bullish of all environments for the U.S. dollar. There is nothing that cripples a weakened emerging market economy (already struggling with its own Winter FG) more than a strong greenback. Emerging market equity markets hate a strong dollar with the same ferocity with which I hate Christian Laettner.
In short, don’t buy Brazilian equities (or any other emerging market) while the entire world is experiencing Winter, and the U.S. Dollar Index is within spitting distance of par (1.00). If you think emerging market equities are cheap now, given them six months and you’ll feel like you just bought childhood drawing byAndy Warhol for $5 at your local flea market.
Finally, we have Terri Spath, the Chief Investment Officer at Sierra Mutual Funds. She thinks “it is intriguing to know that in past periods of fear when high-yield corporate bonds have offered similar returns, the asset class has rebounded more quickly and outpaced U.S. stocks in the following months and even up to three years.” “After drawdowns in March, [high yield] funds are poised to gain with less risk than stocks and similar returns.”
Wow. U.S. corporate earnings are negative. We are within six months of corporate cash flow turning negative. An 18-month corporate debt default cycle just began, and yet Terri thinks the best place for your 10,000 shekels is high yield debt?
The only bullish tailwind (and not nearly as meaningful as people believe) high yield bonds are experiencing right now is that the Federal Reserve is gobbling them up like your Uncle Ray takes down mashed potatoes and cranberry sauce at Thanksgiving dinner.
Given the number of companies that will default or just simply cease to exist over the next 18 months, who in their right mind would risk capital in high yield bonds right now?
The Bottom Line
While the temptation is great, you must resist the urge to do anything with your investments that run contrary to the prevailing Fundamental Gravity. Both the world the U.S. economies are in a Winter Fundamental Gravity until further notice. This Fundamental Gravity reality makes equity markets and high yield bonds a no-go operation until we see a transition back into Spring or Summer. Further, there is no recovery (resembling any letter of the alphabet) because we are still trying to find the floor in economic growth terms. The worst remains in front of us, not behind. Trade accordingly.
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