The Economic Backdrop

  • We are in a secular (long-term) bear market which started in 2000, and which could easily extend into the early 2020s.  This is despite the fact that the S&P500 is 30% higher in 2016 than its highs in 2007 or 2000, which we believe has been artificially and entirely caused by Central Bank QE (Quantitative Easing) and does not reflect typical fundamentals behind any historical secular Bull markets.

  • There are four primary factors behind the secular bear market which has been characterized by a new normal of low global growth

    1. Unprecedented and rapidly increasing levels of sovereign, corporate, and personal Debt

    2. The rapid proliferation of technology and automation which is fundamentally deflationary

    3. Very poor long-term demographic trends in the developed world (except the US) and in China

    4. Continuing income normalization from globalization and the maturation of the outsourcing trend which limits wage growth in the West

  • The primary response to the growth slowdown has been monetary, i.e. QE (Quantitative Easing) and interest rates that have fallen below ZERO!  This has successfully kept the deflationary tide at bay thus far, and has lifted Equity markets to record levels.

  • Global market volatility has increased significantly as the side-effects of these unconventional monetary policies (falling commodity prices and Emerging Market/China deflation) have made the markets much more fragile.

What is next?

  • Volatility is expected to remain in the absence of economic growth, as the market swings from being pulled down by the deflationary secular bear market forces and being pushed up by the Central Bank support from QE and Negative Interest Rates, and fiscal stimulus expected from the new Trump Administration.

  • We believe we are (as of mid 2016) in the last quarter or so of the 7 year old rally from 2009.  We believe this rally cycle will end with a fairly spectacular inflationary pop, and Fed will have no choice but to raise rates coincident with this last stretch of the rally cycle, as they have started to do.

  • A recession is inevitable in the next 2 to 3 years because of the debt overhang and this inflationary pop.  Central Banks lose control when interest rate rises accelerate and inflation appears.  A reversal of the globalization trend could be an additional catalyst.  The weakest links in the sovereign and corporate debt chain can crack and trigger the recession, which could then create a knock-on effect on the dominoes of debt-encumbered Japan, the fragile Eurozone, and junk-rated commodity producers and corporations globally.

  • The new Trump administration's economic policies could potentially lighten the impact of this global recession on the US, making the recession longer but shallower than the 2008/2009 recession.

  • We do not expect the overall secular bear market to end until this recession ends, and until P/E ratios decline into the mid-single digits, as in other past secular bear markets.

Re-thinking Investment Approaches

  • Traditional fundamental oriented investment methods like Buy-and-Hold and Value Investing will fail or substantially under-perform relative to historical baselines, as well as in absolute terms, when measured over the remaining duration of the secular bear market. Read our White Paper on the 4 Reasons why Buy-and-Hold could actually be harmful to your Portfolio.

  • Traditional diversification will fail or under-perform as a hedge against losses because of tighter correlation between asset classes during the intense deflationary periods of this global secular bear.

  • This is a traders market with formidable characteristics from both the 1930’s and the 1970’s, favoring trading-style strategies built on reliable approaches that integrate technical, macro, and fundamental analysis.

 

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