Sorry, what button did you press?
We will probably never know who pressed the wrong button and set off an inadvertent alert for a non-existent ballistic missile attack on the island paradise of Hawaii. This error, by some low-level Joe who is now probably on “administrative leave”, created a world-wide pandemonium. I have several clients who want me on administrative leave for cutting my equity exposure on Friday from 85% to 65% with complete bewilderment on how I could have possibly done this.
All jokes aside, there are a few of you who believe that cutting back a little equity risk after a 5% gain in 2 weeks is moronic. Let me start by saying that I remain incredibly bullish on all asset markets for the balance of 2018 and beyond, as long as US 10-year yields stay below 2.65%. The thematic model portfolio is aggressively long emerging market assets, both equities and carry currencies, as well as technology stocks and global banks. I have stated consistently that if long dated US yields make three-year highs, primarily due to inflation concerns, then global beta could stall. Investors will rotate from growth to value and emerging market equities could face their first hiccup in nearly two years. So, as yields spiked, we took down a little risk. We covered some tactical short bond positions but maintained our long-dated inflation hedges. We add a small hedge to our EM exposure via an EEM short, still leaving us 35% long in EM and sold some US banks. This was another tactical trade, tied to long dated yields moving back to the top of the trading range. This happened, and we covered which was also prudent given the slew of bank earnings this week, an area where we have no edge.
And the response to taking down risk in an environment where US equities are massively overbought on any metric and where data and central bank rhetoric has been marginally stronger at best? I might as well have been that poor sucker who press the wrong button. There are simply no bears in the investing universe I frequent and no one I speak to, which is a pretty good snap shot of the investment community, is making anything but a supremely bullish argument. You have to compare sentiment today to January 2000 for NASDAQ. Even the Nikkei during the Koizumi revolution of 2005 had some skeptics. Global bullishness is excessive. The consensus is that nothing can go wrong near term.
I am not saying to slash risk. Just do not dismiss a less bullish scenario as impossible. Could bank earnings hurt? Maybe. Could the US government get shut down this week? Certainly possible. It may or may not affect asset prices, but it does take the shine off “uber goldilocks”. Over the next month, we will hear about US actions against the Chinese on trade. Difficult to see how the Chinese don’t respond, and as I commented on in last week’s Flagship report, major corrections in the last several years have tended to come from China. They could all be a false alarm. Hopefully so but if not, having a little dry powder would be handy. We are reaching levels where we are starting to add to long UK 10-Year Gilts and offers to sell the GBP. These were long standing orders and I see nothing to change my previous negative views of the UK.
All I am saying is be smart. Many of you are up 3%-5% for the month, hedging is cheap so why wouldn’t you start? I’m not bearish, but do you need to be max long? Does it hurt to book a profit? Be 80% of your potential exposure? If the market keeps going, that’s ok.
The Bank of Canada meets this week. On Tuesday, Japan PPI, Germany and UK CPI. On Wednesday, the US Industrial Production, Japan prints Core Machine Orders, Singapore Non-Oil Domestic Exports, and EU CPI. On Thursday, China publishes GDP, Japan releases Industrial Production, and Australian employment.
Founder, View from the Peak
IND-X Advisors Limited