With the first quarter of 2015 just behind us, it is a perfect opportunity to discuss how we see Financial markets for 2015.
Unfortunately our view has not changed much. I am still bearish and see more risk to the downside than the upside. My reasons are quite straightforward.
Before I go into further depth, I will openly admit, for the past two years I have been too cautious.
Last year equity market rose again and the US markets have reached new records highs this year. Our predictions that financial markets would be a bad bet (with a focus on the US) have proved wrong.
It reminds us once again of a famous saying on Wallstreet: ‘The markets can remain more irrational than you can remain solvent’.
Thankfully I don’t manage other peoples capital, only my own which is luxury and at the same time a potential curse. It is a luxury as I can look out more than one quarter and be a true long term investor, ignoring all the short term ‘noise’. I
t is a potential curse since there is no pressure to perform and I can stick to my view on world financial markets even if I am persistently wrong.
So why am I still cautious and bearish? Is it because I am not willing to admit defeat and accept being wrong? Not at all.
Making mistakes is part of the game and I have made plenty. Managing money is about managing risk (something I learned the hard way back in 2000) and right now it is the ‘risk’ side of the equation that I worry about. This is why as an ‘insurance’ I remain partially short the US market through ETF’s*. Was this a mistake in the past two years? Sure it was. But being short allows me to have good insurance for any correction that sooner or later will take place.
Why do I have such a cautious outlook especially concerning the US market?
For several reasons: how about the fed creating an asset bubble, China slowing down, the currencies creating dislocations (if the USD rises further some big emerging markets cannot fund their debt anymore). I also worry about the 10 yr treasury bond being at 1.85% (what does this tell us about growth prospect and interest rate rises?). Oil collapsing from $100 to $50 is good for the consumer but what does this tell us about global growth? Perhaps the greatest warning sign for investors is coming from investors themselves.
There is huge amount of complacency in the market and a correction of more than 400points in the Dow Jones (see picture below) seems like a distant memory now.
So how am I positioned?
The key is to remain extremely well diversified.
I have a net long position in global equity markets but I have hedged those bets with going short the US market*. I also hold some gold which I have slightly increased again against further central bank printing. Additionally I own a large amount of zero coupon 10 yr treasury bonds for further diversification and my cash levels are higher than ever at nearly 70% (fully aware that cash is not a productive asset right now).
Within equities I remain extremely diversified holding Consumer brand companies with a strong dividend yield, several large REITS (that provide stability and yield) as well as good exposure to emerging market and European shares (both which trade a fair to under-valuation).
In summary I believe remaining cautious at current valuations is the only right approach to take.
I don’t know when equity markets will correct but they will eventually. Could they continue to climb for another year? Sure. But at current world equity prices (except for a few companies in Europe) I believe there is more downside than upside. This is the luxury of managing money independently being accountable to no-one except my cash flow expenditures.
I can stick to a view for a long time even if I am wrong in the short term.
*Investors familiar with leveraged ETF’s (inverse-which are short instruments) will understand that with time, the effect of the short gets diluted. I have been wrong in 2014 and wanted to take advantage with tax loss selling.
As a result I have sold my short ETFs by end of year 2014 and taken a tax loss. At the same time I have invested in higher leveraged short ETF’s to continue being exposed short (actually increasing my short exposure) but having the tax advantage of booking the loss.
This is done for tax optimization (sadly as a US citizen tax plays a large part of your investment return) and I won’t get into more detail -but thought I would disclose this. The current short instruments I hold are: the S&P 500 (using between 1x and 3x leverage), short position in Russell 2000 (1-2x leverage), and short position in the Dow Jones 30(1-3x leverage).
Another reason I am so bearish in the US markets is the lack of volatility in recent years.
With an absolute level of the Dow at 18′ooo it should not be surprising when the Dow loses 4-500 points in a single trading session. Even 800 points would not be out of the ordinary (would only represent 5%). However this seems like a distant memory (see picture below). And the Dow falling 800 points would cause a panic, but would actually be a normal outcome and perfectly healthy. Investors are clearly complacent (see main image of the Bull).
