Market Highs Again – Where Next?

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Markets are at all time highs, what is an investor to do? On August 13th I had the pleasure of speaking with Stuart Varney on Fox Business concerning the sky high valuations in the stock market amid contracting earnings, earnings which are also highly deceptive given the level of financial engineering management has used to artificially boost earnings per share through share-buybacks, which are often debt funded!

We’ve yet to see the economy return to pre-crisis normal growth rates and businesses around the country consistently site government red tape as one of if not their biggest burden. Meanwhile the markets wait breathlessly to dissect the latest words out of a Fed officials mouth. We now live in a world in which the asset prices are heavily dependent on commentary from unelected bureaucrats. Me thinks it unlikely that this all ends well!

Not entirely sure why I was smiling that much… I suspect I may have had just a tad too much coffee. Apologies for the dental display!

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Italian Bank Stress Test Results

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On July 29th I spoke with David Asman on Fox Business concerning the results of the Italian Bank stress tests along with Adam Shapiro, Charles Payne and Steve Forbes. The recent vote in the UK to leave the European Union put a good deal of pressure on the banks in the remaining European Union, with the banks in Italy struggling the most.  Like any good Italian drama, this is likely to be a tight ride until the very end… at which point tutti bene, at least for the next few months!

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Brexit from London

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On June 25th, while in London, I had the pleasure of joining David Asman on Fox News to discuss the meaning of Thursday’s vote to leave the European Union. The view of Brexit from London has been stunning. All those who underestimated the British sense of self-confidence and desire for sovereignty or who were over-confident in the betting odds giving only a 25% change of leaving, are now paying dearly for that confidence. The shock amongst most in the financial sector in London is palatable, with the lights burning bright in most offices all weekend, as portfolio managers, investment bankers and traders work to get their arms around just what this means for them and their clients.

What this means for the US

Pundits in the US are trying to calm markets buy assuring them that this won’t over overly impactful for the US as the UK, the fifth largest economy in the world, only accounts for roughly 3.8% of world GDP, according to estimates for 2016 from the International Monetary Fund, versus the United States, which accounts for around 25.4%. But that misses that this is not just about the UK, but rather about the future viability and success of the European Union, whose GDP is nearly the same as the US. With the tumultuous and highly contentious presidential election cycle in the US,  about 50% of the world’s economy is now experiencing a high level of political uncertainty within the context of an already weak global economy. That is a strong headwind to growth for everyone.

The most immediate impact of Brexit for the US likely a continued increase in the strength of the dollar, which is great for American tourists abroad, but a challenge for American multinational firms that export their products and/or services. The strong dollar will also impact emerging markets that have a good deal of debt denominated in U.S. dollars, acting as a headwind to those economies as that debt becomes more expensive. The uncertainty of how this all will pan out means transactions and contracts between companies in the European Union and with companies outside of the union may be put on hold or cancelled entirely – more headwinds to growth.

Many today are harshly criticizing the Brexit leadership for not having a clear plan for what to do if their side actually won, but the reality is that kind of a plan was literally impossible. A plan would have required having some clarity on how agreements would be worked out with, primarily, other European nations. The leadership of the rest of the European Union had every reason to assure the UK that, “Fine, you want to leave us! Then we will refuse to play with you anymore!” as they desperately wanted the UK to stay. But now that the decision has been made, and after time soothes the many bruised egos a bit, real conversations can begin.

Impact on European Union

The bigger issue here is that the European Union has not delivered on its promises to all who joined. Many countries are suffering in ways that were not expected, with internal tensions rising with every passing year of weak economic growth, high unemployment (particular among the youth) and supercilious finger-wagging from the stronger nations at the weaker ones. As hope for a recovery fades, desperation is rising and the belief that those in Brussels are a cure is shifting to suspicion that they are instead the disease. One of the greatest lessons of political history from the dawn of nations is that the further the decision-makers sit from those affected by the decisions, the poorer the quality of the decision. History shows that the more people that are forced into one size-fits-all solutions, the poorer the end result, often times with dramatic actions to break those bonds.

Those countries in the European Union that have been struggling to reignite their economies post-financial crisis will be closely watching as the events unfold for the UK, placing a lot of pressure on everyone involved. European leaders find themselves in a catch 22. On the one hand, they will be better off having strong trade relationships with the UK, but on the other hand they don’t want other nations that may be contemplating their own exit to see the UK benefiting from this move. Expect more threats, grandstanding and predictions of doom and gloom before this breakup drops from the headlines around the world.

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Italy’s Recent Election and Europe’s Ongoing Struggles

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On June 22nd I had the great pleasure of speaking with Ameera David on RT’s Boom Bust about Italy’s recent elections and Europe’s ongoing struggles, just on day before the United Kingdom holds a referendum on remaining within the European Union.

Rome has just elected its first woman mayor in nearly 3,000  years, the 37-year-old Virginia Raggi, who is a member of the Five Star Movement which was started by comedian Beppe Grillo. This election was highly representative of the challenges facing much of the western world. The campaign promises of those now in office have been forgotten and in their stead we get more of the same disappointing lackluster growth. Infrastructure from trains in Italy to roads in San Diego are in an embarrassing state, looking more and more like what one would expect to see in third world countries. Ms. Raggi campaigned on a platform of anger at frustration with the status quo, a sentiment that appeals to many across both the US and Europe, but her time in office is likely to be a big disappointment as Rome is a massive and incredibly complex city to manage and her background gives no confidence that she’ll be able to manage such an enormous challenge. I hope I’m wrong.

In the US, we have an unprecedented presidential election dynamic wherein the two presumptive candidates enjoy less support from within their own parties than has ever before occurred in modern history. In Europe faith in Brussels’ ability to help get economies within the union growing at a more tolerable rate are fading as is faith in the benefits of the European Union itself. The two largest economies on earth are experiencing heightened level of political turmoil that is likely to continue for some time, as the problems are structural and deep in nature, exacerbated by the aging demographics and under increasing pressure from the immigration/humanitarian crisis.

Things are going to get a lot more complicated before they get better. The asset price “put” assumed to exist through the omniscience and omnipotent of central bankers is becoming more tenuous. There are more and more potential major catalysts for a downturn out there, which means investors need to be prepared to manage heighten downside risks in a market that is already priced with a head-scratching level of optimism.

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Brexit

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Brexit. It’s all the rage these days. The word is whispered over candlelight glasses of wine in dark corners at swanky post-market-closeBrexit, Symbol of the Referendum UK vs EU cocktail bars. It is spit out over conference room tables amongst such phrases as “contingency planning” and “hedging strategies.” It has everything a news agency drools over, drama with the dark horse effect as the yes vote gains unexpected traction on the very last loop around the track.  It provides angry rants that skirt around xenophobia or at least a level of indignant nationalism that can generate eye-catching headlines. It paints the image of a battle of wills between the confident and worldly intellectual, gazing with vague annoyance over wire-rimmed glasses at the rough and tumble, calloused working man who is damn tired of those immigrants stealing jobs. It is a story filled with fear, hope, anger, frustration, isolation and unity.  Whatever version of the story attracts you the most, as an investor a “yes” vote for the UK to leave the European Union has two major impacts, currency and uncertainty.

Currency Effect

The currency effect means a stronger US dollar relative to the Euro and Pound Sterling. This would make american exports more expensive and imports relatively less expensive. The United States is the second largest exporter in the world, so when our exports become more expensive, that’s harder on everyone buying our stuff so it becomes a headwind to growth. With imports relatively less expensive, Americans are more likely to purchase an imported product than they otherwise would have been, which can also hurt american producers.

The currency effect can also be a problem for emerging markets where companies have issued unprecedented levels of debt denominated in US dollars. As the US dollar rises in value, that debt become more and more expensive, resulting in everything from reduced investment in growth to defaults which are further headwinds to global growth.

The currency effect can also have a secondary impact in its correlation with oil. With oil denominated primarily in dollars in the global marketplace, strengthening dollar means weaker oil prices. This can then affect the sovereign wealth funds from those oil-dependent nations as they are pressured to sell assets in order to pour more back into their domestic economies. This is a headwind to global asset prices.

Overall the currency effect is essentially deflationary for the US, which makes it more difficult for the Federal Reserve to return us to a more normal rate environment, prolonging the negative side effects from low-to-zero interest rates.

Uncertainty Effect

The uncertainty effect is all about the impact on companies. Although the word sounds easy enough, Brexit, short, simple and comfortably straightforward, the reality is no one really knows just how this darn thing will pan out! If there is in fact a yes vote, unthinkable a few weeks ago but now looking increasingly like it just might happen, no one is clear as to just how it would be implemented. Then there is the reality that the vast majority of politicians in the U.K., regardless of party, are all against a Brexit, so these folks will find themselves having to enact legislation based on a vote by their constituency that goes against what they believe is best; rock meet hard place.

With the realities of the actual implementation unknown, companies will be much less likely to invest which means less spending/less growth. There will be less M&A activity and the potential momentum of this vote with respect to rising nationalism is a further headwind to already falling levels of global trade which means even slower growth across the globe.

Brexit, the end of french kisses along the Thames?

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