Author Archives: Sven Carlin

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Aluminum: A Leveraged Investment Into the Global Economy


  • If the economy continues on its growth path, aluminum will enter into a supply gap.
  • After 5 years of losses, investors should be in for a treat.
  • The risks and potential rewards of investing in aluminum will be explained in this article.

Introduction

Aluminum is the third most abundant metal in the Earth’s crust and accounts for 8% of its mass. The mineral it is most commonly mined from is bauxite. The most widely known uses of aluminum are aircraft bodies and aluminum foil, but it has a multitude of other uses like window frames, beer cans etc.

Aluminum is a great element to watch in order to better understand the global economy as the supply is unlimited and its price depends purely on demand and production costs. Like any other metal, aluminum is cyclical and this article is going to shed some light on where we are in the cycle now, what the risks are, and introduce you to a few investing opportunities.

figure 1 consumption1
Figure 1: Aluminum consumption by industry (kt). Source: All About Aluminum.

Aluminum Price

The current aluminum price is below its historical average as prices fell along with all other commodities. The current price is $1,591 per metric ton.

figure 2 aluminum
Figure 2: Historical aluminum prices. Source: InfoMine.

From a price perspective, the above figure shows that aluminum is close to the bottom of its cycle. Prices are at the same level where they were in 1990 which is strange because inflation has lowered the value of the dollar by 83% since then and aluminum is a commodity and should therefore protect investors from inflation.

Supply and Demand

Supply and demand has been pretty balanced in the last decade with a slight tendency toward higher consumption which creates a market deficit.

figure 3 supply and demand
Figure 3: Aluminum supply and demand. Source: All About Aluminum.

Aluminum is expected to remain in a market deficit as global consumption is expected to grow by a rate of 4% per year. In total, aluminum consumption is expected to increase by almost 50% by 2025 due to rising utilization intensity and more diverse end-use applications. For example, car manufacturers are expected to use more aluminum because of it lightness.

figure 4 car usage
Figure 4: Use of aluminum per car. Source: Alcoa.

Ford (NYSE: F) uses an all-aluminum body for its F-150 pickup and we can only imagine where aluminum will be if all car manufacturers switch to aluminum. With more electric cars and their range issues, weight becomes more important and aluminum fits perfectly into that scenario.

In addition to cars, another example of why aluminum will be a wanted metal is that consumption in India is at 2kg per person while the global average is 20kg per person.

figure 5 consumption per person
Figure 5: Aluminum consumption per person. Source: Aluminium Association of India.

As for supply, the availability is not the issue as there is plenty of aluminum, but production costs are an issue. In such a competitive environment, scalability is important as high investments are necessary to develop feasible mining projects.

figure 6 aluminum prouducers
Figure 6: Major global aluminum producers. Source: Rusal.

In an environment where a few players dominate, production costs are essential for profitably producing aluminum. The current aluminum price is below the 4th quartile producers which means that 25% of global aluminum producers produce at a loss.

figure 7 cost curve
Figure 7: Aluminum production cost curve. Source: Rusal.

Currently, the reason for the low aluminum price is high inventory levels. As a quarter of producers are not profitable, this should bring a longer term market deficit.

figure 8 aluminum supply and demand forecast
Figure 8: Aluminum global supply and demand balance forecast. Source: Rusal.

If the above presented forecast realizes itself, aluminum investors will be in for a bullish ride.

The main risks are that aluminum demand will not grow as fast as expected and that the new developing projects will create a market oversupply. As transportation is the main demand growth factor for aluminum, any recession that would impact cyclical car sales would also have a negative impact on aluminum demand and consequently, prices.

figure 9 transportation
Figure 9: Aluminum demand in transportation in million metric tons. Source: Rusal.

Due to the high necessary investments to set up aluminum production it is difficult to be flexible and avoid huge losses if the price of aluminum falls.

Investment Opportunities

For those who are convinced that aluminum is the metal of the 21st century, there a lot of investment options. There are several different ETFs which have the word aluminum in their names, but that does not mean much as they consist of various assets. Only two ETFs are pure aluminum plays but they are very small and are at risk of being liquidated due to their low trading volume.

For aluminum exposure, a good ETF is the PowerShares DB Base Metals Fund which has equal exposure (33%) to aluminum, copper and zinc, and is based on the metals’ future contract prices. But as all of the three metals are expected to go into a supply deficit in the next few years, this ETF might be the best exposure to basic metals that an investor can get. You can read more about zinc here, and about copper here. The performance of the ETF has been terrible in the last 5 years which gives a great opportunity for a rebound.

figure 10 performance
Figure 10: PowerShares DB Base Metals Fund performance. Source: Yahoo Finance.

Another method for aluminum exposure would be to invest directly into pure aluminum producers like Rusal, Aluminum Corporation of China (NYSE: ACH) or Alcoa (NYSE: AA) but those investments necessitate a thorough analysis, not only of the systemic risks for aluminum, but also the specific company risks. A more diversified metal play that gets 31% of its revenues from aluminum is Rio Tinto (NYSE: RIO).

Conclusion

In short, it can be said that aluminum is a bet on transportation. This is not such a bad bet given that everything needs to be lighter to lower CO2 emissions or to save on energy consumption, and the developed world car number per capita still has plenty of room to grow.

The current car of the future, Tesla (Nasdaq: TSLA), is made mostly of aluminum, but the metal is still expensive in relation to steel for mass car production. On the flip side, it gives downside protection for aluminum as at lower prices, car manufacturers would make the switch to aluminum much faster.

As aluminum is such a base metal, the risks are related to the global economy. Lower demand for cars would really affect global demand and quickly erode the future expected supply gap. Therefore, aluminum is a metal that should be watched as it is essential for the world as we know it and portfolio exposure can be increased when the metal is cheaper and decreased when more expensive.

 

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BREXIT Aftermath: Where to Look for Returns & What to Avoid Now


  • The U.S. and Europe are overvalued, especially seeing the current political situation and economic fragility.
  • What’s about to hit Europe and the U.S. already hit emerging markets in 2015. There are opportunities in emerging markets now, but where?
  • Bonds seem the riskiest asset of all with no yield and huge potential downside.

Introduction

After last week’s BREXIT vote the markets have been in a free fall with a slight recovery yesterday. But savvy investors have been expecting this and it has been a recurring theme at Investiv Daily that stocks are overvalued. In such an overvalued environment it is normal that inflated asset prices take a beating at any sign of future uncertainty.

As one’s misfortune is another’s fortune, this article is going to elaborate on what to look for and what to avoid in order to limit risks and maximize returns.

The U.S. Stock Market

The U.S. stock market is fully valued and therefore the decline should not have come as a surprise. The S&P 500 has been moving sideways for the last year and a half and many are expecting a recession. In such an environment the risks are high and the potential returns very low.

figure 1 pe earnings
Figure 1: S&P 500 PE ratio and earnings. Source: Multpl.

With a PE ratio of 24 and declining earnings, the only way for investors to realize capital gains by investing in the S&P 500 would be through the formation of an asset bubble. With the current political turmoil, slower U.S. productivity, lower employment participation and strong dollar, this seems like a very unlikely scenario.

On the other hand, those factors might start a recession that could easily lower the S&P 500 to the average historical PE ratio of 15 which would cause a 1,300 point, or 35% drop. Therefore, the conclusion is that the S&P 500 carries a lot of risks with limited upside.

Emerging Markets

Emerging markets were the thing to avoid in 2015, but they still possess long term factors that should make them the long term investment winners, especially if bought at these depressed prices. Let us focus on Brazil as an example.

Brazil was hit by various corruption scandals and by the deepest recession in the last two decades. But, Brazil is still a young country rich in natural resources and on the road to becoming part of the developed world, minor setbacks are normal and should be used as an investment opportunity.

figure 2 brazil GDP
Figure 2: Brazil’s GDP in billions of US dollars. Source: Trading Economics.

Brazil’s GDP grew from $1,107 billion to $2,346 billion in ten years which still represents a yearly average growth of 7.7%. As the market has already factored in the chance of a Brazil bankruptcy, the risks and rewards of investing there are opposite from what they are in the U.S., as there is no risk of a U.S. bankruptcy.

Brazil’s current CAPE (Cyclically adjusted 10 year average price earnings ratio) is currently 3 times undervalued at 8.2, while the S&P 500 has a CAPE ratio of 24.6. The undervaluation is probably the reason why Brazilian stocks have behaved very well in the last few days. The Brazilian stock index is still in positive territory for the month and year to date. On top of the relative stability, U.S. investors could also gain from currency benefits as the oversold real is slowly returning to its real exchange value toward the dollar.

figure 3 usd brl
Figure 3: USD vs BRL in the last year. Source: XE.

To conclude, Brazil represents a young, resource rich country where it seems that all that could go wrong did go wrong last year. More positive news than negative news should now be expected. On top of that, it is one of the most undervalued markets in the world.

Europe

The situation in Europe is similar if not worse than the one in the U.S. To put it simply, the markets are in an asset bubble as the European Central Bank has been issuing huge amounts of liquidity with the hope of faster economic growth and some inflation. It succeeded for a while but the BREXIT issue will for sure have a negative impact on current economic growth when coupled with the overvalued markets, the risks outweigh the rewards.

The average PE ratio in Italy is 31.5, Netherlands 28.5, United Kingdom 35.4 and Germany 19. There is also the euro issue where any political turmoil could weaken the euro and lower investment returns for U.S. investors.

Europe should be avoided until asset prices reflect the real state of the economy and the political situation, thus far below current prices, at least 50%.

Gold and Bonds

It is uncommon to put gold and bonds in the same basket but as they both have practically no yield with negative interest rates on the most secure government bonds, it seems the right choice.

Gold is currently at its year high as investors look for safety. The problem with gold is that it has no yield and most investors come too late to the party as gold primarily appreciates at maximum turmoil as it has done in the past few days.

figure 4 gold prices
Figure 4: Gold prices in the last year. Source: Bloomberg.

If political turmoil persists and inflation arrives due to the high liquidity, gold might be the winner, but any signs of stabilization would negatively affect gold. It can be concluded that gold represents a good hedge and could be a part of a well-diversified portfolio. Investors that seek a riskier investment than gold itself could go for gold mining stocks that offer a dividend yield and potential growth, though gold mining stocks also come with much more volatility.

As for government bonds, the risks seem to outweigh the rewards. Yes, it is possible to make capital gains if interest rates further decline, but this defies logic as there is no point in holding negative yielding bonds. On the other hand, if yields increase bonds could fall tremendously as a 100% increase in bond yields should consequently lower bond prices by 50%. Therefore, the current situation with bonds isn’t what’s typically assumed about bonds—low risk with high rewards—as right now they are high risk with low rewards.

Conclusion

At this point, after a 7-year bull market and high liquidity provided by central banks, investors should be wary of being overweight in the same things that were good 7 years ago. Many analysts have forgotten how to analyze risk as we have not seen a bear market since 2009, but this is exactly the time when one should look at risks before rewards. High asset prices and low yields mean that investors do not see much risk and are willing to pay hefty prices, but this is exactly the kind of situation that can bring lots of investment pains.

Any signs of recession, the continuation of the decline in corporate earnings, and a shift from the current investor’s perception that central banks are still able to save the markets with additional intervention, could easily send the stock market down by 30%. Assess your risks, estimate the rewards, and position your portfolio accordingly.

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Is the Negative Cycle Ending in the Shipping Sector?


  • Most shipping companies are down more than 90% and the short term outlook does not look bright.
  • After 25 years of 10% global fleet gross tonnage growth, 2016 is a turning point with growth lower than 5%.
  • Increased interest rates, fewer ships and constant global trade growth show that there are investment opportunities in the shipping world.

Introduction

It seems strange to analyze the shipping sector in the current volatile markets, but sound sector analyses help to keep nerves firm and to clearly valuate the opportunities a bear market brings. The shipping sector is interesting due to the fact that it represents a perfect example for a bottomless investment theory and an excellent investment opportunity for those who can and know how to catch a falling knife.

Overview of the Shipping Sector

A combination of low interest rates and high shipping prices brought lots of investments in new ships which created a long lasting oversupply of ships. More ships means more shipping capacity which consequently means lower shipping prices. Such a situation brought the Baltic Dry Index—which represents the average price to ship raw materials around the world—to lows not seen in the last 30 years.


Figure 1: Baltic Dry Index. Source: Hofstra University.

In such a low pricing environment, it is difficult for fleet owners to be profitable. Therefore, the shipping ETF is also at 5 year lows.

figure 2 shipping ETF
Figure 2: Shipping ETF. Source: Bloomberg.

Global economic growth made ship owners believe that there would be constant demand for their services and therefore they invested heavily into building new ships.

figure 3 global demand
Figure 3: Expected global demand for shipping in relation to GDP and population growth. Source: International Chamber of Shipping.

The amount of global transported goods is indeed growing but not at a rate that would bring balance to the shipping markets. At the end of 2014 there was a total of 85,094 merchant ships, while in 2005 the number was 61,227. This represents a growth of 40% and is already higher than the growth of world merchandise exports of 34% for the period.

4 figure global trade
Figure 4: World merchandise exports from 1995 to 2014. Source: World Trade Organization.

But on top of the increase in ship numbers, the ships are getting larger and larger in order to be more efficient. In 2005 the world fleet gross tonnage was 600 million tons while currently it is 1,166 million tons, representing an increase of 94% for the period. In such an environment all the marginal cost shipping companies should bankrupt on their debt, but the low interest rates enabled the shippers to survive and constantly add new shipping capacity in hopes of better times.

A small digression here, the shipping industry shows how artificially low interest rates keep a lot of businesses alive. Even if everything looks stable, the low interest rates highly increase the risk of being invested because a turnaround in investor perception toward risk would have an even worse effect on markets than the 2009 Great Recession.

Back to shipping. With low interest rates, ship owners continue to build new ships and low commodity prices continue to keep shipping prices depressed. Even with the current slowdown in gross tonnage growth, with 6.8% of the total global fleet idle it will take a few more years to restore the balance.

Outlook

The outlook for shipping is not a rosy one, Moody sees combined earnings decline by at least 7% this year. The sector is expected to continue to suffer from the above mentioned problem of too many ships and slow demand growth.

The global container shipping fleet grew by 8.6% in 2015 further increasing the already high gross tonnage. Things are starting to slowly change as the growth in new ships in 2016 is expected to be the slowest since 1990, but still the 2015 increase combined with low commodity prices and stable demand will keep the oversupply in the shipping sector for a longer time.

Investment Opportunities

Now, if things are so bad why would anyone even look at this sector as an investment opportunity? Well, the best investments come by looking in the darkest places because they give you the opportunity to buy cheap and enjoy the ride when a turnaround comes.

The figure below gives an overview for five major shipping companies: Diana Shipping (NYSE: DSX), DryShips (NASDAQ: DRYS), Genco Shipping (NYSE: GNK), Golden Ocean Group (NASDAQ: GOGL) and Star Bulk Carriers (NASDAQ: SBLK). Almost all of them are more than 90% down from their five year highs.

figure 5 comparison
Figure 5: Shipping stocks performance comparison. Source: Yahoo Finance.

With such declines an investor must, above all his analysis skills, be brave as all the above mentioned companies are losing money and might be bankrupt soon. But the terrible chart from above creates great opportunities. For an example, Star Bulk Carriers (NASDAQ: SBLK) was at $2 in February 2016 only to jump to $5.30 at the end of April 2016 and is currently down to $2.95.

figure 6 SBLK
Figure 6: SBLK 6-month price movement. Source: Yahoo Finance.

Conclusion

For the short term, the shipping industry gives great trading opportunities, while in the long term the companies that will survive will also bring great returns, but the difficulty is in finding those companies. The goal should be to find the most efficient companies with low debt and wait for a turnaround in shipping prices. It might be too late to wait for a pickup in shipping prices as when that happens shipping companies will be up more than 100%, as was the case for SBLK from February to April.

 

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Is BREXIT Just Noise?


  • Markets fell on Friday but they are exactly where they have been in the last weeks.
  • BREXIT is noise, investors should focus on slower global growth and fragile financial systems.
  • The market is still overvalued in historical terms but there are some opportunities.

Introduction

An avalanche of articles since last week’s BREXIT is forecasting terrible things for the world economy and financial markets especially. Most focus on the huge declines stock markets saw on Friday, but let us first take a closer look. The UK FTSE 100 index fell 3.15% to 6,138 points on Friday, but all-in-all it was a positive week as last week started with the FTSE at 6,021 points.

20160627 BREXIT and other
Figure 1: UK FTSE 100 index in the last month. Source: Bloomberg.

Of course this is only the nominal decline. As the pound declined by 9% toward the dollar, FTSE losses for U.S. investors ended up at 13% in total on Friday.

The S&P 500 also fell 3.59% on Friday, but this was mostly due to the appreciating dollar. As the dollar appreciates, U.S. corporations see their international earnings deteriorate as more than 30% of revenues comes from abroad.

figure 2 dollar spot
Figure 2: Dollar index spot. Source: Bloomberg.

But again, the dollar is just back to where it was at the beginning of the month and the S&P 500 to where it was exactly one month ago on May 23. The point of this introduction is to make investors aware of the difference between noise and real structural significant influences.

What’s Important for an Investor and What’s Just Noise

In the BREXIT aftermath you will be bombarded with various crazy headlines like “FREXIT” (France leaving EU), but don’t let this move your focus from the important things. The important things are that the BREXIT will for sure have a negative impact on the already negative trend of slowing global economic growth. The World Bank has already revised its global growth expectation downwards from 2.9% to 2.4%. The BREXIT will further lower the amount of investments in and from the UK and consequently, Europe. This might push global growth even lower and keep growth in Europe subdued.

figure 3 real gdp growth
Figure 3: Global, Europe and advanced economies real GDP growth expectation. Source: World Bank.

Slower global economic growth and activity will have an impact on every aspect of economic life. But, as usual, central banks will do their best to keep things stable by adding more liquidity. The European Central Bank issued a press release immediately after the BREXIT vote stating that it “stands ready to provide additional liquidity, if needed, in euro and foreign currencies.”

This policy of constant liquidity adding by central banks has been working well in the last seven years but involves some risks. The major risk is that markets change their perspective on monetary policy as an important enough factor for market stability. As soon as central banks become unable to protect the markets with their added liquidity there is nothing to stop the markets from a free fall. Also, the increased liquidity provided by banks with no economic traction would spur inflation. Such a scenario could bring a rare economic situation called stagflation: high inflation and economic stagnation.

The second risk is also related to monetary policy and BREXIT. BREXIT being the cause and monetary policy being the reason. The low interest rates and high liquidity has brought high levels of debt globally and uncertainties about whether the central banks are going to be able to keep things stable without spurring too much inflation in an environment of continuous abundance of liquidity. This risk influenced most European banks to fall between 10% and 15% last Friday, but this was only the tip of the iceberg as the above mentioned reason lowered their share prices by about 50% in the last year.

figure 4 European banks an U.S.
Figure 4: European banks stock price in last two years. Source: Yahoo Finance.

UK Barclays, German Deutsche bank and Italian Intesa all fell by about 50% or more in the last year. The best performing bank in the above chart is Wells Fargo which has fallen only 20% in the last year. This weakness in the financial sector signals that the provided liquidity is still keeping the markets stable, but the decline of bank shares indicates that the markets are not as healthy as they used to be.

The most important thing of all for corporations and their stock prices are, of course, earnings. The stronger dollar will undoubtedly lower corporate earnings and make the already historically high valuations look even more overvalued.

figure 5 sandp multipl
Figure 5: S&P 500 PE ratio. Source: Multpl.

As the above figure shows, the S&P 500 PE ratio has only been higher than the current level on a few occasions. Recent historical examples of higher or similar PE ratios are the 1960s bull market that resulted in a decade long 1970s bear market, and the dot-com bubble and bust. The 2009 spike is related to the 2009 crisis that lowered earnings and not to market overvaluation.

Conclusion and What Can Be Done

In an environment with huge liquidity, high valuations and uncertain economic prospects, there are some things an investor can do. If the high liquidity ignites inflation, it is always good to be exposed to assets whose quantity is fixed. Such assets are commodities. Precious metals in particular as their value increases with economic turmoil. All other commodities should benefit if inflation is ignited and the global economy continues to grow.

An investor can look for companies with low PE ratios and stable non-cyclical revenues, like utilities, communications or consumer staples. It is not easy to find companies like that in this overvalued market but there are a few—like AT&T (NYSE: T) or Southern Company (NYSE: SO)—that look attractive with their PE ratios below 20 and dividend yields north of 4%. A PE ratio below the average does not mean that the price of those stocks will not go down in a bear market.

In any case, investors should brace for volatility ahead as negative economic repercussions keep constantly coming up. Now it is the BREXIT, not so long ago we had the Chinese slowdown crisis in August 2015, low oil prices in January 2016 and as more such things are bound to happen in the fragile, overvalued, highly liquid markets, every investor should prepare for volatility.

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How to Prepare Your Portfolio For The Next Recession or Stock Market Crash


  • The risks of a slowdown are higher than the upside.
  • Fundamental trends are negative in advanced economies while emerging markets show higher growth rates and are cheaper.
  • It is important to create a diversified portfolio with uncorrelated assets.

Introduction

In an environment where it seems maximum potential for the U.S. economy has been reached, the St. Louis FED chief, James Bullard, has said in his most recent report that he favors only one interest rate increase through 2018, which would at best keep things stable. His view is further supported by the fact that the unemployment rate is sitting at below 5%, and the Personal Consumption Expenditures PCE inflation—measured by the Dallas FED—is at 1.84%, both of which signal that the economy has reached its maximum potential.

1 figure trimmed inflation
Figure 1: Trimmed mean PCE inflation. Source: FRED.

The scary part of the report is where Mr. Bullard describes how forecasts are made based on the current situation, which will most definitely change. What is difficult to predict is the direction of the change therefore, forecasts are bound to be incorrect and under the influence of various risks like a return to the normal Phillips curve influence where low unemployment triggers inflation, or a recession even if no current data indicates the possibility of one. Thus only an extremely positive scenario would trigger interest rate increases if fundamentals like inflation or productivity stay stable.

2 figure fed stlouis
Figure 2: St. Louis FED’s U.S. macroeconomic outlook. Source: St. Louis FED.

The conclusion is that practically anything can happen, and the FED has absolutely no idea as to where the economy will be in a year or two. Even FED Chairwoman Yellen admits that the 2013 expected interest rates of 4% for 2016 were too high and that an aging society and a slump in productivity growth will keep the subdued economic indicators persistent.

In such an uncertain environment, an investor should look at the best ways to protect his downside and maximize his upside.

Investment Ideas

Let us start with bonds where interest rates have been declining since the start of this century.

Bonds

3 figure bonds
Figure 3: 10-year government bonds yields. Source: Wall Street Journal.

As bond prices are inverse to bond yields, any increase in yields would precipitate bond prices, thus bonds are currently low yield and high risk. Usually considered safe havens in recession times, bonds currently do not provide such protection as it is better to keep cash than bonds with negative interest rates. There is the option of further bond price increases, but that is a highly unlikely scenario as bond yields are at historical lows.

The Stock Market

The S&P 500 is still holding well, but does not manage to break the previous highs despite having come close several times.

4 figure s&P 500
Figure 4: S&P 500 in the last 12 months. Source: Bloomberg.

The S&P 500 dividend yield is 2.12% which might look tempting when compared to the extremely low bond yields, but it is meagre when compared to the historical mean of 4.39%. A return to the mean would result in a drop of 50% or more of the S&P 500 index. The conclusion here is the same as with bonds: High risk, low returns.

But there is an option with stocks that should limit the downside. Dividend stocks that will not see their cash flows affected by a slowing down in the economy are always assets toward which investors run when trouble comes. Examples can be found in telecommunication, consumer staples and healthcare.

Emerging Markets

If the reason for economic stagnation in the developed world is an aging society, slow productivity growth and emerging markets competition, a contrarian thesis would be to invest into emerging markets.

Emerging markets have a relatively young population and are currently shunned by investors as too risky amidst a commodity price slump. But no matter the current issues, the World Bank expects emerging markets and developing economies to grow at rates north of 4% in the long term, while advanced economies are expected to grow below 2%.

Currently, advanced economies are preferred by investors as they regard them as secure, but long term structural trends are strong in place even if we do not choose to see them. What China has done in the last 15 years could be the same as India is about to do. Brazil will probably also return to growth someday.

The following figure will show that the current developed world impression of asset security is mostly funded by debt which is unsustainable in the long term.

figure 5 investment position
Figure 5: U.S. net international investment position. Source: Bureau of Economic Analysis.

On top of that, emerging markets are much cheaper than developed ones according to the Cyclically Adjusted Price Earnings (CAPE) ratio which takes into account earnings from the past 10 years.

figure 6 global cape
Figure 6: Global CAPE map. Source: Star Capital.

For long term investors, the less risky option might be to dig for good investments in emerging markets with positive demographics and a strong growth outlook. Currently those investments are out of favor, but this is exactly the environment where investments give the best returns.

Gold

Gold is a doomsday investment, it protects you against inflation and is the metal that surges in difficult times. Typically as the economy does well, stocks grow and gold declines because gold has no yield. The opposite happens in turmoil.

7 figure guardian precious metals
Figure 7: Gold and stocks cycle. Source: Guardian Precious Metals.

You can invest in gold by buying it physically, through ETFs or by buying gold miner stocks.

Conclusion

As always, good diversification should provide sufficient downside protection but a portfolio has to be diversified with uncorrelated assets.

If you have Ford in your portfolio and then you add some Caterpillar, that is not real diversification. Gold, emerging markets, cash, and quality stocks should enable a portfolio to weather economic hardships.

Don’t forget that after every recession comes a recovery, so be ready to increase your exposure to stocks when assets are cheap, even if everyone will be thinking that there is no tomorrow.

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Will There Be A Long Term Impact To The Fed’s Shift In Rhetoric?


  • A positive outlook seems more political than realistic as the FED is out of maneuvering power.
  • Keeping interest rates unchanged is the best and the only thing the FED can currently do.
  • Low interest rates will weaken the dollar, boost exports and increase corporate earnings in the upcoming earnings season.

Introduction

In FED’s Chairwoman Yellen semiannual policy report, the rhetoric has significantly changed since the last report in February. In short, the full employment target is almost reached but the inflation rate is still below the targeted 2% and the expectations for the reaching of that target have been changed from short term to medium term. Further, the latest job reports show a slowdown in jobs increases which creates a bit of a scare. The FED estimates the slowdown to be transitory.

On the positive side, wages seem to be finally picking up which is a good sign for inflation. Weak data comes from the economy where the U.S. GDP grew only 0.75% in Q1 2016 on an annual basis due to the fact that the expensive dollar weighs on exports, low oil prices and weak business investments.

The FED On The Economy

On one side, Yellen says that the slowdown in employment should be only transitory and that data from one quarter does not mean much, while on the other side she states that the quarterly pickup in consumer spending and increase in household wealth will bringfurther improvements in the labor market and the economy more broadly over the next few years.

As always, in order to show the other side of the medal Yellen mentions risks like lower employment and business investments that might lower domestic demand, the general slowdown in U.S. productivity potentially continuing, a stronger slowdown in China and a possible Brexit. All of the mentioned possible scenarios might have a negative impact on investors’ perception of risk and therefore abruptly change the current stable market situation.

Monetary Policy

The FED decided to keep interest rates unchanged and even more importantly, keep the FED’s holdings of longer-term securities at an elevated level.

The most important part of the report is related to the fact that interest rates are expected to increase only gradually as the economy is too weak to withstand sharper increases. The necessary rate needed to keep the economy operating close to its full potential is low by historical standards. Only if the above mentioned uncertainties and productivity, and employment slowdowns fade will the FED increase interest rates gradually, if not, rates will remain like this for a longer period of time.

The report is concluded with the case that if the economy were to disappoint, the FED would lower its interest rates.

Comment

In relation to the potential lowering of the interest rate in adverse economic situations one might ask:

Lower the interest rate to where?

As the interest rate is at historical lows, a lowering from 0.5% to 0% doesn’t seem at all significant. It is highly unlikely that demand for houses in a recession will increase if the mortgage rate decreases from 3.75% to 3.25%. In order to be significant for the economy, interest rates have to really have an influence on demand as they had in the previous monetary interventions.

figure 1
Figure 1: FED interest rate changes. Source: Trading Economics.

Probably everyone expected that the economy would pick up like it did in the 1990s and 2000s, but it hasn’t in the last several years, at least not enough to ignite inflation or allow interest rate increases. This puts the FED in a difficult position as it has no maneuvering space if any economy shocks happen. The good news in the bad news is that a similar situation is affecting Europe, Japan and China, so the FED can keep interest rates low without severe outflows of capital.

Long Term Outlook

Keeping the interest rates unchanged is probably the only thing the FED can do at this moment as there are no clear indications in where the economy is going. The current home sales are at a nine-year high, but this again does not change the structural problems like the low productivity because with a sold home no value is created, only on paper due to the increased asset prices further fuel the asset bubble. The median house price increased by an astonishing 4.7% compared to last year.

The low interest rates will weaken the dollar in relation to other currencies and thus make U.S. exports more attractive. Also, corporate earnings will be higher when translated to dollars which should have a good impact in the upcoming earnings season.

figure 2 dollar
Figure 2: Dollar index has been falling in the last 6 months. Source: Bloomberg.

But, the structural issues are still lingering behind the good news and sooner or later, hopefully later, will have an impact.

The FED will continue in trying to keep things stable which is remarkable, and no one can know how long the FED will succeed in this. Perhaps even for years as it has already been doing this for more than 7 years.

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Don’t Be Fooled by Noise, Earnings Will Tell the Truth


  • A look into next month’s earnings season and trends.
  • 6 out of 10 S&P sectors have earnings declining.
  • 72% of companies issued negative guidance.

Introduction

With all eyes focused on Brexit and the FED, it seems that no one really cares what is going on in the economy and, most importantly, with corporate earnings. Don’t forget that next month is earnings season and the earnings trend up until now has been a negative one. As corporate earnings are the main factor in stock returns, you should be focusing on how to prepare for that and not on Brexit as it will probably be forgotten by next week.

Many believe that predicting corporate earnings is not possible, but thanks to the multitude of data constantly published, it does not seem impossible. It just takes a lot of work and analysis.

This article is going to analyze sector-by-sector news in order to estimate the upcoming earnings season results.

Corporate Earnings

The main thesis behind bearish market views is that corporate earnings have been steadily declining for the past two years.

figure 1 Sand P earnings
Figure 1: S&P 500 earnings. Source: Spindles.

The little uptick in Q1 2016 was mainly due to commodities prices rising and smaller losses in the energy sector, but is still below Q1 2015 which marks five consecutive quarters of year-over-year declines in earnings. The main influence in the above decline comes, of course, from energy and materials, but don’t be fooled by that as 6 out of 10 S&P 500 sectors had earnings declining for an average decline of 6.7%.

figure 2 earnings by sector
Figure 2: S&P 500 earnings growth by sector. Source: Factset.

Energy

Energy earnings are easy to predict as they are related to crude oil and gas prices. Stocks usually follow those prices, so it is difficult to get a significant prediction here.

figure 3 energy earnings
Figure 3: S&P 500 energy earnings. Source: Spindles.

As crude oil and gas prices have been on average much higher than in Q1 2016, we should not expect negative surprises in the sector, but earnings will be again lower than Q2 2015.

figure 4 crude oil
Figure 4: Crude oil in last 12 months. Source: Bloomberg.

Materials

The story with materials is similar to the one for energy as prices have rebounded a bit but are still far below Q2 2015. The metal price index shows how the subdued commodity prices are not rebounding that fast and it will take a longer time for the lower margins to eliminate higher cost production.

figure 8 metal prices
Figure 5: Metal price index. Source: index mundi.

This slump in commodity prices is going to keep material earnings depressed and far below the averages of the last 5 years but as the below figure shows, the industry is cyclical both in the long and short term, so traders could grasp the opportunities given by the high volatility and long term investors can buy the excellent low cost commodity producers at low historical prices.

figure 5 materials
Figure 6: S&P 500 materials earnings. Source: Spindles.

Consumer Discretionary, Information Technology and Healthcare

Consumer discretionary, information technology and healthcare were the bright lights of Q1 2016 with earnings growth but this is about to change as the majority of companies issued negative guidance.

figure 6 guidance
Figure 7: Number of S&P companies with positive and negative guidance by sector. Source: Factset.

Of the 113 S&P 500 companies giving guidance, 81 have issued negative guidance while only 32 have issued positive EPS guidance.

A good example of how earnings can be predicted is by looking at car sales. Automotive companies have low PE ratios as everyone expects a decline in sales but the decline is not coming. Car sales have fallen by 7.4% year-over-year but this has been covered by increases in minivan sales.

figure 7 car
Figure 8: U.S. car sales. Source: Wall Street Journal.

For those interested in particular automotive companies and monthly sales, a site to watch is Motor Intelligence. For example, General Motors witnessed a 5% yearly decline in sales which is going to have a very negative effect on earnings while Ford managed to increase sales by 4% in the U.S. for the same period.

Longer Term Earnings Expectations

Analysts are always positive as they are mostly employed by investment banks and whose goal is to pump asset prices in order to gain more on commissions. Therefore, analysts will always see declines as just temporary and base their estimations on the rosiest scenarios. The current trend sees declining corporate margins but analysts expect this trend to turn around immediately.

A good way of debunking this assumption is to compare the current analysts’ estimations with the same from a year ago.

figure 9 analysts estimates margins
Figure 9: Current analysts’ S&P 500 corporate margins estimations. Source: Factset.

Analysts’ estimates from the same period last year were much rosier than what really happened and it is difficult to expect margins improving with full employment negative guidances.

figure 10 estimates last year
Figure 10: Analysts’ S&P 500 corporate earnings estimations from last year. Source: Factset.

The current profit margin is 9.7% while last year analysts estimated a profit margin of 10.6% for this period.

Conclusion

Corporate earnings can be partly estimated for subsequent quarters as lots of data—like car sales or retail trends—are publicly available on a monthly basis. By tracking such indicators an investor can minimize the risks of being caught up in a stock amidst a negative earnings surprise. As in the longer term there are many factors that can lower or increase earnings like the strength of the dollar, Chinese demand or oil prices, no one can know what will happen but can assess the probabilities of something happening and the effect on a portfolio.

The current trend is a negative one showing no strong improvement signs as commodity prices are still subdued. The economy is reaching full employment which should increase operating costs, and buybacks are not that profitable for companies as they are paying high prices for their own shares.

 

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Soros is Back and Betting Heavy On Gold


  • Structural debt issues in China and European fragility will limit global growth.
  • Soros is overweight gold and short the S&P 500.
  • He trimmed his U.S. stock portfolio by 37%.

Introduction

George Soros is an Hungarian-born, 85-years young hedge fund manager and philanthropist famous for his daring investment bets.

He is most famous for ‘breaking the Bank of England’ in 1992 by shorting the pound. Interest rates in the UK were much higher than in Germany and with the pound overvalued, Soros borrowed heavily to short the pound and forced the UK to exit the European exchange rate mechanism. The total estimated profit for Soros was one billion pounds.

There is a lot that can be learned from Soros, and there are $24.7 billion reasons (Bloomberg Billionaires) we should at least follow what the guy is doing. What is even more impressive than the Bank of England play is his average return per year by his Quantum Fund. While he was active at the helm of his fund, Soros managed to achieve returns of 26.3% over a 40-year period.

1 figure returns
Figure 1: Soros vs Buffet. Source: Hedge Fund.

Net of fees, a mere $1,000 dollars invested in the Quantum Fund would return $11.3 million after 40 years, not bad. Soros retired from active management in 2011 but now he is back and this article is going to elaborate on what is he doing.

Current Macro View

In May, Soros disclosed a 19 million share stake in the world’s largest gold producer, Barrick Gold (NYSE: ABX). We almost don’t need to mention that ABX is up 168% year-to-date, which again shows that Soros still has it, even at 85. In the meantime, he also cut his U.S. stock holdings by 37% in the first quarter of 2016.

Soros is basing his bearish moves on various global uncertainties. He is worried that China will not be able to manage an economic slowdown and that its increased debt levels are just postponing the inevitable as lending is mostly used to cover for bad debt. He compares the Chinese economy to the U.S. 2007-2008 economy fueled by debt. Currently $2.4 trillion worth of loans are estimated as risky by Bloomberg, as borrowers’ interest payments are higher than their earnings. This represents 23% of Chinese 2015 GDP.

Soros is also bearish on Europe and as he said that “Europe is in mortal danger” due to its refugee crisis, potential Brexit and Greece. The migration crisis is not such a hot topic currently as things have settled, but the problem is not solved and the situation remains fragile with more than 2 million Syrian refugees in Turkey. On top of that, the Brexit vote shows how fragile Europe is and how any economic destabilization could soon reignite the Greek issue as the problems in Greece were never solved, just postponed by giving Greece more loans.

It is interesting how Soros focuses more on the macro trends like the long term debt trend in China, and refugee and Greek issue in Europe, and not so much on day-to-day news about monetary policies or market movements.

Current Trades

A bet that might scare a lot of people that have investments in mutual funds or ETFs is that besides the 37% decrease in his stocks exposure, Soros also bought 2.1 million put options on the SPDR S&P 500 ETF and further increased that bet by buying 1 million call options of the SPDR Gold Trust ETF. Buying put and call options means that Soros expects the markets to move relatively soon in his direction.

(A put option is a contract that gives the buyer the right to sell 100 shares of an underlying stock at a predetermined price for a preset time period, while a call option is a contract that gives the buyer the right to buy 100 shares of an underlying equity at a predetermined price—the strike price—for a preset period of time.)

The current cost of put options expiring in January 2018 is 10% of the SPDR S&P 500 ETF. The maximum Soros can lose is his total investment while if the S&P 500 declines more than 10%, he is in profit. A 20% decline would give him a 100% return, while a 30% decline would give him a 200% return. Similar risks and returns ratios are in place for his Gold ETF call options bet.

Conclusion

Soros has already made wonderful returns on his gold bets and probably some small negative returns on his S&P 500 shorts but that is the way he plays his game. By looking at long term macro structured trends like debt levels, bad debts, inflation or deflation, he manages to approximately time the markets, and by daring to put a large stake of his portfolio in it, he manages to get extraordinary returns (ABX is his largest current position).

Of course, Soros is not always right. In 2000 Soros constantly preached the inevitable burst of the tech bubble but was caught on the wrong side of that trade as he wanted to make money both in the creation of a bubble, and in its bust. In the first 4 months of 2000 his fund was down 22%. Monday’s stock price surge is working against Soros but this shows that in order to make extra returns, an investor has to be willing to also take extra risks and weather unfriendly market moves.

For those who want to know more about Soros and his investment style, a great start is his book Alchemy of Finance which gives great financial insight and an elaboration of the reflexivity theory, but is a difficult read.

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Dividend Aristocrats: Should You Buy?


  • Stock picking amid dividend aristocrats should give even better results.
  • Dividend aristocrats come from recession-proof industry sectors.
  • PE ratios vary from 11 to 155 and dividend yields from 0.4% to 6.5%.

Introduction

A company receives the title of ‘dividend aristocrat’ when it has continuously increased its dividend for the last 25 or more years. This means that the company manages to go through recessions and market shocks with a growing, healthy cash flow that enables constant dividend increases.

This is what makes those companies so attractive for investors because lots of companies can show positive improvements in times of economic prosperity like the ones we have been enjoying for the last 7 years, but only few are able to do that consistently through economic cycles.

Any company that has increased its dividend in the last 25 years is a great company and therefore has to be analyzed for portfolio inclusion. This article is going to elaborate on how important dividend aristocrats are for a portfolio and what else is important when assessing such wonderful companies.

Current Situation

In an environment of low or no yields on savings, dividends have become increasingly important for investors depending on a constant stream of income. Retirees are an  example. On top of the healthy yields dividend aristocrats offer, the possibility of future yield increases.

The best way to have a look at how dividend aristocrats are doing is by analyzing the S&P 500 Dividend Aristocrats ETF (NOBL) which consists of 5 companies. Since its inception in October 2013 it has outperformed the S&P 500 by 9 percentage points, and this is excluding dividends.

figure 1 nobl vs sandp
Figure 1: NOBL versus the S&P 500 excluding dividends. Source: Yahoo Finance.

It is interesting how even with outperforming the S&P 500 and constant dividend increases the NOBL ETF has a lower PE ratio than the S&P 500, at 20.33 versus 23.94 respectively. As the NOBL was only incepted in 2013, it is not a representative look at the S&P 500 dividend aristocrat index, but will let us know if there really is something in these dividend aristocrats.

figure 2 S&P 5000 dividends
Figure 2: S&P 500 Dividend Aristocrats Index versus S&P 500. Source: S&P Indices.

As the dividend aristocrats have beaten the S&P 500 both in the short and long term, we should all run and buy them, right? Well, not so fast. Something to assess before buying are costs and valuations.

Valuations

Even if just buying all the dividend aristocrats would probably not be such a bad idea, let us first take a look at valuations in order to potentially reach even better results.

We already mentioned that the PE ratio is lower than the S&P 500 average, but in an environment of 50 stocks, much more can be found. A PE ratio above 20 is still risky in historical terms as it implies an earnings yield of 5%, which is of course better than the S&P 500 4.16% but still below historical averages.

The other issue is costs: the NOBL ETF expense ratio is 0.35% which is still something that would consistently lower your returns in the long term for a service that you can perhaps even do better by yourself as all the dividend aristocrats are publicly available. On top of that, the NOBL ETF distribution yield is 1.56% while the S&P dividend aristocrats index dividend yield is 2.54%, which implies a higher expense ratio, but this is not the focus of this article.

TickerCompanyPE RatioDividend Yield
MKCMcCormick & Company, Incorporated33.11.70%
SYYSysco Corporation36.12.50%
EDConsolidated Edison, Inc.20.23.40%
BCRCR Bard Inc.1520.40%
CLXThe Clorox Company25.92.30%
CINFCincinnati Financial Corp.16.52.70%
TAT&T, Inc.17.34.70%
PNRPentair plcN/A2.10%
ADMArcher-Daniels-Midland Company16.32.70%
MDTMedtronic plc49.51.80%
LEGLeggett & Platt, Incorporated20.92.60%
CTASCintas Corporation24.11.10%
KMBKimberly-Clark Corporation44.42.70%
DOVDover Corporation19.12.40%
HCPHCP, Inc.N/A6.50%
BDXBecton, Dickinson and Company44.31.60%
BF-BBrown-Forman Corporation18.51.40%
XOMExxon Mobil Corporation29.23.20%
CLColgate-Palmolive Co.47.12.10%
SPGIS&P Global, Inc.25.371.35%
WMTWal-Mart Stores Inc.15.72.80%
WBAWalgreens Boots Alliance, Inc.27.61.70%
LOWLowe's Companies, Inc.26.21.40%
PGThe Procter & Gamble Company27.13.20%
ECLEcolab Inc.35.61.20%
JNJJohnson & Johnson21.12.60%
NUENucor Corporation44.73.00%
ITWIllinois Tool Works Inc.20.42.00%
PEPPepsico, Inc.29.52.80%
AFLAflac Incorporated11.32.40%
SWKStanley Black & Decker, Inc.18.32.00%
KOThe Coca-Cola Company27.13.00%
MMM3M Company21.72.50%
GPCGenuine Parts Company20.92.60%
CVXChevron Corporation 146.94.20%
VFCV.F. Corporation22.72.30%
ADPAutomatic Data Processing, Inc.27.62.40%
ABBVAbbVie Inc.183.60%
MCDMcDonald's Corp.23.52.90%
APDAir Products and Chemicals, Inc.222.30%
GWWW.W. Grainger, Inc.19.32.10%
SHWThe Sherwin-Williams Company25.31.10%
PPGPPG Industries, Inc.20.41.40%
EMREmerson Electric Co.17.83.60%
HRLHormel Foods Corporation24.11.60%
TROWT. Rowe Price Group, Inc.15.43.00%
CAHCardinal Health, Inc.182.10%
ABTAbbott Laboratories26.32.70%
BENFranklin Resources, Inc.12.12.00%
TGTTarget Corp.12.83.30%
Table 1: Dividend aristocrats by PE ratio and yield. Source: Morningstar.

The above table represents all the dividend aristocrats from the S&P 1500 and shows what a variegate group that is with PE ratios going from 11.3 to 152 and dividend yields from 0.4% to 6.5%. As according to the father of defensive investing Benjamin Graham and his book Security Analysis, a defensive investor should not buy stocks with a PE ratio higher than 15. The above list provides a possibility to choose for yourself and not pay unnecessary fees.

Sector Breakdown

By buying dividend aristocrats yourself you can select the best sector exposure in relation to your existing portfolio.

figure 3 sector exposure
Figure 3: S&P dividend aristocrats sector breakdown. Source: S&P Indices.

It is interesting to note that the biggest chunk of dividend aristocrats is made by recession-proof sectors like consumer staples and discretionary, health care, energy, utilities and telecommunication services. An astute investor could pick only the sectors he expects not to be severely hit by possible future economic turmoil.

Conclusion

The purpose of this article was to indicate that dividend aristocrats usually beat the S&P 500 and that they are also currently cheaper. On top of that, an investor can pick himself the best aristocrats for his portfolio or just wait for the complete market to fall to more normal historical levels and only then be more overweight in stocks.

The above list of companies represents relatively good companies which should make part of a well-diversified portfolio, but only for the right valuation.

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Is Global Recession On Its Way? Brexit May Be A Warning Sign…


  • Global GDP growth rates are stalling even with increased monetary stimulus.
  • There are several potential recession triggers.
  • It is important to assess the risks a portfolio runs as no one can know when a recession will come, but eventually it will as it always has.

Introduction

The main FED goals are sustainable economic growth and full employment. In order to achieve those goals, the FED has decided not to increase interest rates as the economy is still relatively weak and employment has been slowing down. Not only that, but the expectation of future interest rate increases has been revised downwards.

This brings several consequences. In case of an economic downturn, which would be completely normal as we have not had one in the last 7 years, the FED has no maneuvering space left to help the economy as the interest rates are still at recession levels.

1 figure gdp to date
Figure 1: U.S. GDP growth to date. Source: Multpl.

As the last recession was 7 years ago and every economy is cyclical, we should not be surprised if a recession comes along. No one can know when this will happen as recessions always come unannounced, but we can take a look at the risks that can trigger a recession and the consequences of it.

Potential Recession Triggers

Brexit

A vote in favor of the U.K. to leave the EU might influence some longer term market disruptions as London is the European financial center. The U.S. Treasury Secretary recently issued a warning stating that the global economy would be damaged if the U.K. leaves. The recent polls show a scary shift toward a leave.

2 figure brexit
Figure 2: Brexit polls. Source: Financial Times.

The ‘remain’ has always been greater than the ‘leave,’ but it seems that the undecided are turning toward a leave. Next week will be an interesting one as we will see the long awaited Brexit vote confirmed, be it a leave or a remain.

Another Bad Summer in China

Last summer we had the first meaningful stock market fall in the last 7 years as the Chinese stock market precipitated on weaker Chinese growth.

3 figure China GDP growth
Figure 3: Chinese GDP growth per quarter. Source: Trading Economics.

As China is increasing its debt levels in order to force economic growth, the long term perspective is one where if all goes well, China will have stable growth levels but any global shock like the above Brexit might influence further slowing down and a global deflation spiral.

4 figure china debt to gdp
Figure 4: Chinese debt to GDP. Source: Trading Economics.

Debt usually means trying to hold on to the status quo until there is liquidity. The above increases in Chinese GDP show that China is desperate to keep its growth rates as it might implode without high growth rates.

As China and all other economies are dependent on global trading, any indication of global isolation would quickly spur discomfort into the market and this brings us to the next possible trigger.

U.S. Isolationist Tones

Currently Clinton is ahead in the polls but the Brexit example shows how we cannot bet on polls. If Trump’s isolationist rhetoric is more than just election tactics this could have a severe impact on U.S. trade and global economics. History has proved that any kind of isolation is detrimental to economic growth and wellbeing, and the current high standard we are enjoying is a result of global integration increasing its speed in the last three decades.

Global Monetary Policies Imbalances

With the FED slowing down, this is less of a concern as the higher U.S. interest rates would have strengthened the dollar and lowered U.S. exports. Everything produced in the U.S. would have been more expensive and U.S. corporate earnings would have been lower in dollar amounts.

Countries like India or Brazil, where interest rates are relatively high, are still not such a big influence on the global economy, but an economic rebound or inflationary pressure in one of the global economic pillars like Europe or the U.S. would trigger worldwide financial instability.

5 figure global interest rates
Figure 5: Global interest rates are at historical minimums. Source: Trading Economics.

The event of such a situation is highly unlikely especially after the FED has slowed down with its interest rate plans and the situation in Europe is not indicating economic exuberance.

Europe

Europe is the next risk factor for global markets. Even if we haven’t had a ‘Greek’ moment or a bank crisis for a while as the European economy is growing, that growth is still not stellar and has already peaked.

6 figure EU growth
Figure 6: European GDP growth. Source: Trading Economics.

EU growth has reached 2% in 2015 but is already declining and sits at 1.8% currently. This is a good number for Europe as the 2012/2013 recession is not far away, but the growth is fueled by increased debt levels and the non-performing debt ratios are scary for EU banks.

6 figure non performing loans
Figure 7: Non-performing debt ratios for EU banks. Source: European Central Bank.

For comparison, the average U.S. non-performing loans are at 1.67% which is much lower than the EU 7%.

7 figure us non performing loans
Figure 8: U.S. non-performing loans. Source: Statista.

Therefore, Europe not only has the ‘Brexit’ issue as a potential destabilizer but also bank fragility and the fragility of the whole economy.

Understanding of Risk

The last risk related to global markets is the assessment of risk investors have. With yields at historical lows, investors might be losing the perception of risk, especially as central banks run to save the markets as soon as any decline is anticipated.

A shift in the perception of risk might be the biggest risk of all as we have seen that after the FED decided to keep rates steady and lower for a longer period of time, the DOW index declined and did not, as usual, increase based on continued FED stimulus.

Conclusion

The scope of this article is not to be the chicken little but to objectively assess real risks to your portfolio. A recession would be catastrophic at this moment as central banks are out of firepower. Maybe they can keep markets at a permanent high level with low interest rates, but there are several structural and cyclical longer term forces that come into play here and cannot be influenced by monetary policy.

The U.S. is approaching full employment, corporate earnings and investments have been declining for a while even though interest rates are still low. As we already mentioned, we cannot know when any of the above described risks will kick in, maybe even next week with Brexit, or not in the next few years.

Eventually a recession will come, as it always does, unannounced and surprising, nobody knows when but it is good to think of how risky is your portfolio in relation to that and if maybe the same returns can be reached with less risk.