First Quarter of an Uncertain Year

On the 24th August 2015 when the DOW looked into the abyss at 9:30 east cost and had dropped by 1000 points. And when the West Texas Intermediate (WTI) hit its six year’s low, below 40 USD, did it signal the end of this six year rally or was it a manic sell off?

The truth of the matter is that although the Long term growth in the United States is slowing, the US consumer, according to the published statistics, is a whole lot stronger. Hence, one can argue this slow-down to be either a cyclical correction, in a long-term secular bull market, or a revenue recession.

At the same time the chasm between the EPS growth and Revenue growth, which has by no means been spectacular during the past two quarters, has been getting larger and larger. Which point towards the fact that at the end something has to give?

And while no one can profess to be an expert in the internal dynamics of China, looking at the macroeconomics and the interwoven markets at large, one has to realise that the Chinese need the West as much as we need them. Therefore, the preconditions for a compromise have never been better.

Interest Rates

The main problem with low interest rates is the subsequent asset bubble. And this, in the form of higher stock prices for example. This bubble has not been confined to the developed markets only, China is a prime example. Despite all these and/or perhaps because of it, after such prolonged low interest rates there is hardly any real growth in the US.

The fall of the markets in December last year highlights the irrational exuberance about the market participants.  Markets right now are DRUNK on central bank activities. There is an unhealthy co-dependency between the market and the central banks. This dependence means that market participants are expecting or pressuring the other side to do even more and that to a point where it becomes unsustainable. The recent action or the lack of it, from the US FED, was exactly due to such pressures.

Cheap Money: It should also be mentioned that the default cycle has been unusually low. And this due to the fact that we have had 6 years of ultra-low interest rates. As a consequence, a number of companies have come to market and a lot of investors have taken down their debts, without necessarily paying for the spread. And now if the interest rates go up, we will see how these are to unwind. The question therefore, is it going to be like a normal credit cycle?

When the cost of capital is zero, companies can borrow to pay dividends or subsidies their stock buyback plans. In doing so, they push up their stock price creating market anomalies. Some blame the central banks for this, saying “they should not have kept the interest rates low for so long”, or “it should not have been created in the first place”.  In the meantime, all that printed money in the system has to go somewhere.

Crisis in the Credit Market

With the rise in interest rates, credit will be crushed. This in the past has been a precursor to recession. In the US, some 20-25% of the High Yield bonds are energy related. This coupled with the low price of oil, will lead to huge number of bankruptcies. Unless, the companies are able to leverage a lot of the efficient technologies and service providers, that are offering their services, in order to sustain production at low levels and continue to service their cash-flows.

With additional requirements put forward by the SEC, such as the leverage 3-day liquidity without material change, otherwise you can’t be a liquid loan Fund. These requirements are forcing some selling in the high yield market. Therefore, we have a real problem if Mrs. Yellen decides to put up the interest rates again this year. With a raise in the interest rates, the fixed rate bonds will become worthless. Rising interest rates are hence a double edged sword.

Syndicated Loans & the Middle Market: There is no real Bid & Offer in the market today. The syndication process has been the same for the past 100 years. The middle market loan is around 100 billion dollars a year. The general market for bonds is 35 Trillion. The whole of the stock market is around 26 Trillion, hence the Bond market is far bigger than stock market and I think this can get really ugly, if liquidity is to be squeezed. And one mustn’t forget that the FED and the central banks control the short, but not the long-end of the interest rate curve. And with the command economy out of China, we are entering uncharted territory.

Fundamentally, Credit is different from the Equities. Fixed income instruments have a maturity, they have a coupon and you have a security, which will provide support to the extent that liquidity moves against you. People are now selling out of high yield loans and that can create opportunities for long-term investors. If you are one such investor, this is the time you should look in and look for those situations where you can increase your positions.

CAPEX: In a low interest rate environment, where the time value of money is nearly zero and with the amount of uncertainty from East to West even forgetting about the unsettled Geo-political situation, why should anyone invest? Additionally, BRICS like Russia are exporting deflation in the Form of lower commodity prices and reduce economic activity, resulting in lower profits for the developed world. With the existing low interest rates, companies are rewarded by buybacks, which is safe, easier and involves far less risk than CAPEX. This situation can also exacerbate the M&A activities around the globe in the sense that companies borrow to buy other companies rather than developing something on their own. The cash flow so far has gone towards serving their debt load, over time falling available Growth Capital. Valuations over the long term, however, can be suppressed and they will have to rain in further capital.

Therefore, the lack of M&A activities and that, specifically in the SHALE sector, is because of the underlying credit risk. As credit risk grows, if you can buy certain assets out of the credit market or future potential bankruptcies, we don’t think that you are going to pay a premium. But for the time being the bid/ask spreads on the M&A market table are still too wide apart.

Stocks and their P/E Ratios: In such volatile times, the stocks are precipitating towards their fundamentals, where PE ratios are beginning to be more reasonable. And one has to realise that there is a difference between the market value and the fundamentals. Today’s market conditions and volatility are a financial and not an economic issue.

Global Slowdown

In this quarter, the market can be said to have been in a bullish divergence mode, when the shorts were taken out and the sellers had finally got tired.

Right now, we are lacking a global leadership in growth. Neither the US nor Europe can lead if there is a hardly any growth. And right now, everyone including Mrs. Yellen is looking at China and there is nothing coming out of there. Therefore, during this and the latter part of last week, the proxy for the global growth is the Oil again. If the price of oil hovers around or just below USD 40 we will experience a grind to the upside, but if it breaks through the 30s handle, then we are back to a bear market situation.

Slowing Income and Revenue environment: The Thesis here is that the global economy is still decelerating. 2016 will show if the monitory measures, adopted so far, have outlived their hype. Monitory policies can do so much and we are towards the end of what is possible with easy money. These measures cannot necessarily increase productivity, revenue and earnings growth. In the meantime, Banks have far healthier balance sheets, than they did back in 2009. Banks, however, will and cannot increase manufacturing or productivity for that matter. They can facilitate credit but they cannot steer the use of it. Given all these facts, our near term trading strategy is therefore to sell the rallies and wait for the prices to reach levels justified by their fundamentals, rather than a mere promise of future earnings.

Opportunities

Within the global markets, there are always opportunities. Be it on the long/buy or the short/sell side. We at Swiss Wealth Solutions are Bottom fishers, we buy low and using our business strategy we can afford to wait until they come up to their fair value. All given our fundamental analysis is correct in the first place. It was not difficult to bid for a company like VW, which has been producing a vast range of reliable cars for decades. VW shares, towards the end of the last year and the early part of this year plummeted unreasonably and that due to a SW error/manipulation. This kind of anomalies results in ideal buying opportunities to acquire VW then and Valeant Pharmaceuticals and Yahoo now. We advised our clients to buy VW, knowing that the stock price would recover soon. And we were not wrong. Of course, VW was absolutely incorrect and deserved to be punished for manipulating certain of their readings to gain market share. As far as the reliability and safety of their vehicles were concerned, however, nothing had changed. And if the people out there are really concerned with the environment, why did the number of the trucks sold worldwide sky-rocketed with the price of cheap oil? The fact being, that although we are concerned about our environment, our immediate safety and comfort comes first.