Market Outlook July 2016
In our last Market Outlook back in March 2016, we forecast that the UK would certainly vote to leave the European Union. Not many believed us. However, that is old news now so where to from here? We believe that the recent rally in global equities marks a serious regime change that is only just getting started. The recent up moves have been like two people sharing a glass of wine and we think it ultimately ends in a full-on Roman Bacchanalian festival.
We think equity markets may slow a little in August and September, but then move substantially higher, particularly after the US Presidential elections in November. We would be interested in buying any weakness after a Trump victory.
Henry Morgan Ltd has gradually added position size since listing in February 2016 and is now fully invested in equities, currencies, bonds and commodities including hedges.
After equity markets dropped significantly in February 2016 and suffered from quite extreme short-term volatility for almost the entire calendar year thus far, we have converted to the bullish side and now see opportunities practically everywhere – although we could be totally wrong.
Central Bank Monetary Policy and Government Fiscal Policy Stimulus
We suspect that Brexit may give policy makers the impetus, or the excuse more likely, to finally push the world to reflation. We hope so, although the Europeans have been flailing for nearly a decade so we assume it will literally take whole sovereigns becoming insolvent to finally have them even discuss the issue or possibly a major bank facing serious difficulty. Note that Greece has been going since 2011 and a final resolution is not even on the agenda. Recapitalising European and/or Chinese banks would, we think, be extremely bullish and would send strong policy signals.
Ironically, further stimulus may finally end the bond bull market and we would be avoiding government bonds from here and focusing on corporate debt. Fiscal policy is likely to see a resurgence almost everywhere except Europe and the USA may lead the way with Great Britain. This could well fuel a fire in equity markets with many investors badly placed in what we think will be ill-performing asset classes.
We have been heavily involved in the currency markets, which have seen some significant swings across the board. We think the Mexican Peso is one of the world's cheapest currencies, but our position has suffered from one factor – Donald Trump. When a potential new President is stating that he would like to put on a 35% tariff, review NAFTA and build a huge wall, the currency of Mexico will suffer â€“ and it has. However, we remain bullish on the Peso and it is a good yielder.
We expected the Yen to run upwards, and it has. We also think the Euro and the British Pound may also stage a recovery into next year, but we will wait and see what happens economically. Overall, we think growth picks up with still low inflation and relatively low rates- this is pretty much consensus, but we think this could change quickly to higher rates of growth and higher rates of inflation. However, we think the impact on some equity markets will be more extreme to the bullish side. We believe that we are close to a major inflection point that changes the global economic dynamic from deflation to inflation with profound effects.
Gold and Silver
The precious metals complex has outperformed this year and we expect that to continue. We do not think gold and silver are being used as safe havens, but are signaling reflation. We are not normally particularly interested in the precious metals complex, but at the moment we think a multi-year bull market could unfold taking gold and silver in particular much, much higher. Gold bugs may have their day again after being badly beaten the last few years in what may prove to a dip in a huge bull market.
Returns over the last two years have primarily been based on currency trading while equity markets were largely stagnant. Equity markets were volatile around a flat trend line and despite some precarious moves, frequently ended where they started looking at quarterly and six monthly data. We think that is changing now. Certainly we think volatility stays so expect plenty of large up and down moves, but we believe the ultimate direction is higher, possibly a lot higher.
We think the best opportunities are in markets more attuned to growth and also markets that have been flat or even down for many years. This is a long list with many equity markets performing poorly for over a decade, and in Japanâ€™s case since the 1980's. Europe is not far behind having seen higher stock prices in the 1990's than where we are today.
We believe Australia is deeply undervalued. We think the same of China, deeply undervalued and with a market constructed for epic rallies (or epic busts if we are wrong). The USA probably faces some valuation headwinds, but the NASDAQ may still shine. The UK could go up another 30% quite quickly. Valuations are cheap and stimulus could give a serious push. Of course, leaving Europe is hugely positive. Ironically, Europe may wake up and do something positive.
We have been bullish on Europe for a while and been disappointed. We did not think that any group of people could ignore their economic peril for this long, but we were clearly wrong, at least for now. If the Europeans ever get going it will be a huge party and we will try to join in.
Japan looks really interesting. Everyone loved Japanese equities when Abe came in, but this has turned to hate – so we are falling back in love as we think there is a big opportunity. We think Japan should be double what it is now based on valuation and long run policy, but we might be disappointed.
Overall, we think sticking with cheap, high yielding currencies, avoiding bonds, loading up on equities and hedging with big positions in precious metals is the way to go. If we are wrong, we will happily change our minds and seek to adjust – but we are pretty confident we won't have to.