Last year’s Spring Edition introduced “Queen TINA and King Dollar” which predicted the changing market dynamic in 2015. Our CIO and BofA Merrill Lynch Global Research teams nailed it by focusing on two key facts – equities were nearing the top decile of valuation and the knock-on effects of the strong US Dollar would weigh on the already slow global economic growth – insights that hopefully helped CSQ insiders understand what was driving markets and ideally helped them improve their respective portfolio asset allocations.
Embracing the “There Is No Alternative” (TINA) mentality helped fuel a massive debt expansion in emerging markets (EM) and “Queen TINA” reigned because the (least bad) best alternative was to over-allocate to higher yielding risk assets in favor of bonds and cash as global interest rates remained at historically low levels. However, in the second half of 2015 King Dollar trumped the Queen. Seen through the lens of U.S. multi-nationals, the challenge of a stronger USD is clear: weaker profit growth. However, less obvious but still important is the impact on the roughly $9 trillion (according to a BIS report) of dollar denominated debt outside of the United States. Imagine the challenge to foreign companies that have to service debt in US Dollars while earning revenue in significantly depreciated currencies.
The US economy remains strong and the problems overseas are having more of a psychological effect on Mr. Market rather than a real impact on Main Street USA.
When there are no alternatives, markets can be volatile. By February 11, 2016 the average stock as measured by the Value Line Arithmetic Index was down more than 20% from the highs in April 2015 and many pundits have called the US markets as entering a bear market. The surging US Dollar and the depreciation of the Chinese currency have unnerved markets but fundamentally the US economy remains strong and the problems overseas are having more of a psychological effect on Mr. Market rather than a real impact on Main Street USA. Despite the bear market headlines, over the long term the single most important determinant of long-term returns has been valuation, which typically explains 60-90% of returns over a 10-year time horizon.1
While fundamentals drive long-term outcomes, market technical can drive short-term volatility. Investors have been trained to focus on short-term volatility by benchmarking performance each quarter and through convenient apps that allow us to check our accounts anytime. The hyper focus on short-term movements causes more harm than good as it increases the risk that investors lose composure which causes them to abandon long-term goals and make poor investment decisions by chasing performance.
However, technical price movements in stocks can present opportunities for long-term investors to rebalance portfolios. For example, several market technicians have called for the S&P500 stock index to test lower levels as the fear of a China-induced global recession takes hold. Historically, recessions tend to be rather short lived, and we think investors with a long horizon should view the lower prices in a near term recession as an opportunity to purchase assets at attractive prices. According to the BofAML Equity Strategy Team, the S&P500 index could rise to 3500 in 10 years’ time. While stocks are likely more volatile, we think the return premium potential is worth it in a low inflation world.
For those curious to know how we are doing…last year as “Queen TINA and King Dollar”2 was being published I was in the thick of transitioning my business to the elite Private Banking and Investment Group (PBIG) at Merrill Lynch in Century City. I am pleased to report we transitioned more than 90% of our clients.
I sincerely appreciate all of the support we received from our clients and friends. After one year at PBIG, the best portfolio advice I have received is to have a plan in place to weather near-term volatility and focus on investing for the long-term as valuations may soon become compelling enough to wake the Queen from her slumber.
Any opinions expressed herein are given in good faith, are subject to change without notice, and may only be correct as of the stated date of their issue. The investments or strategies presented do not take into account the investment objectives or financial needs of particular investors. It is important that you consider this information in the context of your personal risk tolerance and investment goals. Due to the time sensitive nature of the content and because investment opinions may have changed since the time any comments were made by research analysts, the latest Merrill Lynch investment opinion and investment risk rating for any particular security discussed should be reviewed, including important disclosures, before making any decision.
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1 Bank of America Merrill Lynch U.S. Equity Strategy Year Ahead Different hats: same conclusion: stick with S&P 500 Nov. 24, 2015
2 Queen TINA and King Dollar CSQ.COM March 26, 2015