Global Market Commentary

When Investing, We Must Keep the Big Picture In Mind


The U.S. and many global stock markets have continued to move ahead. Even rising tensions on the Korean peninsula, and the theoretical prospect of nuclear war, were met by markets with a brief shrug — and this during a seasonal period when markets are often unsteady and experience corrections. As we write, the S&P 500 index is just 2.4% down from its all-time high of 2490.87 set on August 8.


Markets are showing resilience in the face of geopolitical concerns, turmoil and gridlock in U.S. politics, and poor seasonals. That resilience is leading many market participants, analysts, and observers to murmur the same thing they’ve been saying under their breath for years now: “The market is near a top; it’s overvalued; we’re in bubble territory; I just feel something coming; this can’t go on.


If this murmur is running through your mind as well, fear not: we are here to reassure you. If the usual seasonal correction continues, we will be pre-pared to buy the weakness, and we are constantly reviewing and revising our buy list.


The reason is simple: a bull market does not die of old age.


How does it die, then? From recession. (Perhaps by extension, one could blame the conditions that bring about a recession, when those are unusual, such as a bona fide financial crisis like the one that threatened


the foundations of global financial stability in 2008. But “recession” is the fundamental answer.)


Navigating corrections is indeed difficult, but not impossible. Most investors are well advised to stay put during corrections unless a particular investment’s fundamental rationale has become untenable, or they have cash that they want to put to work. (Of course, as Canaccord Genuity strategist Tony Dwyer is fond of saying, corrections are always “natural, normal, and healthy” until they’re actually happening. Particularly if they’re associated with political or financial turmoil, they can be truly fearsome. It takes courage to ride them out, and long experience and skill to trade them effectively.)


However, true economic recessions and their associated bear markets are another story. Here, our decades of experience have shown us many of the critical warning signs of an oncoming bull-killing recession — warning signs that are available in public data about (1) business sentiment;


  • the trend of corporate earnings growth across the whole economy, and sector by sector; (3) various macroeconomic and financial conditions, including trends and events in foreign economies and banking systems; and


  • the U.S. yield curve.


These warning signs are not precise, and can result in reducing market exposure before the bull market’s peak, or failing to re-enter markets until after the bear market through has already passed. However, as many investors can attest, the value of avoiding a 50+% peak-to-trough decline can be inestimable for the health of a portfolio and, perhaps more importantly, for an investor’s sanity.


Our monitoring of these warning signs suggests to us that currently, recession risk is not elevated.


The preponderance of indicators currently suggests that a recession, and the bull-market peak that will precede it, are probably still several years away.



The Key Indicators


In this summary, we draw on the analysis of Canaccord Genuity strategist Tony Dwyer — the best U.S. market strategist we follow. Tony has been a steady voice drawing attention to this fundamentals throughout the bull market that began in 2009. Those who have listened to his clear thinking have benefitted greatly, especially during bull-market corrections and periods of anxiety.


The last of the critical indicators mentioned above, and in our opinion the most important, is the yield curve — the spread between long-term and short-term interest rates. Exactly which rates is not particularly important as long as you’re consistent; Tony prefers the 10-year and 6-month rates. When that spread becomes negative — that is, when short-term rates are higher than long-term rates — the yield curve is said to be “inverted.”


How quickly the yield curve inverts depends on the actions of the Fed and the market’s view of long-term economic prospects. Market expectations currently envision an extremely slow pace of increases to the Fed funds rate. Another reading

We Must Keep the Big Picture In Mind, cont’d


of the Fed’s intentions can be sought in the “dot plot,” in which the Fed’s Open Market Committee tells the world the interest-rate path envisioned by its own members at its meetings. The dot plot, which suggests a pace of rate rises more aggressive than the market is currently anticipating, now suggests that the yield curve will not invert until late in 2018.


The time between yield-curve inversion and the beginning of a recession is variable. Over the past seven recessions, yield-curve inversion has preceded its subsequent recession by an average of 13–15 months. Putting together these pieces, we’re led to the conclusion that the next recession will not occur until at least 2019 or 2020.


Just to reiterate: bull markets are killed by recessions, and the next recession is unlikely to occur before 2019 or 2020. This does not mean that we can’t have precipitous and terrifying declines in the meantime, of 15% or even 20%. But after they run their course, it is likely that the bull will resume its run to greater highs.


Of course, recessions are identifiable only in hindsight; they are not useful to investors, who will be in a recession (and its associated bear market) long



before any official government statistics confirm it. So it’s interesting to examine the relationship between yield curve inversion and the market.


In mid-June, a drop in the 10-year Treasury rate brought the spread between the 10-year and the 6-month to about 1%, or 100 basis points. If we look back at the seven recessions shown in the graph above, we see that this initial flattening of the yield curve to 100 basis points is a very bullish event, even though it’s an early sign that a recession is coming into view.


Investors know that substantial profits are made in the final stages of a bull market, and by studying the evidence provided by the yield curve, we can confirm this insight.


Bull markets are ended by recessions. Recessions do not occur unless the yield curve inverts. On average over the past 50 years, more than a year and a half has passed between the initial flattening of the yield curve to 100 basis points, and the subsequent market peak — and during that time, on average, the S&P 500 returned a nearly 30% gain.


Of course, investors cannot consider the yield curve in a vacuum. We mentioned other critical variables above. An important one is the momentum of corporate profit growth; we also study conditions of ease or stress in the financial system, the direction and momentum of inflation trends, and several other key indicators.


Vigilance is still required; the recession of 1981– 1982, in particular, shows that the yield curve can invert quickly. Further, the yield curve does not indicate exactly when the market peak will occur. However, the message is clear: investors who let fear and political noise scare them out of an ongoing bull market will probably leave substantial gains on the table. Harvesting some of those gains, and moving to the sidelines when conditions indicate that a real bear is approaching, seems to us to be a preferable way to build wealth.


Tony Dwyer summarizes his view thus: “Despite the possibility of a bit more correction, we would add to our favored sectors on weakness because:


  • our positive fundamental core thesis remains in place; (2) a synchronized global recovery and

domestic economic re-acceleration continues; (3) EPS and market valuations remain in an uptrend; and (4) the possibility of corporate tax cuts. We believe our SPX 2017 and 2018 targets of 2,510 and 2,800, respectively, may prove to be conservative.”


Investment implications: Listen to your nagging concerns, but subject them to critical analysis. History shows that bull markets don’t die from old age; they die from recessions. History also shows that recessions are preceded by an inversion of the yield curve. When the spread between long-term and short-term interest rates makes its first narrowing to the region of 1%, that is usually a sign not that a bull market is about to end, but rather that it is about to accelerate to its peak. Investors who do not keep focused on economic and financial fundamentals will let fear and political noise scare them out of a bull market — just when it is about to make a significant part of all its returns. If this fall gives you a buying opportunity, we suggest that you buy the dip.





Tech Giants: Clouds On the Horizon?



2016 closed with markets entertaining bold hopes about changes in U.S. fiscal and regulatory policy that would be favorable for particular sectors of the U.S. economy. The beneficiaries of these hopes were above all the stocks of infrastructure-related firms and financial companies. But 2017 did not turn out as planned. The administration that some hoped would be able to marry business sense and political savvy moved from a tumultuous campaign trail to a tumultuous White House. Despite the presence of capable cabinet-members such as Wilbur Ross, Steve Mnuchin, and Gary Cohn, the White House has so far been unable to successfully advance a pro-growth agenda — no infrastructure bill and no tax cuts have yet been forthcoming. (We do think that tax reform or repatriation reform will come eventually.)


That meant that most of the beneficiaries of the “Trump trade” gave up their gains, and the market turned its attention to companies that it believes can grow their profits through thick and thin, tax cut or no tax cut, no matter who’s in the White House and no matter how loud the political chatter. The market’s favorites in 2017, as most readers will know, have been the U.S. tech giants — companies like Alphabet [NASDAQ: GOOG], Amazon [NASDAQ: AMZN], Apple [NASDAQ: AAPL],


Facebook [NASDAQ: FB], and Netflix [NASDAQ: NFLX], as well as some related smaller companies with compelling growth stories, such as Nvidia [NASDAQ: NVDA]. (With global growth and demand remaining strong, big U.S. tech leaders have some company — the stocks of Chinese internet firms such as Alibaba [NYSE: BABA] and YY Inc [NASDAQ: YY] have also done well.)


However, it’s not just the markets that are lavish-ing attention on the behemoths of tech. Increasingly, an ear placed to the ground can hear rumblings from public opinion and from regulators about how powerful these companies have become — and that not all of their economic, social, and political effects are benign.


Some Tech CEOs Seem To Be Asking Themselves This Question



From a public perspective, there are concerns about privacy, and there are concerns that the giant tech “platforms” such as FB and GOOG’s YouTube are being used to incite extremist opinion and recruit agitators or even terrorists.


(On the privacy front, our own research into the current internet and mobile advertising leaders suggest that most consumers would be uncomfortable if they were fully aware of the depths of precise knowledge that online marketers have about them. Still, we think that for most consumers, ease, convenience, and truly relevant ads will push privacy concerns aside. The leading-edge cohort of consumers has been reared on selfies and social media, and privacy is probably not even on their radar.)



Platforms As Utilities


Some critics and politicians are arguing that the dominant platform firms have become more like media outlets than like telecoms, and that like newspapers (but unlike telephones, for example) they should be held responsible for transmitting the things that users post on them. European regulators are already moving in this direction, with Germany set to impose steep fines if the extremist material is not taken down within 24 hours of a firm being notified of its presence. (FB is planning to hire 650 employees to monitor content and comply with the law.)


On the other hand, free speech advocates in the U.S. are already restive about what they perceive to be heavy-handed political favoritism in such content policing as these firms already do. A fight is beginning to brew, and if the tone of U.S. political discourse in the past year is an indicator, it won’t be nice.


The real dangers, ultimately, will stem from the economics of digital disruption and the advantages

that politicians will seek to gain from exploiting shifting public opinion. Eventually, some economists will note, rightly or wrongly, that these companies are destroying more jobs than they’re creating — and also that they’ve managed to pay extraordi-narily low effective tax rates. President Trump’s recently ousted strategist Steven Bannon reportedly believed that the giant tech firms should be regulated like utilities. When an up and coming U.S. politician realizes that making these issues the center of his or her campaign is a ticket to victory, it will be a watershed moment indeed. And some politicians are already starting to do so.


From that point, antitrust regulators in the U.S. will become the real threat. Microsoft [NASDAQ: MSFT] learned this lesson in the late 1990s, and after its own near-death experience learned to curb its public arrogance and maintain a large and finely honed legal team. The last year’s news flow from Silicon Valley does not suggest that the other big tech firms have really absorbed the need for humility. It may take another near-death experience, or the kind of wrath once visited upon Ma Bell, to bring them to heel.


Such events are probably not imminent. For now, they are just clouds on the horizon. In the meantime, the sun continues to shine on big tech, and we continue to like it. We will be buyers of tech on seasonal weakness — even while we





Market Summary


We continue to be bullish on stock-market opportunity, and will buy any dips created in the next few weeks.


remain carefully alert to the winds of public and political opinion.


Investment implications: From a long-term perspective, some clouds are gathering on the horizon for the U.S.’ big tech firms. Eventually, they may find themselves on the wrong side of public opinion and face off against antitrust regulators. But that day is not yet. For now, in the absence of a market rotation back towards the beneficiaries of infrastructure spending and tax cuts, big cap tech still rules the roost. We currently intend to use seasonal weakness to initiate or add to positions in big U.S. and Chinese technology companies. Please note that principals of Guild Investment Management, Inc. (“Guild”) and/or Guild’s clients may at any time own any of the stocks mentioned in this article, and may sell them at any time. Currently, Guild’s principals and clients own AAPL, BABA, FB, GOOG, and YY. In addition, for investment advisory clients of Guild, please check with Guild prior to taking positions in any of the companies mentioned in this article, since Guild may not believe that particular stock is right for the client, either because Guild has already taken a position in that stock for the client or for other reasons.



technology and industrial areas, with special attention on tech leaders that correct. For traders, copper-related mining and processing companies appear attractive.

U.S. Stocks                                                                                       Gold


We continue to be bullish on U.S. stocks in the Gold is gradually moving upwards and should coin continue rally into September, at which time we expect a modest correction. Gold could approach $1320, which is a potential target in our view.



Emerging Markets


We  are  bullish  on  emerging  markets  in  general, especially the manufacturing emerging mar-kets of Asia. We like China, Hong Kong, Thailand, Singapore, Indonesia, and Taiwan, as well as Brazil, Mexico, and Poland.


Thanks for listening; we welcome your calls and questions.