Market Update: Deal With It

I just sent out these brief market thoughts to my favorite client (Of course I say this to each of my small number of clients. I learned this from the Sell Side).

Here they are:

  • Market sentiment is not massively bearish. It seems mostly anxious and confused, though with an identifiable bearish hue. The overall set up going into the best seasonal part of the year is good. Good-to-quite good.
  • The US continues its recovery with subpar growth and low (but growing as a function of time) odds of a recession.
  • EM has begun its L-shaped recovery. I still like EM local ccy bonds more than equities, but EM equities over DM equities should work over the longer term too. Too many got caught out betting on the kind of EM washout many of us cut our teeth on. Many quietly still cling to that view. IMO too many things have changed for that to be the base case.
  • I expect funding ccys vis-á-vis the dollar to decline somewhat, but risk ccys (EM) to appreciate gradually. The combo of L-shaped recovery and reach for yield will attract flows back to EM local ccy bonds now that the long bear market appears over.
  • I don’t fear the Fed that much but from time to time fear others’ fear of it, contingent upon sentiment and positioning at those points in time. Why? Because IMO equity levels today are much less propped up by the Fed than the market is inclined to believe. The average investor doesn’t seem to understand the transmission mechanism of monetary policy any more than s/he did before the GFC.  Plus, investors systematically overstate the role of the price of money in risk appetite. Moreover, the obsessive lookout for bubbles kicks in periodically to help keep bubbles in check. Nonetheless, it is good for the Fed to have put FinStab on their radar last year because excessive risk build up is a positive function of time and we are inching in that direction, as memories of the GFC slowly fade.
  • Europe is always my concern, but I do not for a second fear systemic shocks from DB or the broader banking system over the investment horizon. PTSD is easily awakened and policy makers would not be taken by surprise. They also have the benefit of numerous dress rehearsals  and extensive contingency planning. Longer term, however, I continue to be very pessimistic Europe’s prospects.