Fine, Deflation. But For How Long?
It’s amazing to me that despite staring down the barrels of the same themes that have obsessed markets for the last 2 months (USD strength, energy price impact, SPX valuations near cycle highs) people are now questioning whether the earnings season now upon us is looking challenging – meanwhile the “street” continues to endorse US big cap as being a place to see another great year of returns. Do what you want with earnings season that begins today, but thinking that this is a bottom up world right now is trying to buy the greatest house in the neighborhood when you are not sure what neighborhood you are even in. What’s clear to me is that is all about macro and this alone will dictate whether people can stomach the obvious macro headwinds after 6 historic years of market gains. Only in the last two of these six has stock picking really been that important. It’s all macro!
Macro right now means Greece and also means that the despite this fear, Europe can find its place to outperform in this aforementioned environment that is not an easy read. I challenge anyone to tell me this is a consensus view, but I will accept the challenge of playing relative value (ie: being less “directional”) in an unclear environment where the real potential black swan event is the thing you are getting long against the tried and true safety US play. But that is what I’m saying and doing. You finally have your window and catalyst to see Europe outperform if Greece can hold the line. US earnings season will reveal challenges to not only the 4Q operating environment but to the outlook of many US multinationals, energy companies and industrials. US earnings season will put a bright light on valuations. You will see that Germany is now quite cheap to the US (14.5x DAX vs 17.2 x SPX) and that is getting the dual benefit of a currency that is now trading back to the day it started formally trading in Jan 1999 (largest exporting economy in the world outside of China) and oil prices at $49.00 Brent. You also have 1.2Trn reasons in the form of negative yielding EU sovereign bonds that will make EU equities much more attractive to investment dollars within the continent. A tip of the hat to Guy on rates because I think the US 1.95% 10yr looks like a steal on relative value to European sovereign yields and this is what I used to do for a loving back when I started doing “G24 spreads” at UBS out of business school.
I do take issue with Guy’s highlight of the BDIY and the deflationary thesis. I say we are in a disinflationary environment but that can only be for as long as there is no wage pressure coming out of the US or Europe. Rates at zero and the US labor market strength will create pricing pressures. The greatest argument for some rising cost pressures will actually come from the most beaten up part of the spectrum however: Commodities. Make no mistake, even though economists and central bankers tend to strip out core inflation from food and energy prices, it has been the full aggregate inflation readings that have forced CBs to act aggressively using monetary policy. Lower oil prices have pushed the ECB faster and given them carte blanche with the Germans to do what they need to do on QE. Singling out the BDIY for futility is accurate and noteworthy, but I would choose to say this is where you are getting extreme readings of overdone sentiment that is setting up for a violent snap back in commodities overall. I would turn my focus more to the CRB index however.
Yeah we know that commodities are suffering (Strong USD, no China bid, oversupply…) Yeah I get it but… The CRB is another -1.4% today and now all the way back to the base formed after the worst financial crisis of all time AND to where we started the brunt of the commodity super-cycle run in 2002-03′. Commodity prices in aggregate are now trading back to where they were in 2002/3 when global GDP was around $29Trn and now it’s close to $72trn. Meanwhile the world will still consume over 92m bbls of oil/day in 2015 up from 89m in 2012. No matter what happens with nat gas and renewables, oil demand will grow 1.5%+ on average until 2030. Just because there is an supply reaction ( there ALWAYS is) in the commodity space, doesn’t mean the world is getting smaller or less populous or less energy dependent. We are NEAR or AT cash production costs in oil, ore, and other bulks and ags. Without a “Lehman style” credit event coming out of Europe ( or Japan, second on the probability scale…NOT China) in the next 3 months, the commodities thesis can play out. We may begin to see real basing of key commodities in late 1Q. I might even agree with BK that gold can rally back a bit.
Also important: Last night I watched St Elmos Fire on some far out channel on my cable galaxy and was reminded of a couple things: Hair and clothes were big/ugly and climbing out on roof and playing the sax was a really great way to find your soul. A clarification, we didn’t have frats at Georgetown so there was some artistic license taken. A couple other important observations and questions: Rob Lowe’s still bringing the lumber… Was Ally Sheedy ever considered hot?? Andie MacDowell was VERY hot. Andrew McCarthy was hard to watch… And yes, my brother and I and few buddies did in fact contribute a few lines to that movie. After running into one of the screen writers one late night in ’86 after we were coming out of the Georgetown campus pub, we filled up his notepad with stupid one-liners and jargon that did indeed infiltrate the movie. My claim to fame…