Update: This post was included in the Carnival of Wealth #3
Anyone who has been watching the business news lately would have noticed how often the word ‘uncertainty’ is mentioned in the same sentence as investing. Given the conflicting macro economic data and way in which this data can be construed as either bullish or bearish, inter-market analysis or a comprehensive macro perspective is crucial to formulate investment theses and asset allocation determinations for the long term. Keeping that in mind, we are very happy to present this next interview with a market veteran who has spent a large part of his career formulating research and trade ideas that help investors understand and maneuver unfolding market conditions.
Biography: From 1968 to 2002, J. Anthony Boeckh, Ph.D was Chairman, Chief Executive and Editor-In-Chief of Montreal-based BCA Research. He was also chairman of Greydanus, Boeckh and Associates from 1985-99, a fixed-income investment firm which managed $2-billion in assets when it was sold to Toronto-Dominion Bank in December, 1999.
Mr. Boeckh has a PhD in Finance and Economics from The Wharton School, University of Pennsylvania, and a B. Comm from the University of Toronto. He spent four years in the research department of The Bank of Canada in the early 1960’s working in the areas of monetary and economic analysis. He is a founding trustee of the Fraser Institute in Vancouver British Columbia (an economic “think tank” dedicated to free market principles).
He recently authored The Great Reflation: How Investors Can Profit From the New World of Money published by John Wiley & Sons in 2010 and co-authored The Stock market and inflation, published by Dow Jones-Irwin in 1982.
Currently, Dr. Tony Boeckh coauthors the The Boeckh Investment Letter, a publication that highlights investment and economic commentary with Robert Boeckh.
Q: With the 2 year and 10 year treasuries breaking to new lows recently, where are the equity markets headed the rest of this year and over the next 12-18 months?
A: Over that time period our outlook is cautiously bullish. Low interest rates, improving credit conditions and an extremely lean, profitable corporate sector will continue to drive good earnings results. Having said that, the macro outlook is extremely uncertain and the possibility of more financial shocks warrants a defensive posture from risk adverse investors or those with shorter time horizons.
Q: What about the outlook for the U.S. and global economy?
A: In a word: ugly. Central bankers in the U.S and Europe have recently revised growth forecasts downward. The 25 year private sector credit binge is in the process of being transformed into an explosion of public debt which will lead to a new set of problems in a year a two. Yet, from an investment point of view a fixation on the macro outlook at this point would be a mistake. Markets forecast the economy, not the other way around. In 2008, the corporate sector positioned for a depression that didn’t happen and is now enjoying strong productivity growth. A bit of persistent slack in the system, while bad for employment and wages, is great for corporate earnings in the short run.
Q: It appears as though year over year housing related comps are pointing to a weaker than expected consensus. Unsold housing inventories in various California municipalities were up anywhere from 15% (L.A.), to +33% (San Diego) last month. Mortgage applications for home purchases have collapsed more than 40% in the past two months despite record-low mortgage rates and lenders are demanding 20% down payments in response to the grim reality that over 7 million households are now at least 30 days past due or already in the foreclosure process. With Fannie and Freddie starting to push more repossessed properties onto the market are we in for a significant (>8%) leg down in real estate prices in the near future? What might be the implications of this to the economy and equities?
A: We agree that U.S. housing is a mess. There is a massive inventory of foreclosed homes, including many that banks are just sitting on. It will take years for the market to clear. With the caveat that we are not housing experts, we would be surprised to see another major downleg in house prices. Rather, we expect stabilization at current low levels to persist for a few years. The real problem will be in the home-building sector. In the decade before the housing crisis, this was a major driver of GDP growth and employment, particularly if you factor in the financial dimensions of the industry. Equity markets have already discounted this stuff, so the only real implication is that weak housing will be yet another drag on employment. Ironically, weak housing could actually be a benefit the larger equity market as it will force policy makers to keep the financial system awash in liquidity for an extended period.
Q: Recent data from the Cleveland Fed’s Trimmed-Mean CPI measure slowed to 0.8% YoY while the trimmed-mean PCE inflation rate from the Dallas Fed remained at 0.9% in June (again at the lowest levels ever), do these data points indicate that deflation rather than inflation is the primary threat?
A: We agree that deflation is the primary threat. Despite the rapid expansion of Federal Reserve’s balance sheet, the money multiplier remains weak. For Central Bank liquidity to result in consumer price inflation, the money has to spill out into the general economy through lending to the private sector. There are some early signs that lending is recovering, but not to a degree where over-heating and inflation would be a concern any time soon. If there is a spike in the CPI it will likely come from a sharp decline in the U.S. dollar as a consequence of a sovereign debt crisis. In our opinion, this is a low probability event as the U.S. hardly stands out as a fiscal laggard next to most other developed nations.
Q: A just-released survey by Accenture showed that businesses don’t plan to restore their workforce to pre-recession levels anytime soon. What will it take for unemployment figures to improve substantially and when might we see this?
A: Unfortunately, there are no shortcuts here. It will take years to heal the damage from the credit binge and develop a self-sustaining up-leg in aggregate demand. We have just begun a deleveraging process that will probably last for five or ten years. In fact, we may not return the low unemployment levels of the early 2000’s again.
Q: In terms of asset allocation, where should investors be investing right now?
A: Currently, we are slightly underweight equities, overweight corporate bonds (investment grade and high-yield) and overweight cash. We don’t see much upside in precious metals but recommend a small allocation in the unlikely event of major sovereign debt crisis. Europe is looking pretty cheap right now, and monetary tightening in China has probably ended paving the way for another up leg in Asian equities.
Q: In terms of exogenous shocks or black swans, what worries you most about the economic/investing environment in the U.S.?
A: Political tensions in the mid-east are a major concern, and a nuclear Iran would certainly unsettle conditions there.
Thank You Dr. Boeckh!
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