The devastating crisis in 2008 provided clear evidence that mainstream macroeconomic models ignored risks associated with debt and the financial cycle and were rendered moot when the crisis hit. In recognizing these endogenous risks, an investment framework should integrate financial cycle and macroeconomic risk.
Today I am at Camp Kotok in a remote area of Maine where connectivity (the electronic kind) is limited. Rather than try to write a regular letter, I decided to hand the keyboard over to you – or at least to a few readers like you. I went through the feedback to my last few letters and picked some comments to share and respond to. These are a small fraction of the feedback we received, so forgive me if I omitted your brilliant submission! And because I want to get to the Camp Kotok opening reception in a bit, this letter will be shorter than usual.
At the height of the technology bubble, the median of the most reliable market valuation measures we follow (those most strongly correlated with actual subsequent S&P 500 total returns) briefly reached an apex 178% above historical norms that had been regularly approached or breached over the completion of every market cycle in history.
Today I will show you a simple indicator that has an excellent recession-forecasting record, according to research by the Federal Reserve itself. Though the Fed’s own wacky policies may have weakened this early-warning system’s reliability, an interpretive adjustment can restore its usefulness.
We have created an adaptive regime-based investment framework that generates multi-asset and equity-sector-rotation model portfolios. The investment objective of these model portfolios is to combine downside protection with upside participation. Many firms say they do this – but our process integrates macroeconomic and financial cycle risk.
Last week, the S&P 500 price/revenue ratio reached the highest level in history, outside of the single week of March 24, 2000 that represented the peak of the tech bubble.
I am concerned that another major crisis will ensue by the end of 2018 – though it is possible that a salutary combination of events, aided by complacency, could let us muddle through for another few years. But there is another recession in our future (there is always another recession), and it’s going to be at least as bad as the last one was, in terms of the global pain it causes.
In this month’s Global Economic Perspective, Franklin Templeton Fixed Income Group dives into diverging central bank policy and weighs in on whether the European Central Bank is likely to be less accommodative—and what its timing might look like.
I have lived through recessions and bear markets; I know what they look like. I wish I could forget what they feel like. They don’t come out of nowhere; there are always warning signs. Many investors choose to ignore those signs; I choose not to. I hope you make the same choice.
We see a strong case for convertible securities at this point in the market cycle along with our expectations going forward.