Global CIO Commentary by Scott Minerd
It seems summer brings out the sunny disposition in everyone. Despite the fact that returns across U.S. investment categories are pretty dismal year to date, markets are pricing optimistically and it seems the sunshine has brought growth back to the U.S. economy. Recent data from the Bureau of Labor Statistics showed a 280,000 increase in employment in May. Additionally, building permits rose 11.8 percent in May, better than the 3.5 percent decline forecast by economists, while the pace of existing home sales hit its fastest rate since late 2009. Taking everything into account, the likelihood that the U.S. economy will suffer a recession in the next year or two would appear to be extremely remote.
Still, seemingly isolated events could yet sour the mood. Since the euro crisis erupted back in 2010, the possibility of a “Grexit” has been a recurring issue. A number of commentators have painted the possibility of a Greek exit from the euro zone as the equivalent of a Lehman Brothers-style event, a view I’m not so certain is correct. With that said, seemingly minor occurrences have in the past set the stage for larger economic events, such as the collapse of the Thai baht, a seemingly contained event that ultimately proved to be the first domino to fall in the 1997 Asian crisis. While we cannot discount the consequences that a Greek exit could potentially herald, I believe a solution to paper over this seemingly never-ending crisis is likely to calm markets in the near term.
As for developments at the Federal Reserve, while some commentators have suggested that the Fed is leaning toward December, I can see no reason why the Fed would consider delaying a rate rise beyond September. Either way, I don’t think it matters: The bottom line is that a rate hike is coming. Personally, I consider the bond market to be in fairly good shape and capable of handling the beginning of “normalization” without a rerun of the 2013 taper tantrum, but only time will tell.
Lastly, despite the generally positive environment, it disturbs me how low returns have been across almost every asset class year to date. This tells me that markets may be getting fully priced for the near term, and that investors have already placed their bets on how they see major events of the day playing out. With all the chips on the table, new market inflows are likely needed in order to push prices higher, but I don’t envision significant inflows occurring until the fourth quarter. As evidence, the S&P 500 has not had a weekly move of more than 1 percent in either direction in two months, which is the longest such streak in over two decades. During this period, breadth has broken down in a meaningful way. For now, it doesn’t appear that investors are being compensated for the risks they are taking.
Despite poor year-to-date performance, the majority of forecasters have yet to alter their year-end S&P 500 price targets. In fact, the dispersion around analysts’ predictions is as tight as it’s been since 2009. This tells me the market doesn’t really feel like there’s a lot of uncertainty, which is concerning, because such high levels of complacency usually foreshadow some form of financial accident. I am not talking about a financial crisis, or a recession—we certainly have no indications of either yet—but there have been a number of periods of prolonged expansion where complacency climbs high and we wound up in an extremely turbulent period. Think about 2011, when there was a severe summer pullback in U.S. equities. Similar to today, at that time investors had basically put their bets on the fact the recovery was in place, and that stocks were going higher. Those bets turned out to be correct, but only after we narrowly avoided a 20 percent pullback.
With complacency as high as it is today, I fear we could be in for meaningful turbulence this summer. For this reason I would encourage investors to consider accumulating cash reserves or Treasuries in order to insulate themselves against any potential summer squalls during the next few months.
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