Whatever the case, it is my heartfelt wish that all of you have a wonderful and happy Thanksgiving.
Hopefully, you will spend time with those who mean the most to you. While all of us have worries, there is so much to be thankful for. I’m alive, reasonably healthy and my closest family members will be here in the house with my bride of 44 years. The next generations will be here as well, learning about the joy of loved ones, the pleasure of each others company and too much to eat. We are blessed.
October 28, 2014 • Evan Simonoff
One of the greatest bull markets of most Americans’ lifetime may be in the 5th inning, according to Richard Bernstein, CEO of the eponymous advisory firm. Canvassing the global investment landscape, Bernstein told reporters at a luncheon sponsored by Eaton Vance that few signs of a recession or a bear market are on the horizon. He also sees no reason to change his highly negative outlook on emerging markets.
Bernstein’s words carry weight. A former chief market strategist at Merrill Lynch, he was named best in his discipline by Institutional Investor magazine 10 times. He was also an early and vocal optimist about the current bull market back in 2011 and 2012. In 2012, Bernstein predicted the current bull market might surpass the 17-year run from 1982 to 1999.
The surge of volatility in virtually every asset class that pervaded the financial markets earlier this month is attributable to the fact that hedge funds have been caught flat-footed, underperforming major indexes this year, Bernstein said. Hedge funds argue their reason to exist is that they will protect clients on the downside, even if they underperform on the upside.
In fact, the data reveals that very few hedge funds entered September with short positions of any significance since many of them were playing catch up. The subsequent sell-off in numerous asset classes that transpired in early October was “emotional, not fundamental,” Bernstein said.
The same was true with the lonely asset classes that appreciated. There was nothing “rational” about 10-year Treasurys yielding 1.88 percent, he noted.
But why does Bernstein believe that the bull market in equities still has staying power after climbing about 200 percent off its March 2009 lows? “The behavior that sows the seeds” of future recessions and bear markets “is nowhere to be seen.” Corporations aren’t spending aggressively and consumers refuse to loosen their belts.
The prevalence of the word “uncertainty” is critical to a long economic and equity-market cycle and it remains ubiquitous, he said. In this environment, “err on the side of bullishness.”
Bernstein views investors’ focus on the Fed and Washington, D.C., as a misplaced distraction. “When the Fed raises rates, they will be the last to know,” he said. “Everyone else will know by then.”
Conventional wisdom contending that bull markets end when the Fed raises rates are dead wrong in his view. “They end when the Fed raises rates too much and the yield curve inverts. We are nowhere near that.”
He also took issue with the perception that a near-term increase in interest rates could derail the bull market. “The notion that interest rates will go up and nominal economic growth will go nowhere just is not going to happen.”
Bernstein’s optimistic views on the economy were echoed by Kathleen Gaffney, Eaton Vance vice president of investment-grade fixed income and a highly regarded portfolio manager in her own right. While Bernstein manages several Eaton Vance equity funds as a sub-advisor, Gaffney runs a top-performing bond fund.
She believes that the world is witnessing a “changing of the guard” as the U.S. re-emerges as the driving force behind global growth and that favors equities over bonds. “We’ve haven’t been there [a global economy where the U.S. is the primary driving force] for 20 years,” she noted.
Gaffney didn’t say it, but one reason the price of oil has collapsed so dramatically in the last month is that it was estimated U.S. oil production, whcih increased by almost one million barrels a days in 2014, would do exactly the same in 2015. At this point, all bets are off, as oil markets struggle to discover a new equilibrium price.
Gaffney thinks the yield curve will start to flatten and this will cause high-yield bonds to be repriced. “Equities are a risk worth taking,” she said. Her bond fund has 20 percent of its assets in cash and she wouldn’t mind having more. But as Bernstein observed, bond fund managers as a group have their durations as short as they have ever been.
One of the few spots in the bond market that Bernstein likes is high-yield municipal bonds. Why? Because high-yield U.S. munis are yielding 125 basis points more than Iraq’s sovereign debt. Before ISIS overran much of Iraq, low-rated American municipal bonds were paying 2 percent more.
America may have Detroit and Stockton, Calif., but one quarter of the nation is not controlled by the likes of ISIS. Yet the flood of money into emerging markets’ debt has driven their prices to the point where such pricing distortions are occurring the global bond market.
So what could go wrong? Europe for one. “The European Central Bank will go down in history as the worst ever,” Bernstein said. “They have violated every basic rule of central banking.” In fact, he noted the ECB has been tightening for the last two years while Europe’s corporate sector has been deleveraging and many European nations have been teetering on the brink of another recession.
Bernstein also remains unusually bearish on emerging markets. In his view, they were the major beneficiary of the global credit-market boom of the previous decade and they will continue to be a leading victim of deleveraging.
Inflation and low wages have been triggering riots and protests in many emerging nations, starting in 2011 with the Arab spring and spreading to more established countries like Brazil and Turkey this year. “Why is that a good story?” Bernstein asked, adding that it might be if you were invested in tear gas and mace.