Elisabeth Kübler-Ross was a Swiss psychiatrist who spent most of her career in the US, especially at the University of Chicago. In her signature work, On Death and Dying (1969), she famously postulated the five stages of grief experienced by the terminally ill: denial, anger, bargaining, depression, acceptance.(1) Kübler-Ross may or may not have been right in her theories (research seems to be inconclusive), but if you really want to see these stages of grief in action you need only observe equity investors grieving for their dying Bull Market.
In August we saw investors in full denial. True, markets technically dropped into correction territory, but they quickly recovered and ultimately were down only about 6%. Retail investors actually slowed the pace of their withdrawals from ETFs and mutual funds: $4.9 billion in August, versus $9.6 billion in July and $25.9 billion in April. All this full in the face of the facts we all knew by the of the month, and which were laid out in horrifying detail in my last post.
This month we saw investors moving into anger. On September 17 a terrified Fed beat a hasty retreat from the rate rise it had long telegraphed and became (I know this sounds impossible) even more dovish than ever. Normally, the slightest dovish move by a central banker anywhere on the planet (launching QE, expanding QE, keeping QE level, reducing rates) is immediately followed by exuberant investors buying everything in sight. But, now, furious at their expiring Bull Market, angry investors actually sold.
They sold, of course, because they recognized that the old QE-fueled Bull Market had been turned on its head. Now, when the Fed did something dovish, it didn’t mean the “Yellen put” was in full force and it was time to buy. No, it meant it was time to sell because the global economy must be really bad. Of course, that’s always what QE has meant, but investors never noticed until they entered the five stages of grief.
We still have three phases to suffer through: bargaining (“Please, please keep the markets going up, I promise I’ll never sell another stock!”), depression (“That’s it, I’m going to have to work ‘til I’m eighty”), and, finally, acceptance (“I guess we should have known all along that central bankers know nothing about real economies”).
But we don’t have to wait ‘til the bitter end, by which time markets will be in free-fall, to internalize the investment implications of the facts we knew in August. Let Bull-addicted investors grieve away. We need to adjust our portfolios now in accordance with the new known facts as follows:
* China is slowing faster than we thought and, therefore, global growth will be lower than we thought. Investment implication: Since a slowing in global growth is one of those common factors that drive all correlations to one, reduce risk exposure.
* Commodity export-based economies are going to be even harder hit than we thought. Investment implications: An indexed exposure to the emerging markets is a very bad idea,(2) and even though commodity prices have been clobbered, they are still too high for global economic conditions, suggesting that bottom-fishing in commodities and energy will be unproductive.
* Emerging markets are being buffeted by a powerful double-whammy: a slowing China and a resurgent US. Investment implication: Low multiples notwithstanding, EM is a value trap.
* Any country whose economy is based on exports will slow, including Germany, and that will bring growth to a halt in Europe. Investment implication: Euroland is headed for recession, lighten up in spite of decent valuations.
* Abenomics is deader than the Fukushima nuclear plant. Investment implication: Avoid Japan.
* The US, though better-positioned than the rest of the world, is no Island in the Sun. As Asia slows, pushing Europe and Latin America into recession, the US recovery will reverse itself into a likely US recession in 2016 or 2017. Investment implication: Raise dry powder for use against impending single-digit P/Es.
The trouble comes down to this: for seven long years the world’s central bankers (mainly aping the US Fed) have acted as though the global economy was suffering from a liquidity crisis. Ergo, they reasoned, we’ll inundate the world with liquidity (and hang the consequences) and all will be well.
Actually, of course, what the world is suffering from is a debt crisis, and the central bankers have only made that problem much, much worse. When people, companies and countries are way leveraged up, they can’t borrow any more. When economic actors can’t borrow, commerce slows way down. How many people buy houses or cars with cash? How many people can live well month by month without credit card debt? How many countries can mount sensible fiscal policies if they can’t borrow?
Everything slows down, which is what has happened and will continue to happen. The global growth rate with indebtedness under control might be 5%, but the global growth rate under massive central banker-fueled indebtedness is the growth rate that cash can engineer: about 2%. Batten down the hatches.
(1) Although Kübler-Ross initially formulated her ideas about the stages of grief in connection with the dying, her thinking was eventually extended to the grief experienced by survivors of the loved one and to similar emotions experienced during and following divorce, job loss, chronic illness, and so on. These ideas were articulated in her last book, On Grief and Grieving (2004), written with David Kessler and published one month before her own death.
(2) See Gregory Curtis, “The Qualitative Bear Case for Emerging Markets Equities,” The Journal of Wealth Management, Spring 2014, Vol. 16, No. 4, pp. 27-32.
Next up: The Camp of the Saints
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Please note that this post is intended to provide interested persons with an insight on the capital markets and is not intended to promote any manager or firm, nor does it intend to advertise their performance. All opinions expressed are those of Gregory Curtis and do not necessarily represent the views of Greycourt & Co., Inc., the wealth management firm with which he is associated. The information in this report is not intended to address the needs of any particular investor.