Vigilare Wealth Management Q2 Summary
By Jason@vigilarewealth.com on July 9, 2012 in Investor Lounge
A Half Year In
Oddly enough, the U.S. economy and the financial markets are in midst of uncertainty again. To date, 2012 has followed the same script as 2011 and 2010 with minor variations. Europe is engulfed in a financial and political crisis, and the economies of China and India (half of the world’s population) have slowed down sharply. These concerns have been on our radar for some time (see Q4 2011 commentary posted on the Vigilare website). We wrote about being skeptical of the surprisingly strong U.S. economic data observed in late 2011 and early 2012. We felt that this growth might be short-lived because of the historically mild winter pulling forward demand from the spring and summer months, and because of the pressure from the slowing global economy. We also expressed our view that the China slowdown was being downplayed and that Europe’s short term solutions were going to be met with skepticism. We did underestimate how resilient U.S. corporate earnings would be in the 1st quarter of 2012.
With those assumptions (now observations), we decided to keep our investments on the conservative side of the spectrum and remain very patient within our strategy. This included an overweight to cash and investments in defensive U.S. stocks. Our patient and conservative approach lagged in performance in the first three months of the year as markets around the world rallied. Recently however, the market rally has evaporated and our strategy has very quickly gained ground. Some of the more cyclical sectors such as banking, industrials, and commodities are even approaching new bear market territory.
Vigilare Outlook and Strategy for the Second Half of the Year
“Patience is companion of wisdom” – St. Augustine
There are two potential outcomes that we see affecting portfolios in 2012 and beyond. What is unusual about these two scenarios is that they are opposing outcomes, and yet both are rising in likelihood (compared to muddling along).
Scenario #1 – This summer’s volatility carries into the fall and the European crisis continues and to escalate further. The Emerging markets slowdown starts to put a drag on the U.S. manufacturing renaissance. Uncertainty around the U.S. elections and lack of political cooperation to address the U.S. fiscal situation by the end of the year will further erode optimism about investing in most risk assets.
Exposure to cash, treasuries, highly liquid defensive U.S. stocks, and gold would benefit. Most other investments would be perceived as high-risk and could experience sharp declines similar to 2008. We are not afraid of 2008 repeating. Our portfolios, as positioned today, would weather this scenario well and the purchasing power of our clients’ wealth would rise. Consider that in this scenario, “not losing money”, is like shooting par on a windy day at a U.S. Open. Also, a portfolio flush with cash means having liquidity to buy additional equities which would be at much lower prices.
Scenario #2 – Since the financial crisis of 2008, the U.S. and other world governments (China in particular) have been heavily involved in trying to stimulate the real economy. In the U.S., the Federal Reserve has lowered interest rates to 0%, effectively punishing savings and forcing people (savers) to take on risk in order to maintain their wealth. The U.S. government is running trillion dollar-plus deficits three years in a row by extending incentives such as: lower dividend and capital gains taxes, immediate depreciation of capital investments for companies, extending payroll tax cuts, and boosting unemployment benefits and food stamp programs to record levels.
There is strong evidence that the real economy has become addicted to this kind of government intervention as witnessed by sharp decline in economic activity as soon as there are signs that stimulus is abating (like in 2010 and 2011).
Because of this phenomenon, the U.S. economy appears to be unable to stand on its own two feet and combined with a sharp slowdown in the economies of our trading partners (primarily EU and China), it is very likely that U.S. and other major trading blocs will embark on a more substantial round of stimuli. This would mean a new round of Quantitative Easing (QE3) in the U.S., cutting interest rates to zero in the Eurozone, and large a domestic stimulus agenda in China.
If this scenario becomes a reality and world markets respond as they have in the past, then we could experience a sharp reversal of current negative market sentiment and world markets could experience a repeat of 2009. Most risky investments would be off to the races again.
Our current portfolios would lag, as cash and defensive U.S. stocks would considerably underperform. In this scenario we will act swiftly and decisively to prudently readjust portfolios to investments that would be more advantageous in this new reality. As always we will vigilantly monitor the situation to make sure that these policies are having the lasting effect of restarting the economic engines (as they were intended), because if not the rally would again quickly fade.
Now more than ever is the time to be nimble. Thank you for entrusting us with your wealth.
Enjoy your summer,
The Vigilare Management Team