Fallout From U.S. Election Results

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Dear Members of the Vodia Community,

Well, I don’t exactly know where to start.  The election results from Tuesday night are a turning point for this country and for the world in a way that I never expected to witness in my lifetime.  Unfortunately, it points to a distressing chapter in our history.  I have a number of theories on what happened and what will happen but we will cover that in depth later.

The markets have responded positively after a night of utter chaos. The Dow swung a total of 1,000 points from high to low in twelve hours, currencies have gone every which way with the Peso losing 10% and commodities are flying around as well.  The salient points for our portfolios, as of right now, are:

– Our equities have all done well despite this chaos.  We have a large concentration in healthcare (for fundamental reasons) and healthcare is well ahead today based on the prospects of no Congressional action against drug company price increases – a strong part of Clinton’s platform.

– Our financial holdings in equities also rallied based on the perception of expected lower regulations for the banks.

– The heavy emphasis on fixed income investments has buffered all portfolios.  The expectation of higher inflation combined with dovish Fed policy has created a steeper yield curve, boosting the income stream in our structured notes.

– The private pooled investments are entirely decoupled from this volatility.  Only long-term economic trends will have the potential to impact those investments and we are assessing what this impact may be.

For lack of a better phrase, this is a s***-storm that we are weathering well based on our relatively conservative positioning focused on income generation.  It will take us several weeks to assess the actual impact of the election on our investment portfolios during which time you should expect to see adjustments in your holdings to reduce risk.

Overall, this “change” is likely to harm our economy over a long time span while it, in the short-term, creates some optimism around business-friendly legislation by a Republican Congress.  Though we seem to be well positioned in all aspects as of now, the potential for abrupt change is cause for us to review the portfolios.

As many of you know, together we have weathered other distressing times and our staff has worked consistently during such times to protect your portfolios.  We have never taken for granted your trust in our work and appreciate your partnership as we move forward.

We will be hosting a Live Market Commentary webinar on Tuesday, November 15th, at noon to fully assess the impact of the election on markets, the economy and our society.

Until then,

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David Matias

 

U.K. Facing a Brexit Hangover – and Markets Aren’t Happy

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Be careful what you wish for – You just might get it.

Today the United Kingdom is facing one massive hangover.  After months of discourse over the grand consequences of an exit from the European Union, the Brexit referendum passed by a rather slim majority (52-48), or by roughly 1.3 million votes out of a country of 46 million eligible voters.  With a 70% turnout overall, you have an extremely divided country.  Some regions voted 70-30 in favor of Remain, and vice versa.

The voting pattern was extremely distinct along demographic and geographic lines.  Scotland voted overwhelmingly to Remain, as did London – both areas where bad weather dampened turnout.  Northern Ireland voted to Remain, albeit more tepidly.  Wales and the rest of England were solid Leave.  The Remain camp veered young and wealthy, and the Leave camp older and poor.

This voting pattern reflects the two core trends in the U.K.: wealth inequality and immigration.  Both have created anger and frustration among Leave voters.  It is the same two issues that have fueled Trump’s campaign.  Interestingly, during the last major shift in U.S. politics – Reagan’s rise to the Presidency in the 1980s – the U.K. endured a similar upheaval with the rise of Thatcherism and the New Right.  After all these years, America and England are in lockstep.

An actual Brexit is a disaster. It will provide no economic gains to the UK and likely increase the wealth gap even further.  It might stem unwanted immigration, but the ensuing economic recession will destroy far more jobs than what is reclaimed. In the meantime, the Scottish independence movement is expected to be revisited and the consequences of a weakening European Union, containing our strongest political and economic allies, will be significant.

As for us, the actual impact on the U.S. economy is likely to be nominal.  It will take at least two years for the terms of a Brexit to be determined, and it is to be noted that yesterday’s vote is not binding, but instead a recommendation.  While there will be change, we don’t know what happens next in the political process.

What we do know is that there will be volatility – the bane of markets.  The pound is swinging wildly today (hitting historic lows) and markets are selling off because of fear.  We have seen this before – some event triggers widespread volatility and markets decline – followed by months of swinging markets until rational heads prevail.

We have positioned the portfolios to buffer such moves, and have a large cash position to take advantage of buying opportunities. Our exposure to the U.K. is negligible, but the impact outside of the U.K is yet unknown.  With Europe still recovering from a recession, this will further challenge that region while continuing to place a premium on U.S.-based assets.  In short, change is scary, but there are always opportunities for the long term.

And now we have a lovely start to the summer of 2016.

Cheers,

David

Bad Year.

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We are just eight trading days into 2016, and it is already one of the worst yearly performances in quite a while – down -7.5%.  The next two days will be critical, however, in determining if this is a trend or another speed bump in an already rocky market.

Using the S&P 500 as a gauge, we are down to levels that are consistent with last August and September, but just above those lows.  We are also at a level on the VIX – the indicator of future volatility – that is in line with September, when the market turned back around during the following four weeks.  It is NOT at the levels that we saw in August when there was real concern that the global markets were on the verge of collapse.

Put simply, this is not a market meltdown in the ways that we saw in 2008.  It is disconcerting, and on the heels of a very volatile and depressed 2015, it may be enough to push investors to be done with equities.  There are two core drivers of this market decline – China and Oil. China may very well be slowing down, but the reaction to these indications has been exacerbated by borrowed money and the interference of the Chinese government in the market. Similarly, oil prices will continue to drive many failures in the energy market, but the fundamentals shaping the low prices cannot continue for much longer.

We see some relief from these levels, but limited long-term upside until the economic picture improves.  The biggest unknown is corporate earnings announcements that will be coming out over the next few weeks.  Volatility will continue  as earnings surprises emerge, but the fundamentals are strong enough to dampen the market volatility in the medium term.

David

The Year Is Done!

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The year is done, and it is a challenge to find the bright spots.  There are a few – some tech giants did well in addition to specialized pharma.  With pharma in particular, cheap loans sponsored by the Fed’s policy, M&A activity drove most of the gains to be seen in the market.

The overall numbers, however were between disappointing and abysmal.  The major U.S. indices, the Dow and the S&P 500, both posted losses that were canceled out by the dividends.  Investment grade bonds were pretty much flat or down, and junk-rated debt was hammered in the last weeks of the year.

Most important, however, was energy.  With oil taking a 40% hit on the year after a terrible December of 2014, it sucked the life out of everything from drillers to industrials.  While this trend is temporal – oil demand will increase and supply will drop – the volatility has shaken the financial markets to their core.  Geopolitics have played a major hand in this dynamic – from OPEC’s admitted failures to Iran’s nuclear program – oil is the constant theme.

There is one major bright spot in 2015: our energy-based economy will eventually shift to more sustainable sources, and with 195 countries signing the Paris Climate Accord that trend might begin to accelerate at a meaningful pace.  We are unlikely to avoid serious environmental change, but we could avoid far greater consequences.  These trends, combined with the Fed’s movement into a new rate regime, promise for an extremely interesting, and hopefully clarifying, 2016.

We will explore all of these issues and more in our quarterly Market Update in two weeks.

All the best for a Happy New Year!

David Matias

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Managing Principal

Greek Shocker

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Today was another one of those moments in the history of finance that will be recorded as a “shocker”.  The Greek Prime Minister Alexis Tsipras, in an attempt to save his political career, is playing the ultimate brinksmanship by putting the fate of the European debt relief package up to the Greek voters.  By calling a referendum, he effectively dismantles the negotiations process and destroys his credibility with the rest of Europe.

The issues are simple yet complex.  In a simple sense, a rejection of the bailout package will generate a default on Greek sovereign debt and trigger a departure from the euro.  Anyone holding Greek debt will have to mark down its value severely and reflect the loss in their books.  Given the number of European banks and hedge funds that hold the debt you run the risk of seeing key institutions in the financial system need new investor capital to avert closure.  In the case of some hedge funds, it will be straight out failure.

With the banks and stock exchange closed for the week, and the referendum happening over the weekend, we’ve created the perfect storm for a financial shocker.  Placed on top of a holiday week for the U.S. and you’re increasing the market volatility even further.

While the risk of bank failure sounds similar to the Lehman Collapse of 2008, it is a vastly different situation.  First off, the total amount of Greek debt we are discussing is only $360 billion.  That sounds like a big number, but in the age of trillion dollar balance sheets it isn’t.  Second, this has been in the works for years now, giving key institutions a long time to sort out their reserves and plan for this contingency, or simply get rid of the investment.  Not that they would have done it well, but at least it has been done.

In the end, this is most likely to blow over by the end of the summer and make way for the positive effects of the growing and massive economies around the world.  The damage to the euro, and the implications for future exits by rogue economies, would persist for years.  And Greece will again issue debt, this time denominated in grape leaves.

The complexity is fear, and the reaction to fear, which is based in the unknown.  A default by a euro denominated country has never happened.  The follow-on effects are simply too subtle and complex to predict.  So in typical investor fashion, every asset is punished until a resolution is in hand.  Historically, it takes only a couple of weeks to recover from such a shock (Bloomberg, “A Freight Train of Unknowns Confronts Investors with Greece“).  But in that rare occasion, such as 1987 or 2008, the recovery can take up to a year.

Time will tell, but until we see a true shift in fundamentals, we view this as a nasty but passing storm.

David Matias.