2Q 2015 Asset Management Letter

October 14, 2015   ·   By cfgadmin   ·   Comments Off on 2Q 2015 Asset Management Letter   ·   Posted in Asset Management Letter Archive, News

Summer Reading Lists

We may be showing our age but we can still remember summer reading lists that contained Homer’s “The Illiad” and “The Odyssey”. Tragic and epic Grecian behavior seems to have always been a fixture throughout literary history so it probably fits that debt drama resides there now. Sadly for many it seems the classic they should have focused on was Shakespeare’s “Hamlet” where we hear, “Neither a borrower, nor a lender be; For loan oft loses both itself and friend, and borrowing dulls the edge of husbandry.” Alas, others are experiencing similar issues:  China’s ballooning margin loans, real estate and local government debt and Puerto Rican debt to GDP of 70% along with their recession since 2006, to name the ones garnering the greatest attention.

The Greek debt issue is not one that gives us great concern. Our feelings are similar to the ones we had for our summer reading list: tedium. We have talked about Eurozone debt issues at length in past missives and frankly think that an economy with a GDP comprising less than 2% of the Eurozone is not worth our bluster. In fact, a Greek exit has seemed a foregone conclusion in our mind since 2011 when the ECB and its corresponding banks began preparing for this event. Forgive the pun here, but in our opinion any grandiose salvation at this point is a false prophet. As alluded to earlier, we certainly get the concept of debt and contagion but with the liquidity available to the ECB and the commitment of Spain, Portugal and Italy to the restructuring programs, we feel Greece is not the Black Swan that takes down the stock market. However, when leverage is part of a system, multiplier effects can occur. A fragile and indebted system in China coupled with Puerto Rico and Greece can provide greater volatility than the market can process for short periods of time. We emphasize short periods of time here because our feeling is that all three of these issues are not big enough to create another 2008. In fact, since we have stayed away from Puerto Rican bonds, speculative Chinese stocks, and Greece throughout our history, it is our feeling that our fund managers will be able to pounce on opportunities in the next correction.

That being said, China’s spillover effects do concern us more than Greece and Puerto Rico. From its peak on June 12^th to July 8^th the Shanghai Stock Exchange fell more than 30%. In reaction to this authorities halted trading on over 1300 firms (45% of the market), suspended IPO’s and threatened to arrest sellers. Those who can see 2008 in their rear view mirror will remember our government banning short selling on financial shares and how ineffective that was. Of course, China’s government has greater power than most over its economic direction and seems highly driven to orchestrate positive economic numbers no matter the cyclical nature of the market.  As the saying goes, “The trend is your friend until it is not”.  With over 85% of the stock trades coming from individuals and only a third of those having a high school degree we can’t help but think this ends badly for most individuals. In addition, many of these individuals are buying on margin and this margin makes up 18% of the country’s total credit if the government statistics can be trusted. Thus, there is greater risk in our opinion via China than in Greece or Puerto Rico. Remember that China is the second largest economy now.

All of our dreary words aside, where there is risk, there is oftentimes greater opportunity. China is still up significantly for the year despite the 30%+ correction and should the government halt the downward momentum, then China’s potential reward may counterbalance all the risk. It is our feeling that with China’s pro-growth government, the Eurozone and Japan’s quantitative easing, and the Federal Reserve’s glacier-like movement on raising rates we are short-term cautionary but long term bullish on international holdings. Valuations are not as high in the international arena and dips are a buying opportunity, in our opinion. By contrast, we view many domestic stocks as fuller in valuation and therefore, may correct faster than our very conservative holdings. Consequently, our domestic holdings will not change much but you should look for us to continue to add to international holdings unless you tell us otherwise.

Summer reading jokes aside, we wish we could create epic quarterly letters for you. Too often, we call on our muse and instead get a wrong number. Speaking of numbers, you have ours, please call with any questions. We will be happy to talk about the market as well as literature. To paraphrase Homer, discourse is the sweeter banquet of the mind and we certainly welcome dialogue with our clients.