The Heat Is On

Commentary


Given the late Summer temperatures outside, this is a classic ‘Duh’. But anytime I hear this phrase, I immediately think of Glenn Frey’s 1980’s song, titled the same. It is a great tune, the video even better!! Alas, I chose this for my Gazbit title because of what is happening in the world at present. Where to start? Hmm… There are so many to choose from, the Federal Reserve (an old reliable), the Middle East, the ‘Heat Index’, (sub)emerging markets. So much to opine, so little space and attention. Here we go…


Let’s start with the Middle East – Libya, Egypt and now Syria. So how’s that foreign policy of ‘Leading From Behind” working out…? Answer: Not good. Trying to instill or better yet, “install” democracy in an area steeped in centuries-old, autocratic rule is vexing, from any angle. Popular wisdom held that once the world was rid of Moammar Ghaddafi, Libya would herald a new era of democracy and stability for all the world to see. O.K. Next, popular wisdom (Tahrir Square, maybe) held that once the world was rid of Hosni Mubarak, Egypt would herald a new era of democracy and stability for all the world to see. In fact, free elections were held and the Muslim Brotherhood (with ties to Al-Qaeda) prevailed. Problem is, no one asked the Egyptian military if that was a good idea. Or not. Uh-oh. Fast forward to Syria. Popular wisdom (whomever, that is) holds that once the world is rid of Bashar al-Assad, Syria will herald in a new era of democracy and stability for all the world to see. Granted, using poison gas on your citizens is never a good idea, but here is where the plot thickens, actually more like a morass – Let’s assume popular wisdom is the West (Europe, UK, US). Problem is no one consulted the Russians, who actually like the current regime and are still smarting from getting steamrolled over supporting Libya/Ghaddafi. As an ex-KGB agent, I sincerely doubt Vladimir Putin likes to lose, especially to the West. He needs to be nice, since he is hosting the Sochi Olympics in early 2014, but ask Dmitri Medvedev who was/has been running Russia in a very authoritarian way (think West-leaning journalists murdered – with no ramifications) for a long time…? Da, comrade Putin. This time will be different, as Mother Russia will not sit idly by, so the geopolitical investment risks are elevated, home and abroad. Well, that takes care of…Oops, last but not least, I cannot leave out Turkey. Considered by some the ‘cradle of civilization’ and a great Thanksgiving entrée, Turkey and eponymous prime minister Recip Erdogan, have been rattling the West’s cages lately and is one of the primary countries to benefit from the Fed’s easy monetary policies. Problem is, money flows reverse and when they do, life is a bitch, as Turkey and other “emerging countries” are finding out. Stay tuned as the wailing and gnashing of teeth will go on for quite some time, especially as interest rates normalize.


Locally, hot enough for you? Growing up, I went to sleep, normally on the floor, because that is where the cooler air was, provided by a fan. Air conditioning is most prevalent today, almost rendering the fan extinct, but when it was hot, you just dealt with it. Now, not only do we have high temps, we have the vaunted ‘Heat Index’, which is the air temperature and humidity, thus another way meteorologists can micro-dissect the weather. How in the world did civilization survive until the present? Maybe taking ice and letting it melt?!? Anyhoo, we should rejoice we are getting hot weather since we are coming off the ‘Winter That Would Never End’, the ‘Spring That Never Was’ and the ‘Summer That Finally Came’. After all, Christmas IS less than 4 months away. Emerging markets, aka submerging markets, have almost been front and center economic news, as the aforementioned currency flows (higher interest rates in US) are reversing course and current account deficits are soaring, which is never a good thing, when your economy is expanding (good thing), but you become dependent on foreign money (bad thing). India and Turkey lead the ‘Pain Parade’, in this regard, so you have been hearing monetary officials from these countries (and others) berate our Fed for the mere thought of stopping the easy money train. Well, no one told you to expand beyond your capacity, at least until you show the world the proclivity to pay your debts via a developed economy. ‘Build it and they will come’ works for countries as well as the ‘Field of Dreams’.


Last but not least, my favorite, the Federal Reserve. QE infinity continues with ‘Taper Talk’ keeping markets abuzz and on edge. It has never been about adding liquidity, anybody can do that, as we have seen. From my perspective, it has always been, what is the end game. Weaning markets, domestic and international, off the financial cocaine of easy money, is proving to be way harder in reality, than just wishing it to be so. Many emerging markets (think BRIC’s) have been screaming (see above), many Wall Street people have been whining and most of the world has been trained (think Pavlov) to expect we need low interest rates to stimulate economic growth or a financial markets meltdown is imminent. From my experience, stimulation of any kind, works on a temporary basis, reality sets in and everything goes flat. However, if you build and maintain a solid foundation (read: Expenditures do NOT exceed revenues) and most importantly, keep government involvement to a minimum, economic strength will generate a robust corporate and consumer environment, lifting all to financial success. The wild card in all of this are the ‘unintended consequences’ of the Fed’s actions. Uncle Ben cannot go to a book on this one, so it will have to play itself out, but initial indications are not good. Maybe next time (if there is a next time) we should consider that calculus, before hurtling, first the US, then the world, on a one way, monetary gully-washer.


In the meantime, we (United States and others) have had our ‘spoonful of sugar’, to help the medicine go down (sorry Mary Poppins) and the taste is quite bitter and expensive. We are at the point, politicians need to step aside and let the capital markets work as they were designed. Stop picking winners and losers, let interest rates normalize and get the hell out of the way.


Considering September (historically the worst month for the DJIA) is upon us with a multitude of domestic and world challenges, the risk/reward spectrum for all investments remains heightened, perhaps even more so, now that interest rates (10 year benchmark) are heading north, towards and past, 3.00%. Thus, where to invest? Domestic, large cap, dividend-bearing, multinationals with “battleship balance sheets”. Say that fast 10 times ☺ Next, almost anything Energy-related. We are voracious consumers of “go juice” of any kind, Electricity (form all our gadgets, phones, etc.) Gasoline, Heating (Nat Gas is slowing making this obsolete); Just think when the power goes out and how impotent we feel, for the most part. If our “enemies” wanted to level the playing field (battlefield) to some extent, hit our energy-making industrial complex and that would make a serious dent, no doubt. For now, anything Health Care-related. As our demographics age, this area will continue to benefit, in spite of the Affordable Care Act, (truly the greatest oxymoron there is) so Baxter International, Johnson & Johnson, Medtronic and 3M (lots of $$$ in their surgical division) and of course, the SPDR Health Care ETF. Last, (don’t fall off your chair) are good, old fashioned Certificates of Deposit. Yes, the stodgy CD is on my buying lists, specifically either very short (within 1 ½ years) or the ever-narrowing maturities yielding 3.00% or more. Back in early May, one would have to go out 15 years to get this type of yield; lately it has been less than 9 years. As interest rates continue to bubble upward, I anticipate the duration/maturity to come in closer, thereby allowing a portion of your fixed income allocation (tax- deferred money, 3.0% is actually 5.0%, given 40% combined income tax rates) and laddering up, even more so, if interest rates really climb higher.


For now, keeping investing simple and straightforward, with excellent flexibility to get in or out of a market is crucial in this era of uncertainty. Having a quality investment allocation of selective blue chip stocks mixed with prudent fixed income securities will ride through most any financial storm.


Last, I would be remiss if I did not comment on the municipal bond market, one of my longstanding investment securities, especially for high income earning clients, be it working or retired. Central Falls and Vallejo do not elicit much reaction, but San Bernardino, Stockton and Detroit certainly do. We are at a crossroads regarding municipal debt, primarily General Obligation Bonds, which until now, have gone unchallenged because of their ability to use the ‘full faith and taxing authority of the underlying State, County or City’. Being on the highest rung of the capital structure, in a worst case scenario, which is bankruptcy, you would be protected and in exchange, accepted a lower interest rate. Sounds good in theory and reality. Detroit is beyond broke and everyone knows it. There is no federal bailout coming because if there was, the State of Illinois and City of Chicago would not be far behind, let alone any other financial-strapped municipality, trying to offload debt, of any kind. Thus, as I was quoted in an interview in the Wall Street Journal in early August, “if there is a haircut (reduction) of ANY kind (of principal amount, mainly) the municipal bond market, as we know it, is dead. That is not an understatement or one for shock value. A cram down of GO bondholders (just like GM) would ripple through the trillion dollar municipal bond market, rendering anything but the highest quality bonds, immediate junk, creating a literal tsunami of selling, wave after wave, until some equilibrium would eventually take hold. But it is ‘Sell First, Ask Questions Later’, so I am hyper-focused on these developments and will monitor accordingly.


Football season is upon us, that means Hockey season is one month away, thus Basketball season is two months away, Halloween three months away, you get the picture. Time is flying by so enjoy it. Last interesting tidbit, Thanksgiving and the start of Hanukkah are on the same day, November 28th. Big deal, you think. Right? It really is, since this is first time ever and the next time these two feasts align, without calendar adjustments will be in the year 79,811…!!! (another 77,798 years – Wow) Enjoy the last 1/3 of the year…

All The Best…

Greg Zandlo

Greg Zandlo

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