Summary: Remain long equities, be prepared to buy dips, minimise the use of leverage and seek portfolio protection via derivatives where possible.
Q1 hedge fund letters, conference, scoops etc, Also read Lear Capital: Financial Products You Should Avoid?
Equity markets are likely to remain volatile, but the overarching risk of a recession is not high. Volatility will arise as expensive equity markets and deteriorating liquidity conditions (rising central bank rate & decelerating M2 growth) compete with the positive effects of fiscal stimulus (tax cuts) and the fact that real interest remains negative and thus a source of stimulation. The economy remains in its “expansion” phase per our Economic Cycle model, and the probability of recession remains modest. We recommend investors remain long equities, be prepared to buy dips, minimise the use of leverage and seek portfolio protection via derivatives where possible.
Gates Capital Management's Excess Cash Flow (ECF) Value Funds have returned 14.5% net over the past 25 years, and in 2021, the fund manager continued to outperform. Due to an "absence of large mistakes" during the year, coupled with an "attractive environment for corporate events," the group's flagship ECF Value Fund, L.P returned 32.7% last Read More
In order to begin to become negative on risk assets such as equities, we are looking for the “late cycle” conditions to become prevalent on our Economic Cycle chart, alongside a rising in the Recession Probability to the 70% mark. These factors, along with the evidently tightening liquidity conditions evident in our Leading Economic Indicators, would begin to concern us. At such a time, we will begin to recommend selling risk assets and moving to cash.
The economic cycle is showing continued Economic Expansion phase conditions. Our thesis of a “second wind” for the US economic remains in play.
Recession probability has increased to 44.5% up from 37% in the prior quarter. In the past, recessions have occurred with at least 70% probability of recession on our model. Our view is risks remain low-to-moderate at present.
Market valuation, as measured by the Wilshire 5000 All Cap index divided by GDP is near all time highs making the risk-reward of investment in the market index a weak proposition. Portfolio leverage is NOT advised, use derivatives to hedge the portfolio where possible and be prepared to buy the dips.
As we progress through 2018, Liquidity based Economic Leading Indicators – which are currently negative biased – will increasingly put increasing downward pressure on economic momentum and risk assets. Fed hiking has been consistent whilst slowing M2 growth is a concern. That said, real rates remain negative and fiscal stimulus will begin to flow through national expenditure plans over the remainder of the year. It will take time for the risks of tightening liquidity to materialise in the economy, in our view.
Our stop-loss tool (global market breadth index) has not yet triggered a sell signal.
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