Winter is Coming – Just Not Yet (I)

, London, UK

Recently I visited Dubrovnik, Croatia, for the first time. Aside from the beautiful vistas and being the birthplace of Nikola Tesla (and many other things I have no doubt!), this amazing country was also a key location in the filming of Game of Thrones.  As I hadn’t watched any of this best selling drama, I went back to the UK and proceeded to blast through 5 series of it in just 10 days!

One fascinating aspect of this drama is that whilst battles and court intrigue is being played out – the game of the thrones – there is an ever-looming threat building to the north and there are constant whispers that the ‘winter is coming.’ Of course, when various kings, queens, lords and ladies are warned about the threat and whether they should allocate resources to strengthening the wall to the north, they are generally dismissive. All of their efforts are focused on winning the Game and battling each other. Yet the time  the white walkers (zombies) will march on the south gets closer.

Somehow this all feels too real to me in so many ways, and especially in the investment world upon which I will focus today.  For some of us there is a relentless background noise but not everyone is listening.

I was kind of astounded to hear Fed Chairwoman Yellen’s recent comments that she didn’t think that there would be another crisis in her lifetime! I used to be one of those weird investment types who looked at 100 year charts wherever possible – and one would see the ups and downs. In recent history we have seen major crises in 1987, 1994, 1997, 2000, and 2008. But the history of finance is littered with examples of the rise and fall of various assets and the warring emotions of greed and fear. Given the frequency, I don’t think its controversial to expect another crisis in the next couple of years. One might argue that the chances of a really big one have gotten worse since central banks have become more interventionist.

Yesterday – and despite Yellen’s previous comments – the Fed actually sounded quite dovish. The markets also have doubts about further quick rate hikes. Even the CEO if Citi last night on CNBC said that they were assuming just one rate hike per year. In fact, the inflationary data FIG – well respected around the world – is suggesting that bankers might have even less reason to rush now.

https://www.businesscycle.com/ecri-news-events/news-details/economic-cycle-research-ecri-lakshman-achuthan-fig-all-signs-point-to-a-cyclical-slowdown-in-inflation

Surely many of the Fed members have an inking of what’s possible. Today one of my favourite economists, Robert Schiller, made some fairly strong comments to CNBC:

“… Shiller writes that low volatility could be “the quiet before the storm.” It’s a phenomenon which Shiller says is making him “lie awake worrying.”

And, that’s not the only issue he’s raising.

His Shiller PE Ratio, also known as CAPE, shows the price-earnings ratio based on average inflation-adjusted earnings from the last 10 years is over 30. The number carries significance because the only times it’s been higher was just before the Great Depression in 1929 and mid-1997 to mid-2001.

“I worry that historically earnings have been trend-reverting,” said Shiller. “Admittedly, we do have a president who’s going to ‘make America great again.’ So if he’s right, maybe then we’re launching out in a whole new path. But it would be the first time in American history.”

Shiller’s latest analysis shouldn’t be taken lightly.

His forecasting skills were recognized in 2013 when he won the Nobel Prize in Economics. He’s known for predicting both the dot-com bubble and the housing bubble in his book “Irrational Exuberance.”

If Shiller is right and the stock market ultimately goes back to trend, it could create havoc.

“It would definitely be a negative for equities. It would be pretty big. We are at a high valuation. The only time we’ve had a higher valuation than where we are now was around 1929 and around 2000,” Shiller said.

“We could see a major correction,” he said. “This is not a forecast. It’s a worry.”

Today I want to touch on why Winter is Coming and why you should prepare now, in terms of investments and other decisions. But I also think that it might not happen quite yet. We are indeed in the textbook third  (or speculative) phase of the market’s evolution but perhaps too many experts are expecting it and euphoria hasn’t gone to an extreme yet. Furthermore whilst the global economy looks sick from a structural perspective, the short term economic data has all been bouncing back. Maurice Obstfeld, the IMF’s chief economist recently said we are facing the  “broadest synchronised upswing the world economy has experienced in the past decade”. Here is a recent chart from Morgan Stanley:

I think a prepared mind is a happier mind. And immense opportunities lie ahead for you individually and for us as a planet if we are pre-emptive.

This is  a 2 part letter and the next one  will focus on some of the specific opportunities that I see.

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