Since late July, one of the primary topics of discussion here has been an impending risk reset in the markets. Risk resets are generally nasty affairs that scramble the brain while taking a rubber mallet to the heart. We're seeing this play out in real-time presently, as market participants are failing to distinguish signal from noise, while having their will to proceed in any semblance of a profitable manner compromised severely.
Certainly a risk reset has taken place here. Conditions of froth in both price and sentiment have been removed rather swiftly from the market. All the meanwhile, the news out of China has suddenly taken on an amplified tone, as everything from currency fluctuations to protests in Hong Kong are enough to set the Dow back 400 points.
Investors have become hyper-sensitive to China. Hyper-sensitivity to a particular topic in the market is typically a sign of news flow reaching the manic stage, where it is close to factored in, unless a much more severe escalation takes place.
With respect to China and the U.S., there are very few avenues for real escalation. We already know that trade talks are dead. We already know that both sides are further apart then ever. The economic damage caused by these recent events will start at the emerging market level. Whether that weakness ultimately infiltrates the U.S. economy is debatable.
In the meantime investors have the following pieces of the puzzle falling into place:
- Gold and silver - will say it again, as we have been since December of last year, investors have to allocate a portion of their portfolios into metals here. They are an insurance policy against excessive QE, negative interest rates, out of control central banks and earth shattering shifts in the monetary system taking place over the next several years.
- Real estate - already have made the case for single family residential REITs some months ago. Home builders have been one of the strongest sectors in the market. We own DHI. Have traded in and out of NAIL a bit here and there. Low interest rates and record jobs create buoyancy in the sector.
- Financials - our thesis of financials leading the market during the second half of 2019 is being compromised by the debacle taking place in interest rates. The pressure to the bottom line by perpetually lower rates may create a dead money situation here. Still early to tell. However, for the time being, we aren't taking on new financial exposure unless it's for a trade.
- Mortgage originations - Q3 could be a record for mortgage originations. Quicken Loans - the largest originator - reported Q2 numbers that were a record in the 34 years the company has been around. Q3 is shaping up to be exponentially stronger.
- Mega-cap tech - This isn't a bad spot to be taking on some correlated tech exposure. This basically means semi-conservative tech names that follow the Nasdaq closely. Favorites are MSFT and AMZN.
- Private Equity - Publicly listed private equity names continue to occupy an orbit all their own. In the current environment, they have a license to print money. The equation is simple: Investors need returns given fixed income is now a liability and equity markets are seen as unstable. The biggest and brightest alternative managers are oversubscribed, with investors begging to pay their inflated fees. All the meanwhile, they can leverage deals with cheap money that enhance returns in the current environment. Classic virtuous cycle.
- Market bottom - We're in a window for a fairly important bottom here. There is a chance of some further weakness to the tune of a sudden 2-3% swoosh down to solidify it. There is also a chance that its in the process of being solidified right here and now. What investors need to consider is that the upside from these levels into year end is double digit percentages. So you're essentially risking 2-3% to gain 10%+ from a general market perspective. In other words, this is a good spot to be taking on significant exposure.
Safe trading this week. Keep your head on straight.
