Herzliya Pituach, October 8, 2018
One of the most striking things in the global economy I how complex it is and how it is
influenced by an immense numbers of parameters which are often not well understood and
hardly predictable. Although it incorporates mathematical tools and concepts from the
sciences, the field of economics remains very much a social “science”. Therefore economic
predictions are in our view closer to art than sciences although some will of course disagree.
But looking at history we are not aware of anyone neither in academia nor in the investing
world who has over the long term been able to successfully and systematically anticipate the
major trends, be it the big bull markets on the upside or the major crises on the downside. Of
course, some people accurately predicted one development or the other but usually on a
punctual rather than sustained basis.
The situation in the last two years illustrates well the challenge of making predictions. As is
usually the case with the economy at any point in time there are both positives and
negatives.
The macro-economic data in America is undeniably positive with unemployment at a 49-
years low while the economy continues to show solid growth with no sign of abating. Interest
rates remain low and financial valuations are high but not extreme.
On the other side the current bull-market has been going on for a decade with no major
correction which is relatively rare (but has happened before). History would suggest that at
some point in time a correction is due and has been expected by for a long time by some
intelligent investors who, at least in the past, had a solid track record of success. While not
extreme, valuations are high by historic standard according to most yardsticks in most
markets.
We could go on and on but the point here is not to make an exhaustive list. Rather it is to
illustrate the complexity the situation. Faced with ambiguous and often contradictory data
many investors nevertheless feel that they need to “predict” future market developments.
And what will happen is that their forecasts will, like a Rorschach test, reveal more about
their mind-set than about markets and the economy. The optimists will mainly look at the
positives while overlooking the negatives; the pessimists and the alarmists will focus on the
negatives and dismiss the positives on some ground as either being not sustainable or based
on inaccurate data.
In addition there is no lack of players who face business conflicts that will impact their
forecasts. And in many cases there is an interest to just stick to consensus even though it is
often wrong just because the consequences of making an error that “all the others” also did
are usually preferable to the consequences of doing a mistake than no one else did…
We have intentionally let out geopolitical issues such as trade wars and military tensions
aside. They tend to generate the most concerns and therefore the most headlines but in the
majority of cases end up having limited effect. For all the talk of trade wars and the emotional
rhetoric between the U.S. and Mexico, all the parties involved finally agreed to a new treaty
which is essentially very similar to the original NAFTA.
The large macro-trends that can last for decades have usually a far stronger and more
sustained impact. The continued reduction of interest rates since the peak in the 80s and
then following the 2008 financial crisis was possibly the most significant driver of the 30-years
bond bull market. The effect of the significant wars and international tensions over the same
period amounted to blips at most. Similarly in Israel the reduction in interest rate over the
last decade was a key driver of the real-estate bull market while repeated wars and tensions
had no significant impact on prices.
In consequence the best an investor can hope to do is try to identify the main risks and
opportunities and position him/herself in consequence.
In the current environment we continue to see the risk on an increase in interest risk as one
of the major risks and its probability has only increased considering the strength of the U.S.
economy. The 10-year Treasury recently broke the 3.2% level. As we mentioned previously,
an increase to 5% in the middle term is a possibility. This would affect first and foremost fixed
rate bonds and that is why we are by and large avoiding that asset class. On the other side,
the recent increase in LIBOR means that some floating-rate notes (FRNs) are currently
offering an attractive risk-reward as it is possible to get yields of around 3% from solid issuers
without interest-rate risk as the interest rates on the FRN is usually adjusted every quarter on
the FRNs.
The fact that the valuations in equity markets are demanding means that the risks are
increasing and that conservative investors in particular should be cautious in terms of their
exposure. As we have said before, we believe that the current times are particularly well-
suited for alternative investments offering limited correlation to the developments in the
financial markets. Alternatives, a field in which we have a deep understanding, have therefore
a high weight in our current portfolios.
Orit Raviv Swery Ilan Weil
Founder & CEO Chief Investment Officer