Category: Market Themes

Strategas – Magnitude of Repatriation

Attached is a piece from Strategas that discusses repatriation, fiscal policy, and global tariffs. While many of these numbers are forward projections or estimates, Strategas does make a few major points:

1.) Total Repatriation: they estimate that U.S. companies repatriated $200 billion in Q2 bringing the total amount for the calendar year up to $500 billion; based on these projections, they are trending at $1 trillion of fiscal policy for 2018

2.) Repatriation & Tariffs: tariffs are broadly poor economic policy and can have long term effects on the global economy; however, in the short term, approximately $38 billion in global tariffs will be implemented in 2018 while Cisco alone has repatriated $67 billion so far this year. The potential for shareholder return and/or corporate growth driven by repatriation far exceeds the dollar effects from tariffs to this point

3.) Use of Cash: while some money is being given to shareholders in the form of dividends or buybacks, paying down debt is the most cited use of cash by companies in the S&P 500; this includes increased pension contributions (closing the gap for underfunded pensions) as the tax bill let companies make pension contributions through September at a 35% tax reduction (2017 rate)

Net Dividends from Foreign Subsidiaries – up to 3.4% of GDP if $700 billion gets repatriated

Calendar Year 2018 – Tax cuts vs. tariffs

Use of Repatriation – Announcements from S&P 500 Companies

Peter Malone, CFA

Research Analyst

Direct: 617.226.0030

Fax: 617.523.8118

Crestwood Advisors

One Liberty Square

Suite 500

Boston, MA 02109

www.crestwoodadvisors.com

PLEASE NOTE!

We moved! Please note our new location above!

Strategas Repatriation 8.30.18.pdf

Uncommon Sense – Emerging Market Equities

Attached is the most recent “Uncommon Sense” piece put out by Michael Arone and SSGA. In this article, he suggests that now may be the time to substantially increase an allocation to emerging market equities.

We are currently comfortable with our emerging market weights in our portfolios, but this provides a different perspective on the state of the asset class. Mr. Arone’s optimism is based on the following:

Continue reading “Uncommon Sense – Emerging Market Equities”

Taking Exception to Longest Bull Market

Headlines over the past few days have been celebrating the current bull market as the longest in history. However, there are some that would argue that this is not truly the case.

A bull market begins at the bottom of a bear market, which is widely accepted as a 20% drop from the latest peak in the cycle. The argument can be made that in October 2011, during intraday trading the S&P 500 reached a 20% decline relative to the most recent post crisis high.

This is not meant to truly dispute the “record” but rather to point out that this continued rise in the S&P 500 was not a straight line upward. This is another example to our clients that remaining invested over time provides a much greater opportunity for positive returns. It is easy to look back now at the extreme highs reached since 2009 and forget the major drawdowns in 2011, 2015, and even earlier this year.

Below is a link to a WSJ article discussing this point and a chart from Strategas depicting the different highs and lows since 2009:

https://www.wsj.com/articles/calling-bull-on-the-longest-bull-market-1534940689?mod=hp_lead_pos6

Peter Malone, CFA

Research Analyst

Direct: 617.226.0030

Fax: 617.523.8118

Crestwood Advisors

One Liberty Square

Suite 500

Boston, MA 02109

www.crestwoodadvisors.com

PLEASE NOTE!

We moved! Please note our new location above!

Turkey’s currency collapse and market implications

As you probably know Turkey’s currency, the Lira, has fallen over 70% in value relative to the US Dollar over the past year. The currency declined steadily over the past year and the pace accelerated this month as there has been a rush to get capital out of Turkey.

How did Turkey get here?

A main part of Turkey’s vulnerability is due to rapid growth in US dollar borrowing. Years of near-zero interest rates in US has spurred lending in Dollars overseas. Below is a chart from St. Louis Fed that shows since 2003, lending in Dollars to non-bank emerging market companies has grown from $1 trillion to $3 trillion in 2017 (blue line).

Companies borrowed in Dollars, because at the time funding was cheap and plentiful. Emerging market debt funds were eager to buy EM corporate bonds which comprised a majority of the loan growth. US investors were happy for higher interest rates and borrowers enjoyed the inexpensive financing. Both parties underestimated or ignored the risk of having Dollar exposure. Problem with these loans is that the company earns money in their local currency to pay interest and principal on the loans in Dollars. As the local currency falls against the Dollar, the interest payment increases. In Turkey, interest payments (unhedged) have increased 70% YTD due to the fall in the Lira. Yikes!

Turkey has other vulnerabilities – trade deficit, high inflation and budget deficit. The twin deficits mean that Turkey relies heavily on foreign capital to function, while inflation erodes the value currency. However, it seems the main issue is Dollar debt and the drop in the value of the Lira.

How serious is this for Turkey’s economy?

This plunge in Turkey’s currency is very serious. Turkey will most likely face a recession as the sudden and steep drop in currency will lead to a slowdown in growth. Their highly levered banking sector (loan to deposit ratio of 145% versus US banking system’s ratio of 70%) will need capital to continue making loans to support economic growth. Turkey runs a current account deficit, so trade is not a source of external currencies, but a drain. The steep drop in the value of the Lira shows that market confidence in Turkey is gone. Further lack of confidence in the regime of Recep Erdogan, a dictator with a history of human rights abuse, will be a huge hurtle in obtaining loans from developed countries. Without support it is likely that Turkey faces a severe recession, defaults and a tough decade. The outlook is not good – think Venezuela.

Will Turkey’s problems spread?

Probably. Higher interest rates and stronger US Dollar are a strong headwind for emerging markets especially where there has been heavy Dollar borrowing. In June, Argentina received a $50b bailout from the IMF to help maintain their currency value, so Turkey’s difficulties were not first. Chile, Hungary, Egypt, Brazil and Argentina all have sizable borrowings in foreign currencies. Some of these countries, Argentina, Brazil and Turkey, run trade deficits which can also pressure currency valuations.

Turkey is not alone in the economic characteristics that precipitated this collapse of confidence, but it is not a given that the fear will spread. Certainly markets will keep a watchful eye on similar markets. Please see WSJ article: https://www.wsj.com/articles/turkeys-economic-red-flags-stand-out-among-emerging-markets-1534336200?mod=searchresults&page=1&pos=7

What about Crestwood’s clients?

Crestwood has avoided EM debt funds despite very tempting yields. We believe that bond investors do not get properly paid for currency risk. Also, froth in the EM dollar lending boom was clear. Recall the 100 year Argentinian bond issue? $2.75 billion sold last June despite Argentina’s history of defaulting seven times on external debt. They made it 12 months before needing an IMF bailout. Currently, the bonds are selling $89 on $100 par – only 99 years to go! Or the $500b Tajikistan bond issue to finish a massive dam started by the Soviets in 1970’s. The par value of the bonds represents 15% of countries annual GDP and raises Tajikistan’s external debt level to 50% of GDP. Those too are selling at $89 per bond.

As we have mentioned, we believe the role of bonds in the Growth model is to provide diversification to the equity holdings which provide 90% of the risk. EM Debt does not provide much diversification especially in risk-off periods.

In Crestwood’s Growth model, our exposure to emerging market stocks is modest, standing at 4%. We continue to be overweight US equities (75% of equities) versus international equities (25% of equities).

Please let me know if you have any questions or comments.

Thanks,

John

John R. Ingram CFA

Managing Director

Asset Allocation and Research

Direct: 617.226.0021

Fax: 617.523.8118

Crestwood Advisors

One Liberty Square

Suite 500

Boston, MA 02109

www.crestwoodadvisors.com

REITs – Recent Underperformance, Still Like the Asset Class

Below I discuss the real estate sector and address the reasons for its recent underperformance. Additionally, I look at REIT performance during periods of rising rates and increased inflation.

Key Takeaways:

1.) Thesis intact – we still like REITs as a long term, strategic asset class that adds diversification to our asset allocation and has opportunity to improve risd-adjusted returns

2.) Performance During Rising Rates – the positive economic backdrop during rising rate environments acts as a tail wind for REITs as they tend to outperform over the full period of rate increases

3.) Inflation Protection – as we begin to see increased inflation, real assets should maintain pricing power

Continue reading “REITs – Recent Underperformance, Still Like the Asset Class”