In 1970, Warren Buffett opened a family safety deposit box to discover a letter from his grandfather and $1,000 cash. The letter, written to Buffett’s uncle on his 10th wedding anniversary, extolled the virtues of ready cash, explaining, “Over a period of a good many years I have known a great many people who at some time or another have suffered in various ways simply because they did not have ready cash.”
In the weeks since Washington increased the debt limit, the markets have been a roller coaster ride. Continued fallout from the political debacle of early August and disappointing data from housing, manufacturing and employment sectors have all come together to create the perfect storm for a double dip recession. At Balentine, we have spent the last 18 months preparing portfolios for such an event and are positioned to weather the storm, by including protection from a sustained low interest rate environment, the threat of inflation and the economic struggles of the developed world.
A few weeks ago, the world’s markets began to adjust due to a significantly higher probability that there would be a global recession over the coming year. Stocks are down more than 15%, the yield on the 10-year Treasury bond has fallen below 2.5%, Europe is in trouble and Gold is at record levels. After the markets closed on Friday, August 5, Standard & Poor’s (S&P) downgraded U.S. debt, saying that our elected officials’ failure to agree upon steps to reduce spending and pay down debt caused the U.S. to lose its coveted AAA rating. Should we be worried? Well, yes and no.
Balentine’s approach to investment management is a “risk-first” approach that some may see as defensive, contrarian and even sometimes counter-intuitive. But it is built specifically for periods like this: when markets have given up entire yearly gains in a matter of days. Our considerable investments in assets outside of the United States and our emphasis on hedge strategies, commodities and market-neutral investments means that our clients’ portfolios are better positioned to weather the storm.
Today’s banking crisis was caused by an extension of the forces that have been at play for decades. However, unlike earlier, less debt-laden times, today’s “universal banks” (operating around the clock and the globe) have taken on extraordinary size, wide risks and leverage that only fair weather can justify. The ongoing crisis has infected all but a few of the world’s largest (free market) financial institutions, pushing several once-powerful firms over the edge in rapid succession. Once deemed “too big to fail,” these institutions have failed their major constituents on both sides of the balance sheet.
In November 2010, the Federal Reserve (Fed) announced a second round of quantitative easing (QE2), a plan to buy $600 billion worth of bonds with newly created money to help the still struggling economy. Acting as a sequel to the initial $1.7 trillion used for quantitative easing in 2009 and early 2010, $600 billion was a bold number with two specific goals: to cap long-term interest rates and bolster bond prices. The results have been mixed.
Investors are anxiously monitoring commodity prices this month as they have fallen sharply. During the first week of May, The Economist reported that silver fell by 30%, copper and zinc declined by 5% and oil dropped nearly $10 a barrel. The sudden, sharp decline of commodities prices and continued market volatility have raised a lot of eyebrows and even more questions, prompting investors to ask: Is there a commodity bubble? Is the commodity bubble bursting? And does this signal the beginning of a sharp decline for the stock market?
Our Investment Strategy Team is often asked if gold is still a safe bet despite its extraordinarily high price. At $1,535 per ounce, the price of gold has reached a 50-year high. With the price of gold up over 30% in the past year and 8% since the first of the year, we now face the Chicken Little/Dr. Pangloss conundrum. Will the sky (and the price of gold) fall, or like Dr. Pangloss, should we remain optimistic?
The European Central Bank increased the refinancing rate from 1% to 1.25% yesterday. Emerging markets are showing the first signs of inflation, but it is not stopping there. European inflation will continue to rise as price increases from the emerging markets are passed through and commodity price inflation continues.
The municipal bond market will be under pressure for a number of years as politicians and unions trade barbs. From a broader economic perspective, the bottom line could mean rising municipal bond yields, more market volatility and periodic municipal bankruptcies.