In the lead up to the Kansas City Fed’s Jackson Hole symposium later this week, Europe remains the focus of macro and geopolitical risk narratives. While some positive signals have emerged during the past couple months, such as Fitch’s upgrade of long-term Irish debt, the overall mood among economists and market analysts remains glum. Says David Rosenberg, chief economist and strategist at Toronto–based wealth management firm Gluskin Sheff + Associates, “Make no mistake, the path of least resistance for the euro is down.” Thursday’s purchasing manager index for France and Germany are being eagerly anticipated for any signal of a change in the pace of private-sector activity. On the geopolitical risk side, Ukrainian officials’ release of details today on an attack on a convoy on Monday that left no survivors underscored the lingering risks of acceleration in the conflict in the east of the country.
Inflation contracts in the U.K. July U.K. consumer price inflation released today came in softer than forecast at an annualized 1.6 percent. In light of concerns over disinflationary conditions, the prospect of tightening actions by Bank of England policymakers in the near term is less likely. An analyst focus over the Monetary Policy Committee notes due tomorrow will be any division between members on prospects for any further positive impact of accommodative policy on labor markets there.
Bank of China profit growth slows. State-owned Bank of China reported an increase in net income of 8.5 percent for second-quarter 2014, lower than analyst forecasts. Critically the bank’s increased provision for bad debt represented a level more than double that of what the financial institution last reported. Investors are keeping an eye on Chinese lenders’ credit-quality concerns, a topic policymakers have noted on official Chinese media channels in recent weeks. Separately, in the wake of yesterday’s contraction of home price levels reported for July, the seven-day repurchase rate contracted to a multimonth low in interbank markets, as the prospect of a liquidity intervention by the People’s Bank of China becomes more likely.
U.S. prices at the cash register expected to edge up ever so slightly. Consumer inflation for July will be released in the U.S. this morning. Consensus forecasts call for a marginal increase in core levels but for the headline index to advance at only 0.1 to 0.2 percent for the month on the back of weaker energy prices. In a note this morning, Société Générale’s cross-asset research group wrote that a 0.2 percent increase in the index would drive the annualized rate to 2.2 percent, above the U.S. Federal Reserve target threshold.
Second-quarter earnings season comes into the home stretch. U.S. companies announcing second-quarter 2014 earnings today include Minneapolis–headquartered medical products manufacturer — and recent corporate inversion — Medtronic and Boston–based discount retail chain TJX Companies. Atlanta–headquartered home improvement retailer Home Depot reported same-store sales this morning that beat analysts’ forecasts significantly at 5.8 percent for the period to drive earnings of $1.52 a share, a rebound that is also a positive sign for U.S. homeowner activity. In Europe, Danish shipping giant AP Moeller Maersk raised its earnings guidance through year-end on strong demand for shipping containers.
Portfolio Perspective: Opportunistic Positioning for Multigenerational Wealth — Ignacio Pakciarz, BigSur Partners
After the 2008–’09 financial crisis, we have been in a long and slow moving economic and market cycle, where immense amounts of money have drifted into more liquid areas of the capital markets. As the Fed ends quantitative easing in October, we at BigSur think the European Central Bank will start quantitative easing very soon, prolonging this cycle for at least another two or three years. This cycle has made it difficult to see clear value in the three traditional asset classes. For one, it’s hard to hold cash, when, in real terms, it yields –2 percent. Investors should still hold at least 10 percent in cash for the flexibility needed to take advantage of opportunities that might come fast, however, as black swans erupt and capital markets sell off quickly. For bonds, our estimated annual performance of a diversified fixed-income portfolio over the next five years is 1–2 percent. While high-grade bonds offer negative real rates, credit spreads are at their tightest level ever. As Fed Chair Janet Yellen alerted investors, valuations in the high-yield markets are extreme. Stocks are slightly overvalued, but offer more value compared to the other two primary asset classes.
Our five-year forecasted return for equities is about 5–6 percent a year, down from 18 percent at the beginning of the bull market, of which we believe we’re in the seventh inning. While the focus will be on corporate earnings, stocks will likely go up in price from the 16 to 18 times earnings at the peak of the cycle. Investors are coming to stocks searching for yield — which is rare. All in all, the opportunity in traditional asset classes is limited on an absolute basis as well as on a relative basis compared to the investment landscape of five years ago.
So where does this leave us? We at BigSur focus on finding nontraditional revenue-producing assets that offer intrinsic value of about 10 percent or real rates of roughly 8 percent. These include core commercial real estate; opportunistic hard-money lending (against high-quality assets); private debt and other niche asset classes, such as investing in debt securities that are collateralized with royalty streams from, for example, leading pharmaceuticals. We believe that with time, liquidity will also end up flowing into and pushing up the values of these types of nontraditional assets.
Ignacio Pakciarz is a founding partner and CEO of BigSur Partners, a global multifamily office based in Miami.
