Kass: The Investment World Is Flat
This column originally appeared on Real Money Pro at 7:49 a.m. EDT on June 12.
NEW YORK (Real Money) --
"In China today, Bill Gates is Britney Spears. In America today, Britney Spears is Britney Spears -- and that is our problem."The trading and investing world is flat -- and we have to learn to deal with it. Yesterday was an excellent example of that flatness. (Watch this great segment of "Mad Money" in which Jim "El Capitan" Cramer addresses the issue of the world's influence on our markets.)
"The Bank of Japan refrains from juicing its market for one day and the whole world goes to hell. There is an important message in this reaction; but the majority will ignore it or refuse to acknowledge it." -- Bill King, The King ReportThe above overnight news on Japan caused an emerging markets bond meltdown that in turn quickly hit the U.S. high-yield market and, several hours later, adversely impacted the U.S. stock market. Regardless of our domestic policy, we no longer completely control our economic, interest rate and investing destiny -- it is, in part, in the hands of others (over there). Years ago, globalization started the move from round to flat, as it pushed manufacturing jobs abroad and served as an important contributor to the current structural employment disequilibrium and dilemma in the U.S. Today, capital flows, our lending costs, the availability of capital and even our monetary and fiscal decisions are influenced by central bankers and leaders over there. In a flat world, our religious, social and cultural interactions are directly influenced outside of our borders. A flat world even influences which sports teams and athletes we root for and whose records we buy and concerts we attend. Less open societies beyond our borders are potentially disruptive as they are fertile soil for the sowing of a more regular progression of black swan events -- those exogenous and unpredictable events influence our markets and society. But, maybe most importantly, U.S. economic growth and the status of the profits of our largest companies are influenced by conditions outside our country. Stated simply, the macroeconomic is no longer simply part of a multi-level strategy hedge fund; it is an integral component to our investment mosaic and decision making process. Late yesterday, I wrote that the macro is important to the U.S. for several reasons:
- Liquidity. Central bank easing has provided the liquidity to the capital markets. Without it, an important source of demand for long-dated assets (stocks) is eliminated or reduced.
- Profits are dependent upon global prosperity. No corporation/economy is an island anymore as the largest U.S. corporations are important exporters. This is particularly true of our technology companies. Large S&P companies are reliant/somewhat dependent on the health of Europe and other markets around the world. Their health is important to overall corporate profitability.
- U.S. economic growth. Four years of easing has failed to produce much more than +2% real growth domestically. The uncertainty of a non-self-sustaining recovery will weigh on stocks if QE is tapered.
- Interest rate cliff. In the experiment we call quantitative easing, we know not how smooth the exit might be. Warren Buffett told his audience in Omaha in May that he knows not how they exit this experiment nor what the ramifications might be. Tapering could result in ever higher rates. Our consumers, corporations and government are addicted to low rates. Moreover every discount dividend model depends on a cap or interest rate. Higher rates, in theory, reduce the value of future cash flows. Here is my previous column on the interest rate cliff.
"We don't want to change. Every change is a menace to stability." -- Aldous Huxley, Brave New WorldIn summary, no economy or corporation is an island. A flat trading and investing world expands our alternatives and opens us to greater opportunities, but it also increases risks, raises volatility, expands uncertainty and could reduce valuations (especially relative to history). Get used to it.
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