FIVE THINGS WE’RE FRETTING ABOUT IN MARKET
Peter Hodson gives a balanced viewpoint on some short-term, and even bigger, issues.
We have, at times, been accused of being “overly optimistic.” We do tend to be stock market bulls more often than bears. And why not? The stock market, historically, has always risen, longer term. Since we are still near record high levels, any investor (on average) has made money in the market, provided they are still holding. Besides, we know few (none, actually) very rich short sellers. Pessimists have the market stacked against them in many ways: short sellers need to cover dividends, pay to borrow stock, and, oh yeah, as noted, the stock market tends to go up over time.
But, to give you a balanced viewpoint, there are some things that worry us these days in the market. Some are short-term potential problems, others are bigger issues. Of course, an optimist might say that market valuations already reflect such worries. But let’s give the bears some time here, and provide five things that might worry investors these days.
1)
Trump re-election
We tend to ignore politics, preferring to concentrate our research on companies to try to find good investments, rather than waste time watching political kindergarten fights. After all, a good company should be able to adapt to whatever politicians throw at them. However, Trump has thrown us a curve. He literally seems to do anything he wants, and, somehow, gets away with it. We are worried about what happens if he is re-elected. If he wins, and odds are high he will, then he knows he is limited to four more years as president, and that’s it. There is no second re-election. If he is in power again next November, the gloves might really come off. He does not have to worry about getting elected, his approval rating, or anything. Things, potentially, could really come off the rails. Uncertainty may be the word for the next four years, and equity markets can’t stand uncertainty.
2)
Repo market craziness
A repo is slang for repurchase agreement. It is a common type of short-term borrowing where the underlying collateral is government securities. In a typical repurchase agreement, a financial institution sells government bonds to raise cash today and agrees to buy them back tomorrow. The next-day repurchase is at a higher price, which implies an overnight interest rate referred to as the repo rate. Usually, the repo rate is close to the bank rate, around two per cent. But recently, for various reasons, it has spiked to 10 per cent. Banks were unwilling to lend to each other, so the Fed needed to step in and provide liquidity. There are many theories here, such as a big supply of newly issued bonds messing up banks’ normal supply/demand mix, and tough regulations that simply restrict banks’ ability to lend. Regardless of the reason, though, when we see strange activity in credit it causes worry: Credit seizing up was one of the main problems that exacerbated the 2008 financial crisis.
3)
The growth of liquid alt funds
If you haven’t noticed (from all the marketing) the investment industry has a new trend at play to try to grab more of your money. Liquid alts are mutual funds that have different rules: Essentially, they can short stocks and use leverage, similar to what a normal hedge fund does, but without the same individual buyers’ restrictions (such as having to be an accredited investor) that hedge funds have. The idea is to offer investors non-correlated investments, to balance out the volatility in their portfolios. This is what hedge funds are supposed to do, but alas many do not. In addition to creating another fee-based product, we think the investment industry needs to be careful here. Investors may like the potential of liquid alts, but they may not understand the differences versus traditional funds. Since liquid alts are so new, we can’t predict how investors might react (i.e. panic and sell) when there is a shift in the market or the strategy does not protect them as much as they were expecting. The size of the U.S. market for these products is already US$225 billion; the Canadian market is expected to grow to $20 billion.
4)
The potential breakup of tech companies
Without naming names (you know who you are!) there are some politicians that seem to want to punish powerful tech/ communications companies by breaking them up into smaller companies.
Of course, this goes against the entire free-market economy, and punishing success does not entice others to strive to succeed, which can impact a whole economy.
Companies such as Facebook and Amazon have created thousands of jobs, and government interference is not the way to go here. Sentiment towards tech companies is not likely to improve if the government starts restricting how companies can grow and develop.
Now, we understand antitrust rules, of course, and governments need to watch out for companies that have monopolistic power. But (and this also applies to those with privacy concerns), Facebook is free to use. No one has to use it. We think the government should let large companies run themselves. 5)
The potential billionaire tax Keeping along the political lines, there are politicians who claim that there should be no billionaires. One proposal is for a giant scaling wealth tax on billionaires, increasing over time, which, essentially, wipes out most of a billionaire’s entire net worth over a few decades. Now, we will agree that no one “needs to be a billionaire.” It is a ridiculous amount of money for an individual. But, like our point above, any time a government considers taxing “success” it needs to be careful. Most billionaires come from creating companies. These companies hire thousands of workers. While a founder becomes a billionaire, huge value in their company is created. While Mark Zuckerberg (of Facebook) is one of the billionaires being targeted by the government, he has created a company that is worth half a trillion dollars. Shareholders, the economy and the government have hugely benefited from the company’s success. The government has already seen huge benefits (from employee taxes — Facebook has 40,000 — and capital gains taxes on individuals trading its shares). If the cost of innovation and success is having a few ultra-wealthy individuals, then the government should accept this cost. Sure, billionaires could pay more in tax, but to specifically punish individual success seems the wrong path to take, and longer-term, might stifle innovation and growth.