Financial Outlook July 2019

I want to paraphrase a bit of the teachings of Howard Marks, not only because he is one of the greatest investors of this century, but also because he is one of those who best knew how to transmit the risks associated with scenarios like the ones we are going through.

Investing is basically positioning the capital to benefit from future events. We are not sure what the future holds, but we should always do everything possible to know where we are in terms of the economic cycle.

From this position of knowledge we try to establish the most probable scenarios. Understanding that some scenarios are more likely than others is the basis of good asset allocation; recognizing that knowing the odds is not the same as knowing exactly what is going to happen is the basis for being a good risk manager.

The correction of a bubble driven by expectations, hope and euphoria, is something that theoretically may never happen. But history tells us that it will, and that the longer it takes, the more advanced in the economic cycle we are, the more likely this event becomes.

In an interconnected world, everything that produces unusual return attracts incremental capital until it becomes institutionalized, at which time its return adjusted to risk moves towards the medium (or worse). In return, poorly performing assets become increasingly cheaper, due to their relative depreciation and lack of interest, to the point that their adjusted return also moves towards the medium (or better).

Cycles like these are those that allow you to find good returns on low risk assets. Today in the first group we have a good part of the variable income assets, particularly the financial sectors, low-rated debt, leveraged debt, the technological sector, small caps, and the majority of the over-indebted companies. In the second group are US bonds, gold, mining companies, and a lot of commodities.

The more time passes without these corrections arriving, the more the cycle is forced to an extreme, more voices join to acclaim that the rules of the cycles were overcome, that the correction will never happen. This leads to the excesses of 2000, to the irresponsibility of the sub-prime mortgages in 2007 and in some way to the excesses we are seeing now.

Our role as risk managers is to protect our portfolios against the most likely dangers. And here we are presented with several alternatives from the point of view of asset allocation. We can be very aggressive and decide to short indexes (carefully in case of a blow-off top) and go long in leveraged gold, mining and bonds. We can be more conservative and simply rotate from equities towards bonds and gold with a good amount of liquidity in dollars. Or we can simply sell those things from our equities or debt portfolio that we consider to be the most risky, and perhaps buy some gold as a hedge.

Now the stark reality: the global economy is slowing down, with PMIs below 50 that signal a recession, growth projections based on a recovery in V were erroneous, the yield curves of bonds are mostly invested with a record of negative yield bonds.

Despite all this, the S&P is on record highs, with the hope that two leaders resolve their differences and abandon positions that are harmful to free trade, and the tranquility that the FED will rescue bad investments by cutting rates and eventually through strong financial repression (see Everything You Always Wanted to Know About FED Cuts.)

I'm running out of ways to say the same thing again and again, but that was a pretty reasonable summary.

While the majority refuse to accept the implicit risk in a large part of the equity sectors, I remain positioned waiting for the risks to materialize, but enjoying the fruits of the positions built in US bonds, gold and mining companies.

As I said in last month's report the V recovery in earnings is a chimera, a reality the beta chasers will have to face, something that those who can read the bond market already understood for almost a year .

For July 2019:

• Metals: I maintained exposure to precious metals and mining companies. I continue with a bullish view on metals and mining companies, which had a strong performance in June. (low risk)
• US Indices: I kept the short positions for the Russell 2000, the S & P 500 and the Nasdaq, in that order. (higher risk)
• Bonds: I increased my position in US bonds throughout the curve. (low risk)