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On Global Concern, Keep Your Cash Dry

Published 07/09/2014, 12:02 PM
Updated 05/14/2017, 06:45 AM

We are back in Wyoming in pre-meeting conversations before the July 11 GIC conference. Concerns about the world are evident here. Serious discussions are occurring about geopolitical risk implications and how they could affect markets in the US, other parts of the globe, and the economic recovery.

Exit Energy

We have maintained our cash reserve. In addition, we have exited our overweight position in the Energy sector. That is a major change. Gasoline prices have reached levels that (1) will be sustained for a while in all likelihood and (2) that are, in real terms, equivalent to levels that previously led to economic slowdowns in the US. This development prompted our exit from the sector.

In a compelling study, Ned Davis Research examined the real price of gasoline, adjusted for the inflation rate, and its economic impacts. The inflation-adjusted price of gasoline today has reached levels that have historically throttled growth. Furthermore, the Ned Davis study finds that a higher price for gasoline would be the equivalent of a major shock. The research suggests that under either circumstance – current gas prices or prices that surge even higher – the weight on the economy from that adjustment is onerous.

We agree with the need for caution. Our view is that the Energy sector has priced an outlook for oil prices above $100 on a sustained basis. The sector has done remarkably well in the stock market recovery period. We have put the profits in the bank and will stand aside to let the dust clear for a little before we venture back into the sector. We need to allow some breathing space. A sector in which we are also underweight is the banks. Large banks are having problems in the earnings sphere and are the targets of fines and regulatory pressures. The combination is not a good one.

Overweight Sector

We continue our overweight position in the Utilities sector. This sector has been a terrific performance-oriented group the entire year. We think the stock prices in this sector will go higher. There was a long period of history in which utilities were unloved and under-owned. That came to an end in January of this year. We think utilities still offer good value at the current levels. Our cash reserve could be committed at any time or may be sustained for any number of days, weeks, or months. We do not like the way world looks. We do not like the political impasses in Washington, DC, that will not resolve anything easily. We do not like the policies in place. We think there is great uncertainty now about what the central banks of the world, including our Federal Reserve, will do and when they will do it.

The only bank that has a clear road to tightening policy is the Bank of England under Governor Mark Carney. The European Central Bank's policy is still not clear. They have committed themselves to doing something, but what it is, how long it will be, how much it will be, and how it will unfold remains to be seen.

Our Federal Reserve is tapering to zero this year. What happens next is not clear. The Bank of Japan is trying to figure out what its next policy move will be, depending on whether the Japanese economy generates some inflation instead of deflation and shows some signs of economic recovery.

Rising Uncertainty Premiums

We see that. A cash reserve is a prudent thing.

David R. Kotok, Chairman and Chief Investment Officer

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