Sunday, October 11, 2015

Darst's Six C's theme - negatives stories abound



I am not afraid of running with the ideas of others, or at least using a good turn of phase. Picasso said, "Good artists copy, great artists steal." 

David Darst, who has been a good strategist for a very long time, was quoted as saying that he is focusing on the six C's as the key investment themes for the fourth quarter. I do not fully agree with his stories, but I am in full agreement that the C's are what you have to watch.

Before launching into the six C's, I will note the value of using devices to help focus attention and memory. Most investors cannot hold more than three to four ideas at a time, so using tools to focus on what is important is not trivial. It is a useful heuristic.

The six C's: 

Credit - The high yield markets have backed up especially for the energy and commodity sectors. While there has been some firming of markets in the post-September FOMC, there has been a new wariness on credit. The spreads are now at three year highs and while not at 2011 levels suggest a more careful look. This is especially the case for emerging markets where net annual outflows have turned negative for the first time since 1988. Defaults have not appreciable increased but that would be the next shoe to drop if there is a global growth slowdown.

Currencies - The main story in currencies has been the dollar gain based on the expectation of a Fed rate increase. Now that the main story for a dollar increase has been kicked to the curb we expect  that there will be at best a sideways movement of the dollar. Nevertheless, a tailwind for the dollar is EM outflows and the fact that the growth in the US may be less uncertain than the EM world.

Commodities - Glencore is the commodity equity canary in the coal mine. The super cycle has clearly turned, but has not hit bottom. The Bloomberg commodity index saw the worst quarter since 2008. Slow global demand and a supply problem that has to be further solved means downward pressure on commodities is still present. Oil prices may have increased on geopolitical tensions and production declines in the US since July, but neither is enough to solve this critical supply-demand imbalance.

China - Stock prices have firmed slightly only because the government has used every policy alternative available to arrest the decline. The key story is growth and there is a growing fear that the numbers we are seeing out of China should be viewed with skepticism. Now, the government is using both fiscal and monetary policy to help the economy, but confidence problem means that many investors are biased against China growth.

Crude oil - We have discussed commodities, but crude still has a special place within the asset class. Loans terms for oil companies are being revised based on new reserve value estimates. There is a energy credit problem that is growing. SWF assets are mainly driven by oil revenue, so there  has  been rebalancing of portfolios which will place pressure on hedge funds. DM consumers have benefited from lower oil prices, but it is unclear whether that is enough to offset the drag on EM countries.

Corporate profits - Entering earnings season with slow growth and a strong dollar means that we have see surprises on the downside. Earnings from overseas operations represents over 45 percent for companies in the S&P 500. Poor earnings and a negative technical equity bias will place more pressure on equity markets.

The fourth quarter will be driven by the six C's and most of this focus will be on the negative.


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