Letter - October 2016

 

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A Year of Living Dangerously

January began with a sharp sell-off in the market prompted by fears of a looming recession. These fears proved unwarranted and the market rallied. Then there was the unexpected vote by the UK to leave the European Union, Brexit. A surprised and unprepared market sold off sharply again only to rally back after a few days. The market remained wobbly due to uncertainty as to whether or not the Federal Reserve would raise interest rates in September in the face of sub 2% GDP growth. It did not; the market rallied. Recently the market stumbled as the largest German bank and pillar of the European banking system, Deutsche Bank, was hit with a $14 billion fine by the US Department of Justice, a fine which threatened the bank with insolvency and could possibly trigger another international financial crisis. The market soon rallied when rumors surfaced that Justice would settle for a mere $6 billion.

Coming up in about a month is the presidential election between two historically disliked contenders. Clinton promises more of the same: larger government, more debt, more regulation, more free stuff, hardly a recipe for growth. Trump promises to disrupt the status quo but lacks consistent policy and presidential gravitas, to be kind. Both belittle the benefits of free foreign trade. How the markets will respond to the winner is anybodyís guess. This is beginning to look like an unfunny version of the Perils of Pauline!

On the macro level, growth has been low and tenuous in the US and even more so in Europe. Asian growth is higher but well off the level of previous years. Demand remains subdued and there is an oversupply of capacity in many sectors. This is why there is so much focus on the Fed. Many investors fear that raising rates under current conditions will push the world economy into recession. Others are advocating higher rates. They are of a mind that low rates are dangerous, causing a misallocation of capital which could lead to a financial bubble like 2007. We are sympathetic to both schools of thought. It is possible that both can be right. The Fed is in a very tight spot.

Internationally, not much has changed over the past nine months and we donít expect much to change in the year going forward. The massacre in Syria continues with Russian duplicity and bad faith. China continues to challenge US interests in the South China Sea. The Philippines are drifting out of the US circle of influence and currying favor with China. A lack of a muscular foreign policy by the US is eroding Pax Americana. This is a fertile field for unexpected developments that could roil markets.

These are dangerous times for investors. Market valuations are high but the market is astonishingly resilient. Whatís going on? One thought is that the market is expecting an upturn in corporate earnings after six consecutive quarters of decline. The negative impact of a fall in oil prices on aggregate earnings is dissipating. Perhaps GDP growth is poised to accelerate in the quarters ahead allowing the Fed to raise rates from a position of strength and without fear of recession.

Our strategy remains unchanged. Market valuations are too high for us to be very bullish. Client cash positions remain high. We will take profits when appropriate and buy in periods of confusion. 2016 continues to be a year of living dangerously but it might turn out OK after all.

 

Tom Herzig


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PR Herzig & Co. has moved to another office in the same office complex. Our phone and fax numbers remain the same. The ADV Part II has been adjusted accordingly. The new mailing address is:


PR Herzig & Co., Inc.
4 Expressway Plaza, Suite 220
Roslyn Heights, NY 11577

 


 

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