TRANSCRIPT: Exploring Investment Opportunities Amidst Global Challenges with Martina Longauer
TRANSCRIPT: Exploring Investment Opportunities Amidst Global Challenges with Martina Longauer and Warren Gerow
Below is a transcript of our latest Advisor Interview with Sightline’s Warren Gerow and Sightline Senior Investment Advisor Martina Longauer.
Hello everyone. I’m here with Warren Gerow, Sightline’s strategist, for our conversation. Hi, Warren.
Before we start talking, let’s just paint the picture of where we are. I can’t believe it’s May, but the Fed recently agreed to increase the interest rates again by 25 basis points. This is the 10th consecutive rate hike, which is very interesting. We have the election coming up – kind of around the corner – and surprise, surprise, the energy and materials sectors are finding their way to conversations. Discussions of a recession are increasing, and as we are looking at the headlines, everybody’s projecting how soon or if we’re already in a recession. Also, there are geopolitical tensions that we hoped would be behind us. For example, the Ukrainian conflict is not, it’s only increasing, and it seems like some of the spots around the world are perking up to add to it instead of cooling it down. In light of this climate, we wanted to address what asset classes we like to invest in right now in clients’ portfolios, and perhaps commenting on why. The floor is yours, Warren.
Thank you, Martina. Before we get into that, I just want to give a brief overview as you did, but I want to be a little more concise with the four or five macro trends that we see out there. First, of course, is the debt crisis, that we do in fact have a debt crisis on a global basis. If you look at debt, debt to GDP, both in Canada and the U.S., it’s very high. And our actual debt in Canada is expected to be, at the end of 2023, about 2.1 trillion. In the U.S., it’s over 32 trillion. So, you know, this debt to GDP number is starting to go over a hundred percent. I think, in the U.S., it’s like 132% or something like that. It’s very, very high. Certainly, we have this debt crisis that we have to deal with. At some point, it will be dealt with one way or the other.
We also have internal conflicts. Of course, we’ve seen the polarization in almost all countries – the Western countries. I’m speaking of primarily a polarization between the left and the right. The primary focus of the agenda has been on social and political issues rather than economic ones. We’ve had, as many of you have seen, civil unrest in many centers, like Paris, that are protesting over the change in legislation regarding pensions. We’ve seen civil unrest in pockets in the U.S. and so forth.
The third sort of macro trend we see is external conflicts. External conflicts could be wars, deglobalization, economic sanctions, de-dollarization and so forth. So that’s another major trend that we have to deal with going forward.
The fourth macro trend that we’ve been looking at in trying to assess the best place to invest is considered acts of nature in these centers, such as droughts, floods, and pandemics. These certainly will have an impact on our market conditions. As we’ve seen with the recent pandemic, we had to shut down the economy which had a significant impact on economic activity.
The fifth macro trend that we see that comes into play in our way of thinking is human intervention and technology development. The human species has the ability to adapt just like in nature. This ability for adaptation is one of the characteristics that sets us apart. We’re able to respond to our current circumstances and make adjustments that we need to, and technology development is part of that. We’re seeing enormous leaps in technology development, for example in automation, A.I. and so forth. That’s certainly going to have a major play in one of the theses that we like when we talk about the industrial reshoring of industry and manufacturing. There’s going to be a lot of automation involved in that.
That sort of gives you a bit of a backdrop of the five macro trends that we’ve been looking at. And as you said in your initial comment, we’re talking about where we are from an economic point of view. As you mentioned, we’ve seen the Fed raise their rates another 25 basis points this past week. We saw the Bank of Canada come out, and they said that they had paused this last meeting. They said that they were thinking about the possibility of raising rates. Again, typically, they usually do follow the U.S., but in this case, they were leading the U.S. on the pause.
They may have to increase rates at the next meeting. Who knows. Now what’s interesting is Australia paused, as well, during their previous meeting. Then, this week, they decided to raise 25 basis points, as the E.U. did this morning. So, central banks around the world are looking at persistent inflation. Even though inflation is coming down, it still is substantially higher than what the target rate of return is, which is the 2% inflation rate that we’ve heard from virtually every central bank. That’s where they want to see inflation. Until inflation gets down to that level, we may have rates a little bit higher than we would like for longer. This certainly has been the rhetoric we’ve seen.
Now, Martina, that could all change as a result of the banking crisis in the U.S. and the further deterioration of some of the regional banks. We’ve recently seen First Republic be taken by JP Morgan, and there may be more of that. If there’s more pressure in that area, then the Fed may have to say, you know what, we have to pause. We have to reduce rates. A lot of pundits out there are suggesting that we could see rates pause. In other words, this is the last rate increase. We probably paused for a bit. Then they’re suggesting that we’ll see rate decreases coming at the end of the year – certainly by the end of the first quarter of 2024. Most analysts believe U.S. interest rates will start coming down, and central banks will start decreasing rates.
Typically, historically speaking, when you enter a recession, and most people think we’re going to enter a recession, markets respond partway through the recession and start to have strong moves upward. And the reason is that they anticipate that we are going to be coming out of a recession. Certainly, if we see rates start coming down, central bank rates start coming down. People are anticipating that you’ll see a substantial increase in stock valuations. I guess, as an indication of that, we saw last year when rates first started going up, technology stocks were hit dramatically. They were hit pretty hard because of the re-evaluation based on the higher interest rate and the discount models. And now this year, everybody’s anticipating a pause or a pullback in rates, and all of sudden technology stocks are flying up again on the Nasdaq like 15-16%.
There are about three or four areas that we kind of like right now. Even though it may be early, we think long-term prospects for some of these areas that we like are very, very good. I’ll start with the first one, and that is commodities. Now, over the last little while, commodities have just been awful. We saw the price of metals and, and oil really take off a year ago. Since then, we’ve seen, for example, the price of oil coming off quite dramatically. There have been pretty serious reductions in a lot of other commodities, as well. You know, corn, lumber, wheat – a lot of grains have come off quite a bit, while everybody’s anticipating that we’re going to see shortages in food.
The reason we like oil and a lot of the other commodities is that we think the prospects down the road are much more promising. We think that, given the nature of the oil market, we’re not really drilling a lot of holes. We’re not putting a lot of holes in the ground. We’re not expanding the resource. In fact, oil companies are looking at improving their capabilities of existing wells and buying other wells, as opposed to exploration. So, we think that demand will continue to be where it is. Even though we’re trying to transition to electric, it’s going to take a lot of fossil fuels to make that transition successful. We also need a lot of infrastructure built. That means you’re going to need a lot of fossil fuels to dig the mines, create the mines, and build the mines out.
You’re going to need a lot of metals. So, this transition’s going to take a known revere. We think there’s going to be a lot of unfortunate CapEx, and there hasn’t really been a lot of money spent on CapEx recently. We think supplies are somewhat limited, and as a result, we think that you could see oil have a good run here for two, three, maybe even four years, but right now, it’s suppressed. We would suggest right now that this asset looks fairly attractive. The oil market at $68 today looks very, very attractive. We think it’s a good place to be. The same thing with food. We think that the grains right now have come off their peak. We believe based on what we’re hearing and what we’re reading, there’s going to be shortages of various grains.
Just recently, they released the rice production in Pakistan and China, and it’s significantly less than it’s ever been. Pakistan I did not know, has about 7.6% of the world’s supply that they produce every year, and their production levels are significantly lower than they’ve been in the past. And rice is one of the predominant foods of the majority of the world. So, rice production is down, and we’ve seen the winter wheat crop in the U.S. was not as strong as they anticipated. As a result, we believe that there’s a chance that we’re going to continue to see food inflation. I think, on the inflation front has come down quite a bit, but we’re still seeing food inflation and labor inflation. We think that inflation is going to be sticky and very difficult to tame, while the commodity area is one area we like.
Warren, are you in the same opinion when it comes to the base metals? Because you touched on the precious metals, the energy, the oil, the food. What about the infrastructure within base metals? Do you have them in the same pattern?
Yeah, definitely base metals, because as I said, to build out the infrastructure required for this transition to electric, we’re going to need a lot of materials – copper, iron, steel. We’re going to need all that. So again, supplies are relatively short for what it takes to bring a mine on. I think it’s upwards of 10 years to bring a mine on to get all the permitting done and so forth. So, we think supplies are going to be tight. There are a couple of ETFs out there that we really like. One, in particular, is the mining sector. It’s a global situation. Believe it or not, it’s actually got a very attractive yield – over 6% in dividends. These companies are beaten up, but they have great free cash flow. So that’s another area that we like.
As far as precious metals go, we think the time has come. Again, we believe that, with fiat currencies, a lot of it is just a pure confidence play. I think gold and silver are going to have a nice move here in the next, let’s call it a year, year and a half, as people continue to lose confidence in the government, particularly Western governments. China and Russia, some of these third-world countries are buying gold and are backing their own currency, rather than relying strictly on U.S. treasuries as in the past. So, rather than use U.S. treasury as they reserve, they’re transitioning into gold. I think that’s complex.
You’ve got the food, you’ve got the oil, you’ve got the mines and metals and you have precious metals, I think they’re all going to do well, but again, they are depressed right now, which is why we think it’s an opportunity.
Okay, so the first area, the bullish is the commodity. Let’s just move to the second one.
It’s not going to happen next week or next month. It’s going to take some time, but we think it’s just a good place to start right now because of the price. The second area that I like is technology. The reason I like technology, there’s a number of reasons for that, is I think what’s happening is a result of the supply shocks that we saw as a result of COVID. There’s been a lot of reconsideration because of the external conflicts that we’re having with the wars involving China and Russia. We think there’s going to be a lot of reshoring of the manufacturing activity. As these manufacturing capabilities come back to the West – either in the U.S., Canada, or Mexico – a lot of this we think is going to be theirs, and they’re going to turn to automation.
As we know, there are more jobs available than there are employees or workers. So, there’s a shortage of workers, shortage of labor, and we think a lot of that’s going to be addressed through automation. So, we believe technology’s going to do well. Everybody’s talking about A.I., and we think technology seems to come in these big pushes. We think that we’re getting ready for another push, and it’s going to be automation. As a result, we like the tech sector. However, I don’t know whether you can endorse general tech, but there are certainly specific areas of technology I think we’re going to do very, very well.
Additionally, the NASDAQ is up 15-16% currently – will it go up up another 15-16%? I have no idea, but I do know that over the longer term we like the technology area, and some of these tech stocks are generating great earnings. Other stocks are certainly overpriced. We’ve seen a big move in tech stocks, particularly Microsoft and Apple, which represent about, up until the end of April, about 85% of the move in the S&P 500.
The third area alluded to that I like is the industrial sector. The reason for that has to do with the theme I talked about with technology – the reassuring of manufacturing. We believe that the supply disruption that we had is driving this, as well as the external conflicts that we’re having with China and Russia. For example, with chip-making, if the majority of that is in Taiwan and if China decides to take over Taiwan, how are we going to get our chips? We’re going to see a transfer of that technology and that capability into more favorable regions. So, we think that the industrial side is going to do well.
I think that, based on our conversations before and even recent ones, I believe you were kind of lacking in one of the areas that you tend to address on a regular basis, and that’s cash.
Well, funny you mentioned that I like cash. I like cash because let’s say we have a correction you can sit in cash right now and make 5% risk-free. Why not have a portion of your portfolio in cash? One of the things that we’ve been adding to our models recently, and we’re suggesting is cash. Because we think there could be buying opportunities within the next six to nine months that may be very, very attractive. So, yes, I would agree cash looks very attractive right now. I know Ray Dalio said that he thought cash was trash. He’s not saying that now, he’s saying, you know have a balanced portfolio but also have some cash to pick up opportunities, be opportunistic with it. Martina, I think there’s a place in the portfolio right now for cash, especially when you can get 5% in cash. I like the idea a lot.
We see the money markets accessible on a daily basis, anywhere from 4 to 4.5%. When it comes to U.S. dollars with the recent hike, the 4.4 % that was offered before, I think we’ll jump a little bit. It might be closer to 5% when all is said and done, just because it was so recent. Usually, those have a bit of a lag to react. The cash is not even the one that is accessible on a daily basis. It’s not that unattractive. It’s fairly attractive with the optionality of repositioning when you know one feels fit. Right?
Right. The one thing we didn’t mention was bonds. I don’t know whether some of your listeners saw Jeff Gundlach yesterday. He basically said that he thought right now is the time to be buying bonds, but it’s a short-term play on a quality issue because he thinks this is the last chance before there’s a significant rally. However, he’s in a camp that thinks that rates are going to be coming down and that the Fed is going to have to pivot and must reduce rates, and he looks at it as an opportunity to buy some longs. Now, he was talking long bonds. I think you have to be very selective if you find a bond manager. Here at Sightline, we have a couple of names that we like, but I’m not a huge fan of bonds right now, even though I know there could be an opportunity.
It’s just, to me, there’s too much uncertainty about these issues that I talked about earlier with the debt crisis, the internal conflicts, external conflicts, and so forth. I think there are too many cross-currents out there. So, to be safe rather than buy bonds, I think probably for most investors, unless you’re very opportunistic and can manage, I think cash may be the best place to be. That would be sort of my thinking on bonds right now. We may be near the end of rate increases, but are they going to come down? I don’t know.
The other thing in the past rate, hiking periods, going back to the seventies, is that we always end up with a real rate of return. Right now, we have a negative real rate. What I mean by that is the inflation rate, call it 4.5%, is higher than the bond rate. That’s a negative rate of return, and it always goes positive. Now, it goes positive one or two ways. Either inflation comes down dramatically and rates stay where they are, or rates have to go higher and inflation stays stable or comes down a little bit and rates have to go higher. We need a real rate of return on our bond portfolios, and right now we don’t have it. That’s the other reason why I’m a little bit nervous about bonds. I think you need to see that ship right itself. You know, so far, I’m a little bit uncertain, a little anxious in that area.
I would invite all investors to go back to their advisors to talk about what kind of specific products we would recommend for their individual portfolios. But just to conclude, is there anything else that you feel we haven’t touched that would be important to close with?
No, not really. I think we covered the bases pretty well. I guess the main thing really is to have a very fulsome talk with your advisor and talk about how much risk you want to assume in your portfolio and when you’re going to need your money. A lot of what I talked about is a little bit longer-term duration because of all the uncertainty that we have with the current market conditions. So, I think a real heart-to-heart discussion with your advisors and what you’re looking for in your timeframe is very important here in this in this difficult period. Since we have an election next year in the U.S., I have to believe, given the parties involved, there’s going to be turmoil in the market – the market’s going to have some additional volatility in addition to the Fed, in addition to the wars and so forth and so on. I just believe there’s a high level of uncertainty out there right now, and I think a good discussion, or at least a review with your advisor, would be critically important this time.
Well, thank you, Warren. This was really nice. Thank you for your time and all your insights. I hope to have another conversation soon – I think we’re scheduled to have one closer to the end of the year together. We;ll see what those few months bring. But thank you very much.
Well, thank you very much, and thanks for having me. Looking forward to the next time.
Warren Gerow is an independent investment wealth consultant at Sightline Wealth Management.
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