Beware The Bonfire of Institutional Memories

The capital markets have risk from an above normal bonfire of institutional memories accompanying close to a decade of quantitative ease and a coarsening of political discourse. Such coarsening has been most overt in the United States and Britain but also in Europe. It was a feature of the slow 1930s not just from fascists or about colonization but also then as now about immigration, trade and exchange rates. It is also not unlike the mid-1980s amid obsolescence that raised uncomfortable challenges for countries and companies. In advanced and emerging countries alike, the judiciary is being dragged into disputes that at base are due to political weakness. Geopolitical objectives that had consensus on objectives but now seems generating domestic strife represents yet another qualitative change, not unlike the early 1970s. In turn for investment portfolios, overemphasis on meta data and rationalizing equity valuation based on low administered rates needs to be balanced against other experiences, including that in Japan. After all compared to prior periods of a 4-5 year cycle, even a decade in capital markets means experience of only one cycle in effect. Further with differences from credit to employment conditions, central bank policy is in flux, including rate increases in the U.S. and China as well as uncertainty in Europe.

Contrary to complacency, the impact is likely to be deep when conditions change. We suspect it will include valuation contraction and sharply higher volatility as well  as heightened lemming like behavior. Within portfolios, the need to evaluate quality appears required as does diversification. Within the crucial Financials, the balance sheet and business advantages appear to lie with the strong. Within growth, valuation, innovation driven products and strong financial statements favor Information Technology. Within cyclicals, Industrials have valuation and product growth advantages over alternates. Market disdain had prevailed until 2016 but diversification opportunities favor Materials and Energy over erstwhile market favorites of interest rate sensitives. Meanwhile  systemic risk seems most overt for long dated fixed income. We would be watchful on currency as harbinger of stress. Gold bullion has quietly started to move back up.

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