That 70s Show

Buy Low!

The 1970s were certainly an eventful decade for yours truly. I moved back to Canada from a brief stint in the U.S., met a girl in high school who is now my wife, got my first real job, and also fell in love with markets.

I'm sure the inflation trade that defined that era is an foreign environment to many of the current investing public. But my wife and I sure felt it when we set out to buy our first home in 1979, as prices were shooting up 40% during our house hunt.

Easy money was the catalyst then, as it is now, and could be the cause of the rotation towards commodities. All the liquidity in this cycle has gone into financial assets. Central banks have held firm to their belief in the time tested mechanism of the wealth effect. But have they been pushing on the string long enough to create a cyclical spurt? The excess capacity of the world economy is slowly being squeezed out. Could it now be time for the commodity board to join the party?

The most contrarian buy call right now is hard assets. In the last commodity bull market, the story was the explosive China-lead infrastructure boom. The effects of that era are just about fully forgotten now as all focus has, correctly, been on the low-vol and growth trades. Commodities as an asset class have been fading from sight and institutional allocations are at a low ebb.

Dennis Gartman on CNBC put out the chart show above that shows just how out of favour commodities have been. I have been focussed on this sector for my whole life, given the history of how I came to be interested in the financial markets. Some of you may know that I started as an oil analyst, way-back when. The impetus for my hiring out of business school was the relentless outperformance of oil stocks in the late 70s. But I have prided myself of never falling in love with hard assets to the point of perma-bull status. In fact, I was one one the biggest bears on oil in late 2014, calling a possible drop to $30 based on my 1986 experience.

I'm not calling for an immediate return to favour for the CRB as it takes a correction in the "winning" trade before relative performance shifts. A positive earnings backdrop, combined with low bond yields, means the low vol/tech bubble is unlikely to pop just yet.

But the relative performance rotation could be "V" shaped as it has been in the past given the extreme positioning of most portfolios. At least there is a prudent diversification benefit in recommending the trade into commodities.

I always said investors always spend 90% of the time worrying about earnings and only 10% in considering the multiple that one applies to them. In the early stages of a correction or bear market, the first thing to move is the multiple. With a slowly rising discount rate as a backdrop, any decline in earnings growth expectations will cause a disproportionate drop in the multiples of the growth stocks.

We don't know what the catalyst for this change in attitude will be. Right now, investors are just going with the flow. Given the high level of pessimism about the economy and the geo-political backdrop, it's impossible to know what will generate the shift towards value. Just as they did when they preemptively responded to Trump's Fall victory, investors need to be encouraged enough by the prospect of acceleration in global growth to shift their portfolios away from the overvalued FANGs.

The market's seasonality bias argues for an annual fall correction. Just about the time my thumb will better. The operation went well and I've been watching a lot of golf.

I'm already booking some rehab games for Q1. It seems 2018 is looking like a better year for long the forgotten commodities trade as well as it's old traders!

Thumbs up!