Investment professionals with exceptional research skills, proven track records, and access to large amounts of data are in a better position than average people to discern the investment future.
So, with that in mind, here are well-prepared assessments from Kevin C. Smith, CFA, founder and CEO of Crescat Capital, Denver, and investor Jim Rogers on what we can expect in the first year of Trump’s new term as president.
First, Rogers says in an interview that “some stocks in America are turning into a bubble. The bubble’s gonna come. Then it’s gonna collapse and you should be very worried.”
How big will this crash be?
Smith said “it’s going to be the biggest in my lifetime and I’m older than you. No, it’s going to be serious stuff. We’ve had financial problems in America — let’s use America — every four to seven years, since the beginning of the republic. Well, it’s been over eight since the last one. This is the longest or second longest in recorded history, so it’s coming. And the next time it comes — you know, in 2008, we had a problem because of debt and the debt now; that debt is nothing compared to what’s happening now.”
He predicts this crash could happen within the next two years.
Agreeing with this assessment, Smith, who manages a hedge fund firm with institutional and individual clients, presented a well-reasoned scenario, based on history and data, as something average investors should consider.
In a quarterly client newsletter, Smith said that investor psychology drives the creation and demise of market bubbles. But there is more.
The first problem is that the current market expansion has run its course from a historical perspective. Smith noted that the current economic expansion is about eight years long, while the average expansion has lasted 5.8 years, according to the nonpartisan National Bureau of Economic Research (NBER). Based on the NBER average business cycle length, this means the current expansion is 65% longer than the average expansion.
He also said that central banks play a significant role in bubbles and busts. “They certainly possess the tools and the intellect to smooth the business cycle if they wanted to, but the problem is that they are beholden to the political cycle, so like many investors, they also tend to be one step behind the curve, and they tend to perpetuate rather than smooth the business cycle.
Smith added that another problem is the Fed. “The central bankers running the Fed today were all appointed under the Obama administration. In my mind, they are at odds with Trump and the Republicans in Congress. It seems that the Fed is thus determined to continue hiking rates and pursuing other contractionary monetary policies despite stalling inflation and economic growth data. The possibility of tax cuts gives them the cover to do so.”
It is not a fluke we get asset bubbles bursting in that same first year and that the bursting of these bubbles either coincides with, or very soon leads, to a recession. This has been the case with the prior four Democratic to Republican presidential regime changes, Eisenhower (1953), Nixon (1969), Reagan (1981), Bush (2001).
So here is the end result of this convergence in policies and the investment cycle. “In the first year of a new Republican president after a Democratic regime change, the Fed tends to raise rates late in the business cycle. It is not a fluke that we get asset bubbles bursting in that same first year, and the bursting of these bubbles either coincides with or very soon leads to a recession.
“This has been the case with the prior four Democratic-Republican presidential regime changes: Eisenhower (1953), Nixon (1969), Reagan (1981), and Bush (2001). This is why investors need to consider past political, business, and Fed cycles in their forward-thinking analysis and apply it to today. This is why the stock market has much downside risk between now and year-end.”
As for investors, Smith suggested that investors should start looking forward rather than backward. This explains why investors chase short-term past performance instead of focusing on past three- and five-year performance to choose managers. But even this longer time frame is not enough, he said. “A full business cycle averages more like seven to nine years, so managers should be selected based on their ability to deliver solid risk-adjusted net performance over a full business cycle.
While Smith addressed his comments to investment consultants for institutional investors, his advice is also valid for individuals. “By focusing on too short of a time horizon, consultants tend to be risk magnets and poor investment timers. They tend to continually position their clients one step behind the business cycle. I think most consultants are thus value detractors. The way that they have their clients positioned today, heavily long equities, risky credit, and emerging markets that are exposed to the China bubble; I believe consultants are creating a pension crisis that will feature prominently in the next recession.”
