Key Themes

Investors,

   First, Obama and Merkel have tremendous incentive to keep the world from falling apart before their respective re-elections, so expect any bad news to be met with swift if vague promises of action (e.g.the hints we're currently getting out of Europe of a rate cap).  The Federal Reserve is 60%+ to launch a third round of quantitative easing before the November presidential election; if equities sell off sharply, this possibility becomes certainty, so equity downside is constrained for the next couple months, but then things get ugly.   


   The key themes of the next 3 years are:

- Austerity in the US.  After the November presidential election, the winner will have no choice but to implement austerity and will likely want to get it out of the way as soon as possible.  This austerity will decrease aggregate demand which will sharply lower corporate profit margins and therefore earnings ,and impose strong downward pressure on US equities.  

-Continued brinksmanship out of Europe that will most likely continue to unfold as it has been - a combination of monetization and effective default of periphery debt.  I don't know whether the monetization or deleveraging forces will have a greater impact.  There remains a significant risk of a disorderly breakup, but I think it is less than 30%. 

-Global stagnation.  Even without a severe drop in US demand, there simply isn't an engine for global growth over the next 3 years.  China will be working through excess capacity for the next few years, which means less demand for steel and concrete; this hurts a variety of commodity exporters, most notably Brazil.  This theme will seem to contradict the longer term theme of resource scarcity that I'm about to discuss, but as we've seen over the last 4 years, global demand for many commodities is continuing to grow even without real GDP growth.  Basically, commodities tied to infrastructure like steel, copper, iron, and concrete probably won't be strongly bid amidst weak global growth.

 - I can't call it a 3-year theme because of my general pessimism about global growth and my uncertainty of the timing, so I'll just call it a general theme - growing resource scarcity.  Jeremy Grantham of GMO has another nice write up on the long-term trend of rising agriculture and energy prices (you must sign up to read it, but it's free).  They predict that within a decade it will lead to widespread famine and social unrest, but timing is difficult.  For a long-term investor, the best approach is to gradually scale into long commodity exposure, saving plenty of ammunition in case we get a severe recession that provides very attractive prices.  


   As we head into the November elections and enjoy the recent moderate equity rally, I am growing more bearish.  I am now net short of equities and will continue to leg into a moderate position as we approach US and German elections.  I am long a few specific commodity-related equities including fertilizer producers, and crude and nat gas drillers.  I will soon be looking to expand my commodity investments to other arenas like pipeline and energy equipment manufacturers, and possibly agricultural research firms.  I still have my moderate short Yen and short US treasury positions and expect to hold both for up to a decade.  I will use selloffs in equity markets to establish long-term equity longs in china and other emerging markets.  While I still think European equities provide some value, I'd prefer to wait for a panic to entice me into that market.  I haven't yet found any specific European names that are obviously deep value investments.  

Cheers,

Ari