A Return to “Normalcy”
Lately, I’ve been watching the markets and pondering the economy’s next step. There are many debates going on right now about reflation, stagflation, hyper-inflation, deflation, as well as those debating the shape of the recovery, if there is one. While I contend that we are navigating uncharted waters here and any economic prognostications should be taken with a grain of salt, I am going to go out on a limb and say that we are going to experience a return to normalcy.
But what constitutes normalcy?
I hesitate to use a term such as “normalcy” when describing markets, because what is a normal market? Most people would equate that term with some idyllic bull market where everything goes up with very little volatility. But, as we have found over time, those are not normal markets by any means. Thus, by a return to normalcy I mean a return to the prevailing themes that were guiding the markets before they were interrupted by the credit crunch. Actions since may have exacerbated some of them, and slowed down others, but I contend that they will prevail:
1. Globalization: While many see a protectionism in our future, I haven’t seen anything that would signal that the globalization trade is off. What does this mean? A continuation of capital flows to emerging markets countries, new markets for US Global companies, and greater competition for US Labor. It seems that the market is betting on this. Over the past three months, the emerging markets index has outperformed the S&P 500 by 20% and it seems to me that we are picking up right where we left off, frontier markets. I’m not saying that is the trade to make, but rather that it was the trade before the crisis hit, and appears to be picking up again.
2. Commodities Bull Market – Before the crisis hit we were in the middle of enormous commodity bull market. Take a look at major commodities over the past month as well as oil and material stocks to see what the market thinks about this. Once again this theme may not HOLD UP, but it seems to be picking up again.
3. Infrastructure – Back in 2006 and 2007, the global infrastructure play was all the rage. This ties into both commodities and globalization and appears to be hot as ever. Look at the performance of MDR compared with the S&P to see what the market thinks about this. Throw in Obama’s stimulus and the theme even strengthens.
4. The Dollar – Before the crisis hit the dollar was getting trashed, well guess what, its starting to get trashed again. This had to do with competing currencies such as the Euro as well as rising deficit spending. This crisis hasn’t helped much, and while the rest of the world is flooding the markets with their currency as well, we’re going to be forced to devalue to the dollar if we want to destroy the debt and compete on the global stage. In addition, there were many companies that were booking large foreign exchange gains on their profits simply by doing business overseas. Since many companies are now global, this was bullish for the market as a whole and should be again as long as this theme holds. It ties in directly with the commodities bull market and globalization themes.
5. Inflation in things we need, Deflation in things we want – As technology continues to be the biggest deflationary force in history, industrialization in developing countries is increasing the demand, and price for things that we need, such as energy and food. If you are unsure about this theme see this and this.
There are many other themes that were going on before this all hit, and if you think of any please add them to the list. I do believe that the market seems to be leaning towards this return to normalcy. While these themes may not hold up in the longer term, in the short term, it may be helpful to think 2006-2007 when approaching the current market.