Trends Watch: November 15, 2018

EisnerAmper’s Trends Watch is a weekly entry to our Alternative Investments Intelligence blog, featuring the views and insights of executives from alternative investment firms. If you’re interested in being featured, please contact Elana Margulies-Snyderman.

This week, Elana talks with Louis Gargour, CIO, LNG Capital.

What is your outlook for alternatives?

Alternative funds will begin to outperform long-only funds in 2019. Alternative managers have the tools to be able to take advantage of disadvantageous and difficult market conditions which include falling or downward trending markets, potentially overstretched valuations, and market volatility. Furthermore, alternative funds can take advantage of idiosyncratic opportunities by shorting individual stocks and bonds. This is a key attribute making alternatives attractive going forward. Alternative managers can be short individual securities as well as the broader market for brief or extended periods of time in order to protect against downward trending markets and individual security downgrades and selloffs.  Therefore, if the markets become more volatile or begin to trade badly, alternative funds are set to outperform. If investors are concerned about market volatility and systemic or idiosyncratic selloffs across different asset classes, alternative investment managers in those asset classes are a very good way of protecting against the downside and taking advantage of prolonged market corrections.

What is your outlook for the economy?

We are mildly positive on an overall basis for the global economy. We are a strong, convicted positive for the U.S. economy, which is showing signs of accelerating growth and low unemployment, with only moderate inflation giving investors reasonable inflation-adjusted real rates of return. In Europe unemployment is being driven lower but remains stubbornly high in Spain, France and Italy (E.U. unemployment stands at 8%). The overall economic situation has improved and the European Central Bank (ECB) has kept rates low in order to continue to stimulate growth and make capital readily available to both consumers and businesses. We believe that the ECB needs to remain accommodative, far further than mid-2019 which is current ECB guidance as to when they will begin hiking rates. Emerging markets are showing signs of diminishing growth and are being negatively impacted by a strong dollar and higher levels of debt relative to GDP. We are deeply concerned about emerging market growth, specifically Latin America and Asia. In China, we are seeing the effects of U.S. tariffs on the equity market and on the currency, with both having corrected sharply this year. In Latin America, we are seeing the effects of a strong dollar across all local currencies and in Turkey we have also seen the effect of a stronger dollar affecting the country's ability to repay its large U.S.-dollar-denominated debt. Our current recommendation to clients on emerging markets is to remain underweight; however there will come a point at which all the bad news is priced in and they begin to become attractive.

What keeps you up at night?

U.S. equity market valuations are at all-time highs, with expectations of continued growth across all sectors but most pronounced in technology priced into current levels.  What keeps us up at night is the risk that a selloff in the U.S. equity market triggers a repricing of all asset classes including bonds, real estate, commodities, and emerging markets. Furthermore, a deeply fragmented U.S. government with Democrats and Republicans diametrically opposed on policy and a weakened U.S. president in terms of effective executive policy could diminish U.S. growth.

U.S.

• U.S. economy is at full steam.
• GDP growth at over 4% in Q2 forecast is 3.5% annualized.
• Investment continues to be boosted by tax cuts and regulatory reforms of fiscal spending.
• Equity market valuations at all-time highs; technology valuations (FANG) look fragile.
• Funding rates likely to increase dramatically both short and long-term.
• U.S. labour market tight but inflation is moderate for now…
• Expectations that moderate inflation will move much higher.
  • Wages have started to increase
  • Commodity prices are higher
  • Corporate profit margins squeezed by a stronger dollar
• Sectors affected include consumer cyclical, retail, automotive and potentially technology.

Global

• Trade tariffs creating exchange rate distortions.
• Biggest impact on China affecting GDP.
• Spill over could benefit export driven economy such as Germany.

Eurozone

• Eurozone inflation expectations remain muted.
• France 9.1% unemployment, Spain 16% unemployment, Italy 11% unemployment and Germany 5.5% unemployment.
• German growth 1.6%, France 2.0% and Spain 2.2%.
• Potentially government bonds come under pressure.
• ECB bond purchasing program over and distortion to investment grade will result in higher spreads over governments.
• Low potential of ECB hawkish action until mid-2019.
• ECB could become too hawkish too early therefore need stable dovish ECB… Downside risk remains.
• Italian budget disagreement weakens Euro in short term.

Global Negatives

• Rising levels of uncertainty.
• Strong dollar affecting emerging market currencies.
• U.S.-Chinese trade tensions to get worse.
• Concerted action by central banks a thing of the past.
• Currency wars a thing of the future.
• Fragmented, more nationalistic environment.