Trends Watch: November 29, 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 Dan Schwartz, Portfolio Manager, Montrock48 Capital.

What is your outlook for alternatives? 

It depends on how one defines alternatives.  It is pretty clear that central banks flooding the financial system with money and holding interest rates at historically low levels has been good for some classes of alternative investment vehicles and less so for others.  For example, keeping the cost of debt well below the cost of equity was clearly beneficial for private equity and venture capital.  At the same time, it hurt traditional hedge fund strategies that rely on alpha generation, notably long/short equity and my own space, discretionary global macro.

The monetary normalization process is well advanced in the United States, and is just kicking off in other major economies such as the Eurozone and Japan.  Over time, this should reverse some of the relative advantages some strategies have enjoyed this decade under the broader alternatives umbrella.  I can certainly say that the opportunity set in global macro right now is as attractive as I’ve seen it look since prior to the 2008-09 global recession.  The era of quantitative easing really dulled two of the things that create an edge in the space, by divorcing medium-term economic fundamentals from market performance and through the artificial suppression of market volatility.

What is your outlook for the economy?  

I remain pretty upbeat about the medium-term outlook for the economy.  I think that the market is conflating what can often be painful (but historically normal) bouts of volatility with some sort of signal about the end of the expansion.  While the labor market is a lagging indicator, it’s pretty clear that we are beyond the point of full employment in the United States and that wage growth is picking up.  Ample availability of jobs combined with rising paychecks should keep U.S. consumption running at or even above the pace we’ve experienced this year.

Second, while the market is transfixed by trade policy I think it’s not paying enough attention to the positive impact fiscal and regulatory policy are likely to have on growth in 2019.  The ramp-up in federal spending is going to be in full bloom for a few quarters to come, and spending at the state and local government levels tends to be highly procyclical.  Moreover, the relaxation of regulatory requirements in the financial sector should only increase the supply of credit available to the economy, which remains ample despite the 200+ basis points of interest rate hikes already enacted by the Fed.

Third, there has been comparatively less focus on this than there was say two years ago, but there are some signs that productivity growth is picking up after trudging along at a very soft rate throughout the current cycle.  The recent acceleration hardly looks explosive, but if sustained would allow the cycle to extend longer than the markets currently expect.

What keeps you up at night? 

Beyond the usual concerns one hears voiced frequently in markets about escalating trade tensions, the rise of populism, and the like, one of the bigger concerns for me is the likelihood that U.S.-China tensions spill over out of the realm of trade.  There are many forms this could take but even assuming that escalation stops short of full military confrontation, the experience is likely to be very unpleasant for financial markets.  For example, the United States pursued a number of actions this year with Taiwan that were viewed as extremely provocative by the Chinese government.  If there is a miscalculation on either side and the status quo is broken, it will be very hard to put the issues back in the box.

On a more medium-term basis, I am very concerned about the next economic downturn and the policy response to it.  There’s been much ink spilled about the wisdom of stimulating the economy at the top of the cycle, but I’m more concerned about what comes next.  As I mentioned above, I’m pretty upbeat about the outlook for next year, and possibly into 2020 as well, but when the next downturn comes, the government’s fiscal ammunition to counteract a recession is going to be seriously depleted.  At the same time, budget deficits are likely to be massive, on a par with what we saw at the depths of the last recession, even if the severity of the next downturn is nowhere close to that of 2009.   Coming out of a period where we’ve leaned extensively on the Fed for far too long, monetary policy is unlikely to be sufficient to counteract a recession on its own.  It’s not obvious today what pushes us into the next downturn, but the reality is it could be much more protracted than we’ve become accustomed to in past cycles.