To: Our Clients
From: Peter Cavelti
Unstable World, Robust Markets
As you’ve no doubt heard, it’s ten years since Lehman Brothers collapsed and the financial world unraveled. I don’t want to rehash what happened then—suffice it to say that we entered the crisis with cash reserves that seemed alarmist, but helped us weather the storm and be able to stock up on quality equities after their precipitous drop.
Once again, we are extremely cautious, with cash positions between 40% and 50%. And once again, our posture appears exaggerated, at least when we listen to the messages produced by the presidential tweet machine and Wall Street’s hype factory. On the other hand, we notice that organizations like the IMF and the OECD see what we see: an overly debt-levered financial system that could crash at any time. Take a look at our charts on this page.
The first one shows you global debt growth by sector. Notice the alarming growth in corporate and government debt; the former has increased 62%, the latter 91%, in the past ten years! Financial sector debt and household debt look comparatively better, having grown about 10% and 30% respectively. But remember, here too, debt levels are at historical highs and above the thresholds that triggered the 2008 mess.
Now, consider the next chart, which traces economic growth less federal debt issuance in the United States. Clearly, the U.S. economy is so addicted to continuous massive debt infusions that, without them, it can no longer grow. The situation in Europe, Japan and elsewhere is virtually identical. This worries us sufficiently to err on the side of caution.
No one can predict when the debt party will end and the hangover will begin, but that doesn’t mean we can’t be among the people who leave early—especially in view of the 50%-plus portfolio appreciation we managed during the 2016/2017 period.
Having said that, I’m aware that aggressively trimming back our market positions has not served us well this year—at least not so far. Your assets, when adjusted for withdrawals and deposits, have appreciated 3.8% for the year to date, as opposed to gains in the 6% – 8% range for the most relevant U.S. equity indices.
Yet, moving toward year-end, we feel profoundly comfortable with our defensive portfolio composition. Given the number of political, social and economic uncertainties, it’s easy to imagine that cash could once again become a cherished asset class.
Please let us know if you have comments or questions.