Monthly Letter December 2016
The month of December incorporated much of what we at Madrague thought would be the theme and price action in 2017. A fierce rotation into financials and cyclicals and a very strong (to say the least) equity market coupled with strong USD and bond yields continuing higher. When we attended a sell-side fixed income strategy-dinner just after the US election, the unanimous call from all the attending rate-investors (we were the only equity attendees) was that the US 10yr bond yields would be at 2.3% in a year’s time. By sheer coincidence, it was trading at just that level when we sat down at the table. As the maverick equity guy, we predicted 3.5-4% by the end of 2017 with the simple argument; if we get 2-3% growth and 2-3% inflation where should the 10yr be? Well in all honesty it was not difficult to be the maverick in that room. Maybe there were too many Swedes there or maybe it is simply so much easier to be out of consensus when you’re treading slightly outside your own area of expertise. We might have the same problem with our thinking about the equity markets now.
Our base case 12 months ago was that we might have 2-3 years left in this economic and equity cycle. If that was correct we are now down to 1-2 years, getting close to a recessionary pullback. Long overdue one might say, but the recovery has been feeble and as we all know very much reliant on cheap money which has distorted asset prices. Undoubtedly, we have been made aware of the main reflationary arguments of the Trump policy (increased government spending, lower taxes, and less regulation) and we have been inundated with comparisons between Trump and Reagan. What a lot of those comparisons lack however, is the starting point; the US is at 105% gross debt now vs. 31% when Reagan took office, bond yield is at 2.4% vs. 12.6%, unemployment is at 4.8% vs. 7.5%, Schiller P/E for the S&P is at 28 times vs. 9 times. All these statistics don’t mean that we are in for a crash, but to really get the equity markets going from here we need earnings to surprise on the upside. This is not the most common of things in a world with consistently overoptimistic equity analysts. Madrague had a good month in December, +1.52%, bringing the year to date return to 15.27%. During the month we decreased our net exposure from 55% to 31% whereas our gross exposure was only slightly higher compared to the 197% at the start of the month.