Opportunities In The 'Front-Loaded' Recovery

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In an interview with CNBC Tuesday and an accompanying op-ed Wednesday, Richard Fisher, the Dallas Fed president from 2005 to 2015, told us not to blame China for recent stock market volatility. Rather, he said that the Fed had “front-loaded” a recovery following the financial crisis, pumping unprecedented levels of stimulus into the economy and essentially guaranteeing a “digestive period” down the line.

In his view, we’ve reached that period, and I agree. The spectacular market returns we saw from 2009 to last summer were not the result of an organic recovery in economic fundamentals. The demand that drove them was artificial, conjured up by the central bank that was created to do just that, when necessary.

And it was necessary. Without quantitative easing and dirt-cheap credit, the labor market would be in a sorry state, not to mention the stock market. In broad terms, super-accommodative policy worked, and now we have nearly full employment, robust demand—for services at least—and practically no inflation. But there’s a price to pay. We bought a recovery on credit.

Still I feel like Fisher is a bit pessimistic about this “payback period.” He referred to “very richly priced” valuations and Warren Buffett’s famous image of the tide going out—when you get to see who’s swimming naked. He spoke of his cautious Barclay’s colleagues’ cash positions. His references to “fallow returns” and “a lesser movement in stock prices” make it seem like he doesn’t have anything too catastrophic in mind, but all around he seemed rather gloomy.

Investors should look at the year ahead as an opportunity. The past few years weren’t a boom. The rally was driven by policy, not exuberance, so there’s little reason to expect an accompanying bust. Valuations are a bit high, but the market will probably correct sideways, becoming more reasonable over time, rather than plummeting back to reasonable levels.

We might see another flat year in the major indexes, maybe even a slightly negative one. But there’s no reason investors can’t earn a positive return, or at least set themselves up for higher returns down the line. Junk bonds look risky and government debt looks comatose, but there are non-callable preferred issues out there that can easily yield 5-6%. If you can stomach flat or negative returns for a year, there are companies whose management would sooner commit seppuku than cut dividends, and reinvesting those dividends can set you up for higher returns when markets stabilize.

Make no mistake, China could well experience a hard landing. Officials have gone on a debt binge so large that few can get a handle on its size. They’ve swept it into so many corners, twisted and converted it into so many forms, trying to make it disappear or at least look innocuous, that they may even have lost track of its magnitude. The “new normal” will be painful for a while, but the pain will be mostly domestic. Commodity exporters have already been feeling China’s slowdown for some time. They may even begin to recover soon (not the petrostates), as consolidation in mining and elsewhere smooths out excess capacity.

Outside of shale country, America doesn’t suffer from the commodity curse. China won’t do inordinate damage, barring a full-fledged political crisis. Drops in China’s stock markets—which are really just bigger versions of FanDuel—certainly won’t. So every time the Shenzhen index plunges, why not snap up a few of the high yielding large-caps that get dragged down with it, and let the heightened yields buy you shares for when the economy is done digesting?

Finally, it’s good to remind ourselves that something pretty crucial didn’t exist when the Fed-sponsored rally kicked off in 2009: the mobile economy, app economy, sharing economy, Plattform-Kapitalismus, or whatever term you prefer. Of course this development creates as it destroys, automates jobs away as it provides new ways for people to learn, work and earn cash from their assets. But I think in the long run we’ll see a net boost in demand and net benefits to the labor market.

We probably have yet to see much of the “boom” that mobile devices might spur. Sure the FANGs—Facebook Inc (FB), Inc (AMZN), Netflix Inc (NFLX) and Alphabet Inc (GOOGGOOGL)—have soared in 2015, and are collectively the only reason stocks logged a positive return at all. But the probably-overvalued unicorns have been locked away in private markets, and chip makers are floundering as though the logical extension of this mobile revolution—the so-called Internet of Things—will not boost demand for their wares in due time.

I’m not flogging the New Economy here. The next tech boom will be just that, a boom, followed by a bust. My point is only that it hasn’t run its course yet and may barely have begun. It might pick up in the next year or two, it might wait longer.

But the idea that the “front-loaded” recovery was an unsustainable rally and is now on the cusp of being dragged down by China, seems flawed. It was an artificially catalyzed rally, and we’re seeing the not-entirely-pretty rebalance that was always going to follow. But the atmosphere of dread is a rare opportunity for investors who are willing to load up on boring assets in the year ahead.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

David Floyd

David Floyd is an Atlanta native and a Kenyon alum living in Brooklyn. He writes about the intersections of investing, politics, energy and international relations. His work also appears at Investopedia.

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