Portfolio Review and Analysis

Portfolio Review and Analysis

By Julien B. Booth

August 7, 2015

Macroeconomic Physics – Reality Returns

Newton’s laws of motion are three physical laws that together lay the foundation for classical mechanics. They describe the relationship between a body and the forces acting upon it, and its motion in response to said forces. They have been expressed in several different ways over nearly three centuries and can be summarized as follows.

First law: When viewed in an internal reference frame, an object either remains at rest or continues to move at a constant velocity, unless acted upon by an external force

Second law: The vector sum of the external forces F on an object is equal to the mass m of that object multiplied by the acceleration vector a of the object: F = ma.

Third law: When one body exerts a force on a second body, the second body simultaneously exerts a force equal in magnitude and opposite in direction on the first body.

We spend a lot of time in the granularity of understanding credit quality and subsequent equity valuation of over 1,100 companies via our sister firm Sixty Guilders Research (www.sixtyguildersresearch.com). While incredibly important over the longer term, financial markets are now primarily driven by the economic forces of interest rates, currencies, global growth dynamics, and political policy. The interactions and outcomes of these forces are always in motion, pushing and pulling on one another as global players compete for growth. Growth is an absolute necessity to outrun the volume of debt created over the past 7 years. We remain skeptics that debt-funded growth is the long-term way to prosperity. Those 0% down, interest only mortgages did not even work out! Academics have concluded debt in excess of 100% of GDP reduces a countries growth. We concur, as debt loads tend to increase with the demographic changes in maturing countrieseconomies. For example, the bailout of Greece will raise their debt to GDP in excess of 350%; and many other European and eastern (CHINA) economies face similar structural issues. While it avoids short-term pain (exit of Euro), there is little probability Greece can perform on this debt-EVER. A fool by any other name remains a fool. Europeans can self delude with the best of them – perhaps they will extend Greek debt to 50 years with 0% coupon payment (actual proposal).

Update – the Chinese currency devaluation (being ironically decried as manipulation-humor*) is an explicit recognition that economic physics can only be defied temporarily. The world economy is slowing and the Chinese are officially recognizing the absolute necessity to support their export-dependent economy. The net effect is the export of deflation and crashing commodity prices.

NET-NET: Will the Federal Reserve raise rates into a chaotic Europe, Chinese devaluation, plunging commodity prices-surging US Dollar, and unstable global macro marketplace?

INTEREST RATES will be LOWER for longer. There is compelling opportunity in tax-free bonds, closed-end funds, REITS, some mortgages, and selected bond-like stocks/MLP (utilities)

As usual, thank you for investing with Forest Capital! For additional information on portfolio positioning, please contact Forest Capital directly at jbooth@forestcapital.net.