“It appears many investment decisions are being made today on the basis of relative return, the unacceptability of the returns on cash and Treasurys, the belief that the overpriced market may have further to go, and FOMO.” – Howard Marks

This morning one of my analysts came into work and was reviewing one of our holdings in Japan.

After about 30 minutes of analysis he walks over to my desk and goes, “I want to sell the entire position in xxx.  The stock hit my target price, I want out…”

Another junior analyst overhears us chimes in emphatically, “What are you crazy?  Who would sell anything in this market?”

There was a few seconds of an uncomfortable pause before I finally rolled my eyes and told them to both go back to work.

Sadly they were both wrong.

This was classic fundamental vs. momentum investing gone haywire.

(In case you are wondering, the correct way to trade this, assuming the underlying fundamentals have not changed, is to start taking profit at and above the target price and let a portion ride with a trailing stop).  

As this late stage bull market melt-up continues, we are now merely 18 months away from what will be the longest period of US economic expansion in history.  The global economies have also joined the chorus, collectively all gaining steam in a synchronized manner and the longer this goes on the for more foolish my 2018 risk forecasts look!

Analysts across the street have all upped their growth assumptions while at the same time de-escalating the potential threats of rapid rate hikes due to inflation, recession and of course geopolitical conflict.

Valuations don’t mean a thing to investors right now and even the talking heads over at the World Economic Forum this week joined in on the peanut gallery preaching as well.  Most notably, Ray Dalio, founder of the largest hedge fund in the world Bridgewater Associates, chimed in saying:

“There is a lot of cash on the sidelines. … We’re going to be inundated with cash. If you’re holding cash, you’re going to feel pretty stupid.”

“…you’re going to feel pretty stupid.”  Source: CNBC

He also announced that the bond market is officially in a bear market now and a rise in yields could spark the biggest crisis in 40 years for bond investors.

Alright Ray, well if you put it that way, I guess we’re going “all in” on equities then!

By the way, if you haven’t read his book Principles yet, I highly recommend you doing so. No, I don’t have any affiliation with it, and yes when it first came out and he was promoting it I too was thinking “why the f is this guy promoting a book instead of managing his US$150 billion dollar fund??!”  

All that to say, having finally read the book I must say, it is really good. There’s a reason that he’s built such a track record and is now managing more money than any other hedge fund in the world.  

Asian investors seem to agree with Ray’s sentiment as well.  The Heng Seng Index has been on an absolute tear, up nearly 15% in just the first 18 days of trading which annoys active fund managers like myself who are being outpaced by the mom and pop investor who just “bought the index.”

Here’s a fun fact about Asian investors…we’re very superstitious and never fall prey to what is known is the West as the “Gambler’s fallacy.”

I’ll give you a real life example — at the roulette tables in Macau, if the wheel has come up 7 times in a row on red, Asians will always continue to bet on red so as not to break the streak (break the luck). Also, 8 is the luckiest number in Asia, so no one in their right minds would ever dare bet against that…

What does this mean for markets? In Asia, trading momentum works really well…and when stocks run, then really run.  (hence why you shouldn’t sell all at your target price)

Source: Bloomberg

The HSI and HSCEI (Heng Seng China Enterprises Index) still remain cheaper than global peers on a price to earnings basis which makes the case for investors to consider rotation into emerging markets.

Fund flow always chases short-term performance so if US markets look toppish with limited upside, Asia will inevitably be the next place that does well.

Dolla’, dolla’ bill, y’all

Up until 2016 the US dollar has been a dominant force in the markets enduring a solid eight year bull market run. Over the last 2 years we’ve seen some consolidation in the dollar which just so happens to be a powerful driver of emerging market equities looking forward.

Given the toppish valuations in US equities and the bear market that bonds have just begun (according to Dalio), it is pretty clear that there will be a flood of money moving away from the US and into emerging markets.

In the very same way that individual investors have been wrestling with whether to throw their PA portfolios into traditional investments or cryptocurrencies (which offer outsized returns) so do large institutional investors partake in the constant and comparative yield hunt. When US markets top or begin to correct, these large investors exit and look for better opportunities elsewhere.

A weaker dollar is also a boon to foreign companies who price their goods and services in dollars. The cost of goods and services sold for companies in emerging markets immediately get a reprieve when their dollar priced inputs become cheaper.

Wealth Transfers

Speaking of fund flows, I always chuckle when I read articles talking about how the rise of cryptocurrencies is “the single largest wealth transfer in the history of mankind”…as if that’s a good thing.  

I mean seriously, let’s take a look at exactly where this wealth is being transferred from.  One look at the Bitcoin distribution curve tells you that there are less than 1% of all addresses that own more than 87% of all the bitcoins mined so far. Those addresses belong to predominately two types of holders — 1) the super geek early adopters from nearly a decade ago, and 2) rich venture capital type investors or other prominent Silicon Valley types who could afford to spend a sizable amount of money on something that has zero fundamentals, as a “punt”.  

And with the extreme volatility that these coins have seen, particularly in the last year, its safe to say that the money flow has gone from the middle of the bell curve (average moms and pops who have no business trading crypto) back to the 2 groups of original holders.  In other words, the single largest wealth transfer in the history of mankind has gone from the innocent bystanders back to the WRONG PEOPLE.

How’s this for a wealth transfer?

Source: SCMP

Crypto shenanigans aside, I remain bullish on Asia and Emerging markets, and I’m not just saying that cause I live here…and happen to also be Asian.  

China, despite all the growing pains it has experienced, continues to make leaps and strides in the world stage. So whether you want to rotate now or let your US holdings ride a little longer, it would be prudent to start looking over on this side of the pond for places to squirrel away your cash for a rainy day.