Macroeconomic Insights

Ok, so I usually write about trends and concepts (VR, space, the cloud, etc.), but after some recent conversations on specific stocks, I decided to put together a list for readers. 2017 remains a complex year to invest when you consider current market valuations, monetary policy forecasts, geopolitical sensitivities and other headline data that the Street keeps losing sleep over. Smart companies move forward, though, and I continue to believe that if we make individual investments based on macro factors and timing (such as waiting to buy a certain stock because you think the market’s too expensive), history shows it would be an uphill battle…one might have missed out on buying Amazon because he/she was terrified of internet stocks during the 2000 dot-com bust, or you could have thrown Apple out with the bathwater during the 2008 financial crisis. Neither trade would have captured the epic returns that followed. With that said, below are some of the stocks I own or plan to add to this year. The factors behind them include a time horizon of 5+ years, the total addressable market sizes, their specific products, business models and current demographic trends. I’ve skipped elaborating on the technical details around cash flow assumptions and ‘where the stock will be trading next year’, and instead, am focused more on why I like the company and its proposition. Most are in the growth space. Some are well covered on the Street, but that doesn’t make them worn-out investments, and I’ve elaborated on my personal reasoning. DigitalGlobe (DGI) and Mobileye (MBLY), two of my previous listers, aren’t mentioned as they are getting acquired. Splunk (SPLK), Nvidia (NVDA), Whole Foods (WFM), Starbucks (SBUX), Lululemon Athletica (LULU) and some microcaps are among those I also really like, but I’m still evaluating their long run prospects. I’ll publish another list in Q4 – perhaps some of them will make the cut!

The order isn’t relevant. Feel free to reach out at [email protected] if you have questions or thoughts. Here we go:

 Editas Medicine (EDIT): Let’s begin with one of the most fascinating subjects in the science world – gene editing. Cambridge-based Editas Medicine (EDIT) is relatively new on the public scene, having IPO’ed in early 2016. With $6 million in revenues, it is still microscopic in nature (note the pun). Why do I like it? Because gene editing is extraordinary…the branch of genetic engineering where you literally insert, delete or replace DNA in living organisms has incredible frontiers: eradicating mosquito-borne illnesses by altering DNA structures (it’s what Bill Gates is upto these days), removing genetic disorders in humans, curing cancer by changing immune cells so they can target tumors, to name a few potential uses…the increasing spending by research institutions and drug makers makes the few firms specializing in gene editing very interesting from an investment perspective; EDIT is one of them. The company won a major patent battle in early ’17 for the rights to patents on the CRISPR/Cas9 genome-editing tool (note that this will be appealed, so some risk remains)…the stock shot up by nearly 30% on the announcement, given the obvious runway for growth. It also announced a deal with Allergan worth $90 million by providing licenses to a number of its programs, including those for a rare blindness disease. I believe numerous such relationships are likely ahead; per consensus estimates, we are looking at a $5+ billion market for gene editing by 2020, and reaching $8 billion by 2025, compared to less than $3 billion today. EDIT is a way for investors to follow the advances in this science. It’s high risk…but hey, high rewards don’t come any other way.

 HDFC Bank (HDB): While international investors would consider an emerging market bank investment niche territory, HDFC Bank is a powerhouse in Indian retail finance; it trades in the US as ADRs, with a $60 billion market cap. I like the company because you’re looking at a base consumer group of 1.2 billion Indians, with nearly 40% of adults not having bank accounts yet; the average age is 27, and nominal GDP per capita is 20% of that of China’s. Note that the economy is growing at 7%, and is largely driven by services (including banking). As a result, it’s a solid structural growth story – and development can’t happen without – you guessed it – more banking access. Until the mid-90s, state banks ruled the roost; since liberalization, private players including ICICI, Yes Bank, Axis and HDFC Bank have rapidly grown – what was a 78% deposit market share in 2014 by public sector banks is down to 74% over just the past two years. HDFC Bank stands out because I think of it as a retail pureplay…with $80 billion in deposits, the bank is churning out loans at a growth rate of 27% YoY (vs the industry average of 12%). If you’re worried about their quality, note that non-performing assets are at an amazingly low 0.3% vs the public sector’s ~17% troubled assets ratio. Alongside, HDFC Bank is India’s market leader in credit card issuance, is diversified across the socioeconomic base (55% of its branches are in semi-urban and rural areas), and has been able to grow earnings at over 25% over the past five years; in fact, net margins are over 20% as well. Importantly, the Indian government decided to demonetize (pivot the economy towards cashless transactions) in late 2016, and with the public cloud-based biometric identification system (Aadhaar) now having registered over 99% of Indian adults, banks – especially those that are technologically advanced – stand to benefit from tremendous tailwinds as people enter the banking world and formal economy. HDFC is one of them. Try making the case on why not to invest with a 5+ year horizon…I can’t find any reasons!

 iRobot (IRBT): Over to consumption…as The Economist stated so well, Walmart taught us the value of money, but Amazon has taught us the value of time. iRobot is perfectly positioned in the discretionary spending space to give consumers time back by removing what many (including myself) view as unproductive tasks, including vacuuming, wet mopping and lawn mowing. The company drove the robotic vacuum segment’s development; 15 years on, it remains dominant with a 60%+ market share globally, and over 90% in the United States. The $1.1 billion segment is projected to grow at a CAGR of over 15% in the next five years; alongside, lawn mowing is a $25 billion potential market, while wet mopping is $4 billion in size. iRobot has an incredibly powerful patent portfolio, a cash stash of over $250 million (aka ~40% of revenues) and has been able to double sales over the past five years – all while shutting down its Defense and Security unit to pivot towards consumers, which grew sales by 35% last year in the United States. Importantly, while growing quickly, the company’s gross margins have expanded from 41% to nearly 50%. iRobot has negligible debt obligations, is heavily spending on R&D and is ramping up its distribution network in Asia by buying its Japanese distributor this year. With less than 8% of US households penetrated, amid the oncoming IoT and connected devices wave, the company is really positioning itself as a keeper for the smarthome with tie-ups with Amazon’s Alexa, smartphone apps, vision mapping and more. What other home product can you think of that can gather data AND move around on its own at the same time – all while hosting a cat on top? I’m expecting growth rates of over 20% in the next five years, and a stock double in the next 2-3 years shouldn’t be a surprise to investors that like cleaning up.

 Illumina (ILMN): We covered gene editing. Looking for something else that’s extraordinary? Gene sequencing is extraordinary. It involves figuring out the order of nucleotides that make up your DNA – among the numerous amazing applications, we can find inherited disorders and create personalized treatments based on the unique patterns of each patient. Illumina, its 20-year old San Diego-based pioneer, is the leader in providing products and services that analyze gene variations; with over $2.5 billion in sales last year, it was ranked the 3^rd smartest company in the world by MIT Technology Review in 2016. Estimates show the gene sequencing market is poised to grow over 15% annually to approximately $20 billion by 2020; Illumina has transformed it by driving the costs of sequencing a human genome down from millions in the 1990s to about $300,000 ten years ago, and $1,000 as of last year; it’s aiming for $100 bucks. Think about the research possibilities being unlocked….while customers currently involve mainly research institutions, easier and affordable access would push it towards clinical uses. A $2.8 trillion healthcare industry in the US alone awaits, and each segment within it would find value in gene sequencing applications. Illumina’s own new subsidiary, Grail, is aiming to use blood tests to look for DNA fragments released by cancer cells. I’m incredibly optimistic on this. If you ever doubted the magic of markets, such public companies reinforce it…you give capital to smart ideas, and watch them run. Illumina has doubled sales over the past four years, while improving gross margins from 67% to 68.5%; net margins are over 30%. I’m all in on declaring this company as amazing for the long run – not just for the stock, but also for society.

 Tesla (TSLA): Yes, it doesn’t make money. Yes, it’s burning through cash. Yes, it will raise more capital. And yes, if think about last year’s sales, Tesla has a market capitalization of $625,000 per car sold in 2016 vs $5,000 for General Motors – so you could interpret that as each Tesla car is 125x more valuable than a GM car. Insane, right?

But hey, this is Tesla we’re talking about. Combine structural tailwinds for clean energy and sustainability (government can’t change this), a demographic loyalty towards the brand and Elon Musk that’s unparalleled, the potential to reach millions of people in the way Ford revolutionized car access, and being totally off the grid if you think about solar panels charging homes, storing energy in Powerwalls and charging cars with scale efficiencies…one can imagine why this company is being treated as being revolutionary. Then, consider that the global clean energy market is around $1.4 trillion in size…massive, yes, but renewable sources power less than 15% of US energy consumption and electricity generation. That’s where I see Tesla coming in. 88 million cars were sold last year worldwide; barely 500k of those were electric cars. Tesla’s demand surpasses supply bigtime, and that’s where I see Tesla capturing share with new manufacturing possibilities. Alongside, the energy storage market in the US is barely worth $2 billion today; it grew 250% last year. Tesla could completely alter this space, and drive the market to well over $50 billion in electrochemical storage. So, Tesla’s growth potential, in my opinion, is incredibly large. And even if you focus just on cars, say, if it does reach its goal of 1 million cars produced in 2020 (or whenever), assuming an average price of $35k per Model 3, you’re still looking at revenues around $35 billion – just from car sales. Tesla’s valuation doesn’t seem as outlandish if you look at it from a 10-year horizon. The stock seems wild, but I’m calling shotgun for this ride. Just note that as an investor, you’ll definitely need a seatbelt to enjoy the returns.

Twitter (TWTR): What does Katy Perry, Barack Obama, Donald Trump, and nearly the entire journalism industry have in common? You got that right – they all love Twitter: the omnipresent, unrivaled, most as-real-time-as-possible mode of communication out there. And yet, the brilliant idea has been unable to monetize the addiction of its daily active users; revenue growth was a meager 14% in 2016, after a 91% CAGR over the previous three years. Why do I like it? Because some day, rather than going for Facebook-style world dominance, management will realize that quality matters over quantity; you could have 100 million users and those could be the most active, lucrative and loyal users in the whole world – way better than having 1 billion mediocre ones. And that’s where I think we may be finally headed: monthly active users flatlined around 319 million in Q3 and Q4 of 2016, but daily active users increased by 7% and 11% respectively in that same span. That’s a very important sign…it means more people are engaged, and I have faith that the leadership at Twitter knows it. Advertisements, subscriptions, premium content and direct messaging possibilities all await. At an $11 billion market cap today, compared to $400 billion for Facebook and $580 billion for Google, it’s worth peanuts; how can you ignore it? A pivot in the business model would help it multiply several times in value. I’m optimistic on the prospects. Worst case, it could get bought out by one of the giants, and you’d still get a solid premium as an investor.

 Under Armor (UA): Under Armor’s down 50% down over the past 12 months. What?? This is a nightmare – but you could consider it a dream come true if you like bargains. The company’s growth rate in 2016 was 22%, compared to Nike’s 6% and Adidas’s 14%. Despite that, it’s trading at 1.8x sales, compared to Adidas’s 1.9x and Nike’s 2.9x, per WSJ data. Don’t get me wrong – I like and own all three companies. But UA’s the new kid on the block, and after delivering nearly two dozen quarters of 20%+ growth, one lower guidance does not spell gloom and doom. Yes, Kevin Plank’s commentary on Trump also hurt the stock, but these are temporary blips. Footwear, athleisure wear, home wear, niche sports, and an international market where people literally don’t know the brand are all markets to be tapped – per Barron’s data, a nearly $300 billion sportswear industry exists today; I’m expecting growth rates of nearly 10% as consumption increases in developing countries, and the focus on health continues to grow. International revenues accounted for barely 16% at Under Armour, versus nearly 50% at Nike and over 70% at Adidas. Alongside, Under Armour has always positioned itself as a technology company, with the purchases of MapMyFitness, Endomondo, and MyFitnessPal for nearly $1 billion; it already sells sensor-driven clothing and smart shoes. If you missed the boat since UA’s IPO, or simply want to add to your long term stash, the past year has created an amazing stock deal. Note that if you had invested in Nike during its IPO in 1980, you would be up nearly 720x your initial investment. Yeah. Even if Under Armour achieves anywhere close to such success, investors should consider it a slam dunk for the long run.

 Chipotle (CMG): Yes, the jokes were deserved…along with stomachs, investors’ appetites have gotten crushed – the stock’s down 40% since its high in late 2015. That being said, just as with so many peers over the years, I believe the illness issues and corresponding empty lines are temporary in nature…the great food taste, a simple less-than-60-ingredients portfolio, an enduring focus on sustainability, and its phenomenal pre-crisis era revenue rate of $250/square foot – nearly 70% higher than the fast casual industry median number – gives me hope that the fundamental business model and proposition remains intact. Comparable sales got hammered in 2016 due to the food safety crisis, but they’ve rebounded by over 15% in December and January this year; the stock’s up 20% YTD, and at barely $4 billion in sales, I still consider this to be early days for the company. ‘Clearly we live in a post-Chipotle world’, is what Panera Bread’s CEO said recently. I couldn’t disagree more. Check out the lines at stores…it’s very visible that they’re increasing in length – albeit slowly. I get the impatience, but customer loyalty takes time to regain – numerous other foods brands have been through this, and have pulled through fine. This burrito is ready to be eaten. Bite into the fundamentals – I’m quite sure your appetite for returns will get satisfied soon.

 Facebook (FB): Because this company is so, so constantly discussed by the media, I’m going to skip on why the usual metrics around 1.6 billion monthly active users, 30% net margins and 50%+ revenue growth rates matter. Are these incredible financials why I like the stock? No. Do I think advertising will remain their main source of revenues in the long run? Likely not. Do I believe the newsfeed will exist in five years? It won’t matter. The reason I’m into Facebook is because I believe in the company’s ten year roadmap, in which it aims to focus on artificial intelligence, connectivity and virtual/augmented reality. Facebook has shown an incredible ability to spot new trends before they go mainstream – by either defining them organically, or just through visionary M&A activity…WhatsApp, Instagram, Messenger, (ongoing) chatbot integration and Oculus are what I consider success stories. Therefore, I believe the total markets for this company are seemingly endless; so might be future cash flows. You can debate founder-driven company behavior and disproportionate voting rights all you want. In this case, I’m glad Mark Z’s at the helm to steer the ship towards prosperous lands without any short-term traders biting at his heels.

Shake Shack (SHAK): Want a good, fast casual, millennial-friendly burger? Over the past five years, Shake Shack has gone from 14 shacks to over 110; revenues have grown from $39 million to around $260 million. Why do I like it? Because the product tastes good, the fast casual space is going to keep expanding, and the reason investors have sold off is due to seeing single digit comp sales, rather than fundamental business model problems, given pure restaurant operating margins are well over 25%, the company is profitable, and revenue generation per store is well above industry averages, at over $2 million, putting it in the top 10 lists of quick service and fast casual restaurants…aka each shack is amazing at churning out cash. Why am I not worried about comp sales? Because this is still the first innings; literally half of their stores barely existed over the past two years. I don’t believe we can get a good measure on such a small base…not to mention spreading the word of mouth, creating brand loyalty and encouraging recurring customers, especially in international locations, will take time. This is a company where I would invest, eat a burger and chill out for a few years.

Netflix (NFLX): Netflix has changed our daily routines with the same force that Amazon has revolutionized retail spending. Human behavior will never be the same – you want what you want when you want it – and nor will the cable, television and movie industry. With over 90 million subscribers and 25%+ growth rates, just imagine the insane amount of data Netflix has on what time we watched what shows, at what points you got bored and paused, or what you watched back to back…personalized television, welcome home! With all of this information, the power of production is enormous; Netflix is spending over $6 billion in original programming this year – blowing away every media peer except ESPN. If you’re worried about revenues, note that average monthly fees went up 12% last year, but subscribers rose 25%, showing how much pricing power it has. At just $60 billion in market cap, a total television disrupter through internet streaming and media consumption will get highly rewarded over time. Just wait until it gets into live sports, incorporates some advertising or offers premium content. Binge watching Stranger Things is far more entertaining than seeing the stock rocket up or down on every earnings report – but years from now, it’s likely we will see a very happy end with this investment story.

Salesforce (CRM): Salesforce pioneered the cloud revolution – which I argue is the most important technological creation of the past 20 years (explained why in my post here). The cloud industry has a 20%+ growth rate, is driving nearly $1 trillion in IT spending over the next five years, and is well placed to be the continuing foundation for asset-light, idea-intensive, scale-on-demand business models. Salesforce leads the way here, with its expertise in delivering personalized customer relationship management services and data analytics solutions to clients. Granted, the software-as-a-service and overall cloud industry is prone to disruption and quick pivots, and Salesforce will soon face more competition from Oracle (ORCL) and specialized upstarts. However, I’m willing to fight any Wall Street apprehension on it. Why? Because I believe in Marc Benioff’s leadership. His vision falls in the same league as the Musks and Bezos of the world, and his social activist-driven nature (vocal stances on equal pay for women, low-income housing initiatives, etc.) is extremely attractive for the millenials and Gen-Z’s of the world that tend to yawn at old-school corporate conduct. On the business side, the incorporation of AI into its products, aka Salesforce Einstein, is an incredibly cool concept and the ease of access for all businesses will continue to make it the ultimate software services provider out there, ubiquitous for any customer that wants to work in the space. The company has driven revenues up by ~30% annually over the past four years, and has tripled free cash flows over the past three; with record earnings per share in the past quarter and just $8.4 billion in sales, I believe the foundations are fully in place for a future blue chip stock.

Amazon (AMZN): The title of gamechanger doesn’t do it justice. The company has totally changed how humans spend money, value time and access products and services. Just like Facebook, due to the overwhelming coverage, I’m not going to speak about its growth statistics…in essence, my reason for liking this company is simple: the moat that it has created for being the go-to place to buy anything and everything remains just outrageously out of reach for other retailers; as it continues to spread its wings into logistics, TV and film production, groceries, cloud infrastructure, and whatever else (think space, education, artificial intelligence, etc.), the data it collects through Prime will pave the way for personalized solutions, recurring customers and eventually substantial profits. At only $400 billion in market capitalization, this remains early days; I’m on board with the crowd of bulls that believe this could break through the $1+ trillion ceiling in the coming years.

Alphabet (GOOG): Here’s a growth stock at $580 billion in market capitalization. The company remains the dominant digital advertising platform, with a 40% market share; growing at ~20% on a revenue base of $90 billion is not easy, but that’s just how Google works. Let it be noted, though, that I am not in this company for its search prowess, which I think is very susceptible to Amazon and other companies (including itself) that could figure out a way to bypass a search platform using artificial intelligence to link directly to users. In other words, it sounds weird, but the entire concept of ‘searching’ for something is one I believe might get outdated soon. Rather, I am more interested in their other bets, as well as the Android operating system (which powers over 80% of smartphones worldwide), and YouTube, which could become the channel of choice for younger viewers. And last but equally importantly, $86 billion in cash is a huge stash that can be deployed in far-reaching R&D, keeping the smartest minds on deck, and for M&A activity (think London-based DeepMind, specializing in AI). Alphabet has given enough reasons for Wall Street to be happy; don’t be surprised if more come through soon.

Fanuc (FANUY): Tight labor markets due to aging global demographics (the world is losing ~1 million workers each year for the next two decades), faster go-to-market speeds to cater to instant-gratification-driven millennials, and an emphasis on costs in a slow growth environment: bring in the robots for ~30% more productivity and ~25% cheaper labor costs (BCG data). The robotics industry today is barely $40 billion in size and is projected to double in five years; combining automation and peripherals, we’re looking at nearly $150 billion in industrial spending. Robots are long term capex buys, and quality matters. IFR data reveals the disproportionate usage today: in South Korea, there were 5.3 robots per 100 workers last year; in the US, just 1.7 robots, and in China, just .5. Each industrial nation will automate with time; the runway for growth is tremendous, and that’s where Fanuc comes in: it has had a presence in the US since 1965 (per Barron’s data), predominantly in the auto industry, and has a dominant 50%+ market share; in China, it’s over 10%. Last year, it was literally unable to keep up with demand, which led to business hiccups – but I’m not concerned, as the growth story remains intact. Note that Fanuc is not an infinity-stock story…you’ll need to keep an eye on it as competition continues to creep up – especially from Silicon Valley by combining AI, big data and automation (check out the eerie videos from Boston Dynamics). However, I do believe there is room for everyone – you have Kuka (KUKAY), which I own as well, and Yaskawa Electric (YASKY) in the field too, but Fanuc’s entrenched nature gives me faith regarding double digit stock returns for the coming five years.

Orbital ATK (OA): This is a Dulles-based aerospace and defense company with roughly equal revenues generated from flight systems, defense, and space services and components. Space remains one of my favorite sectors – and Orbital ATK is one of the few contenders for launch equipment, satellite services and propulsion systems, along with SpaceX and Aerojet Rocketdyne (AJRD). Long-winded contracts with tech companies and an approximately $14 billion order backlog shows long-term stability and low volatility; alongside, Trump-era military spending boosts should provide defense revenue growth. At only 15x forward earnings, a revenue of $4.6 billion and $5.9 billion in market cap, I don’t think investors are giving it enough credit after the merger integration that brought together Orbital and Alliant Techsystems over the past two years to form OA, especially given the positioning it now has in the aerospace industry. Other industry players trade higher; Lockheed Martin (LMT) trades at 21x forward earnings, Boeing (BA) at 20x, and Aerojet Rocketdyne (AJRD) at 23x. As space spending gains altitude (personally, I’m looking at 10%+ industry CAGRs), Orbital ATK should get a proportional piece of the pie and trade closer to 20x forward earnings, implying a stock increase of around 30%.

 ABB (ABB): Here’s a global conglomerate with $33 billion in sales, but only ~$50 billion in market capitalization. It’s in prime position to provide software and automation solutions to the rapidly growing robotics space, as described above with Fanuc (FANUY). ABB’s pivot is occurring – nearly half of its sales come from automation, per WSJ data, but investors seem to focus more on the slow utilities division, which comprises the other revenue stream. Consequently, I find substantial undervaluation when you think long term. Check out 2016’s annual report…ABB has gone to great lengths to show the focus on robotics and its positioning for the fourth industrial revolution; in effect, the company’s priorities are in the right place. It has a price/sales ratio of ~1.5; similar companies in the robotics and automation space (Rockwell Automation, etc.) show well above 2x. In my opinion, given their product applications, we’re looking at capital appreciation potential in the range of 20%+, along with a 3% dividend to wait as the company aims for industrial capex share gains worldwide.

 ExxonMobil (XOM): My reasoning for this gigantic company is pretty straightforward…it has excellent revenue diversification (upstream, downstream and chemical exposure) to make money in pretty much all oil price conditions, it has exposure to shale as well as conventional gas sources worldwide, it shows incredibly strong leverage ratios in its sector (it might not be AAA anymore, but hey, we can live with it), and it was the only oil major to show positive cash flow in the Great Oil Collapse of 2016 (I’ve made that name up). In fact, it even raised its dividend! Walmart’s entire business model (and consequent #1 Fortune 500 rank) is facing an Amazonian threat; ExxonMobil, on the other hand, has very little competition except with itself. Consider buying it you’re thinking about portfolio cruise control.

 Apple (AAPL): Hey, what’s not to like? Nearly every product it has created has been either revolutionary or way beyond peers in quality. And sure, while the iPhone has driven its success story, note that smartphone penetration worldwide is still around ~30%; countries like India have substantial potential to grow. Apple’s share within the smartphone world is nearly 20%, and the company captures an incredible 85%+ of total profits in the category. Company-wide net margins have consistently been over 20% – more in line with software firms rather than hardware firms – and services still account for just 10% of revenues, with bankable double digit growth ahead and a phenomenally sticky ecosystem. On top of that, it provides a dividend of 2%, trades at barely 15x forward earnings, has nearly $250 billion in cash on its balance sheet and carries one of the smartest workforces on the planet. Hard to argue against all this in one package deal. Bite into the story, people…you’ll enjoy the taste of sweet returns.

And there we have it. There’s no such thing as easy money on Wall Street, but hey – patience pays dividends without any costs. I believe the companies above are well positioned to deliver in the long run to investors that have faith and are willing to give them time. I’ll add more ideas in future posts, and publish another list in Q4. Until then, happy investing!

Buying clothes – or anything we humans wear – is pretty much a routine activity. The factors driving the decisions in purchases, though, have undoubtedly changed since the caveman era – will-this-clothing-protect-me-from-the-elements-while-hunting-for-food is hardly a question you ask yourself while scanning for value at H&M or Gap. Rather, the branding, the look, the feel, the color – the ‘social’ aspect, if you will, is what moves us. Hey, Maslow’s hierarchy foundation…you won. With the basic needs conquered, the focus on higher planes, aka psychological feel-good stuff, is sky high in today’s world of Instagram and constant connectivity.

Could the same technology, however, bring us back to our roots? What if our clothes and accessories actually ended up being the key ingredient to a longer, healthier life? In my opinion, the apparel of the next generation may actually have that ace up its sleeve – and possibly the ability to enhance life expectancy on a scale that hasn’t occurred since, perhaps, the discovery of antibiotics and infection management over the past century. We’re not talking about just finer cotton: data collection that could be driven through accessories and clothing could be a serious elixir for an extended, happier life. Humor me as I lay this out…

To begin, let’s talk wearables. The who? Smart watches. Fitness trackers. Cameras. Augmented reality devices. Here’s an industry that came to the spotlight barely a few years ago, on the principles of increasing internet connectivity, computing advances and an emphasis on health. It stands at roughly $8 billion in size for the first two items today, with a monthly user base of nearly 40 million Americans; projections show such devices providing nearly $25 billion in sales worldwide by 2020, with over 200 million wearables sold annually, per estimates. That’s substantial growth – but will these numbers and devices necessarily deliver to the grand vision above? Projections over the recent past haven’t exactly flattered: eMarketer had estimated over 60 million people would be wearing wearables by this year; 12 million Apple watches were sold in 2015 vs forecasts that were five times higher. Return rates have touched 30%, and data shows most buyers literally forget they own Fitbits within days of purchases.

But does this signal a need to taper down projections ahead? Absolute not, in my opinion. My optimism here comes from the potential industry expansion to include products that aren’t being talked about today – products that could be ‘converted’ into wearables, if you will, unlike fitness trackers and smartwatches, which started out as them. What am I talking about? Rings. Contact lenses. Other jewelry. Wallets. Scarves. Clothing. Socks. Shoes. If outfitted with sensors and connected through the Internet of Things, just imagine the data you could derive on your health. Correlate heart beats with the number of steps; get blood pressure through your wedding ring, relate weather conditions with perspiration and t shirts that can reflect sunlight based on your needs. Transmit all of that information to the cloud, and an absolute goldmine of data just waits to be discovered – for millions, or rather, billions of people…you could eat better, think better, sleep better, exercise better…we can go a step further and combine this with gene sequencing, and follow that up with gene editing…and therefore, create the link between hereditary conditions and your current state to diagnose symptoms and treat issues early. Smartwatches were revolutionary in terms of location-based information, data access and social expression (among so many other things). Moving forward, if you think about it, your apparel could do all of this for you. Imagine a Magic Leap augmented reality screen projecting information on your palm. Or the ability to pull up information on your contact lenses (glasses will suffice, I suppose). An ability for your ring to vibrate when it realizes you are dehydrated; and sensors indicating the need to slow down if you are stressed based on your blood pressure.

Furthermore, the potential to relay thoughts with a mix of emotions in a way similar to TARS in Interstellar, or R2D2 in Star Wars would be the next frontier; those involve physical dimensions, but deep learning based on years of data could possibly provide answers to questions such as ‘what would mom say if I did this?’ even if she wasn’t around, through a computer. Last week, Elon Musk’s Neuralink started discussing neural interface technologies, through which one could actually connect the brain with a computer, uploading and downloading thoughts. It’s hard to argue against this: the wave of wearables, and consequent computer-human interaction, is just beginning, and society stands to gain massively due to the colossal amount of data that could be derived from this sector. Of course, cans of worms around ethics and divisions in society are bound to crop up, but we’ll worry about that later. Either way, progress will prevail.

To invest in wearables, the ballgame isn’t all that difficult to find companies at first sight. The tricky part, however, is to dissect consumer habits and split hardware from software. Fitbit (FIT) is a leader in sales in the segment, but even with growth projections of over 15% for ‘17, the inability to remain top of mind (aka forgetting your trackers in the drawer) and shrinking margins has contributed to the stock getting crushed. Apple (AAPL) brings its smartwatches and services – but even yet, shipments fell 72% in Q3’16 YoY, and the stock is mainly reflective of the iPhone’s success, more than anything else. Garmin (GRMN) has held its own in the industry, through product differentiation in high end watches and focus on specific sports; the stock is up 10% over the past six months. Another classifiable wearable, GoPro (GPRO), has dramatically crashed, but one could imagine the usage of its cameras and images in other wearable applications, potentially providing new revenue streams.

In other words, this is a new sector, and while companies and investors find their bearings, note that things aren’t that bad in the near term. While 2018 growth rates are around 20% for ’17 (not too high considering the low base), millennials had a penetration rate of over 30% in ‘16, compared to the 18% for the entire population. This segment has a massive purchasing power, and a far greater obsession on health than older peers. Consequently, it is likely they will continue spending and upgrading to the latest gadgets with time, as R&D in wearables breaks new frontiers. From a connectivity and chips perspective, it’s a slightly calmer field; the usual players include Intel (INTC), Broadcom (AVGO), and Qualcomm (QCOM) through NXPI. Invensense (INVN) makes motion sensors, and forecasts are calling for a 20%+ EPS growth over the next 5 years; STMicroelectronics (STM) provide strong exposure through sensors, gyroscopes, and digital compasses. Neither of these are slam dunks – but hey, the total addressable market makes them worth thinking about when you’re hunting for your next high risk, high reward venture.

The worry with such hardware remains commoditization; Goldman research shows technology hardware prices for products have a tendency of falling 5-10% annually in the long run. Therefore, firms with data and software bring a slight premium; Under Armor (UA), a long-time favorite of mine (and substantial underperformer in the past year for so many reasons), remains alluring mainly for its focus on software – its purchases including MapMyFitness, Endomondo, and MyFitnessPal for nearly $1 billion were a clear signal regarding its connected health vision – the company already sells sensor-driven clothing and smart shoes. Look at it 10 years from now, and I’m betting there will be good returns, similar to Nike (NKE). China’s fitness tracker market now rivals the US’s size, with nearly 20 million trackers sold in ’16, including Xiaomi’s Mi band. So, the potential is gobal, spans software and hardware, and everyone’s looking for a piece of what should be an increasingly large pie. What’s noteworthy is that this is an industry where capex is absolutely not the rate limiting factor…rather, R&D drives the path ahead, and progress should be exponential in nature. I’m skeptical on models that project the growth rates of wearables or connected tech in 10 years, because they are likely to massively underestimate the value creation through byproducts (including around health, productivity, communication and physical activity). Real estimates for wearable solutions will be in trillions, not billions – similar to the entire Internet of Things wave. That’s why the TAM is massive, and we’re just getting started.

What it means for you: It’s critical to note that big data analysis, cloud usage and the Internet of Things are not mere trends. These are massive, disruptive, structural changes impacting the world on all frontiers. On this very platform arises the wearables and connected technology industry: a small one today, but one that could be life-altering as we know it a few years from now. Watch this get proven in the markets through the power of science, technology and the genius of the human mind in the coming years. Hey, health is wealth, right? Investors, take note: this is a question for which the consensus is a resounding yes – and they’re absolutely correct.

With week 1 of the Trump Era under our belts, the Dow has plowed through 20,000 and the NASDAQ has already delivered 5% YTD. Let’s get this straight: amid border adjustment tax talk, cash repatriation possibilities, trade tariff implementations and Twitter-wars, all sorts of issues could have highly, highly material impacts on earnings – positive or negative – for the S&P 500.

Wall Street, it seems, isn’t too worried about the negatives.

Sure, we get it. Consumer confidence, small business optimism, home price rebounds, affordable gas prices, and pretty lucrative earnings projections among other factors definitely warrant some optimism. But don’t they get balanced out with expensive valuations, tightening monetary conditions, and protectionist agendas – including trade wars with neighbors?

No good answer here. You’ll need to be a political expert if you want to win by trading stocks in 2017 – a year likely to be remembered as the time Washington took over Wall Street and left everyone exhausted.

Anyway, life goes on for the long-term investor. This month, the focus here at EconomicStreets is on the cloud – an apolitical, non-geographically bound concept that has revolutionized the world – whether you realized it or not – and is barely in its infancy in terms of application. Here are my thoughts on how the cloud is taking society to some amazing frontiers, and why investors should pay close attention.

To begin, let’s clarify the concept. References to the cloud are all over the place. What is it? In essence, cloud computing involves the use of centralized servers for the storage of data, which can then be accessed any time, any place, and over the internet instead of through your personal hardware. Therefore, the cloud is the foundation of business models that rely on on-demand access to these centralized computing resources, which provide servers, storage, applications, networks and analytics – and are managed by parties other than the client; as a result, the client can go back to pursuing his or her ideas without having to worry about all of the capex, scalability concerns and other issues that prior-generation entrepreneurs likely faced. So, it’s pretty amazing and incredibly revolutionary – and the concept, as a whole, can basically be likened to the internet. Several entities, including the Department of Defense and CERN (the European Organization for Nuclear Research) get credited for pioneering the internet; the cloud, meanwhile, has its roots with Salesforce, Compaq, Amazon and other corporations. That’s some serious value-addition by for-profit enterprises.

Before we get into that, let’s talk market sizes to understand the relevancy. Estimates vary; the cloud has essentially been around since the late 90s, and took off over the years as the asset-light, idea-intensive tech revolution gathered steam – along with the reach of cloud solutions providers such as Amazon Web Services, which made it amazingly accessible to everyone. Gartner predicts a +17% growth rate to $208 billion for public cloud services this year, and with all signs pointing towards continuing growth, estimates show that nearly $1 trillion in IT spending will be directly or indirectly affected by companies shifting to the cloud during the next five years. Firms including Cisco (CSCO), IBM (IBM), Microsoft (MSFT), Oracle (ORCL) and IT services and providers – think Infosys (INFY), Wipro (WIT), and others – have all had to rapidly change their business models to cater to this new age: one where companies don’t own, but instead rent hardware, and prefer outsourcing IT needs to specialized cloud firms rather than just becoming all-encompassing companies with back-end hassles and mediocre outputs. There were several decriers of the concept as it grew, including Larry Ellison and Apple’s co-founder, Steve Wozniak; the worries included the potential for mass-crashes and lucrative hacks given companies would now trust third parties with their data. It hasn’t panned out: data breaches continue to hit the news, but the cloud hasn’t had anything to do with most of them. From a consumer’s perspective, life online, in fact, has gotten pretty great. Ever lost your iPhone? Rest assured that your photos aren’t going anywhere…because they’ve already been backed up on the cloud. Collaborated on Google Docs? That’s the cloud at work. Watched Netflix? The company is renting out Amazon’s cloud products and services. How about checking out your customer analytics or using internal company chatter? You’re likely going through Salesforce’s cloud platform. A guy named Drew Houston forgot his USB drive during a trip from Boston to New York back in 2007, and came up with an idea for storing files online. Thus, Dropbox was born – and it’s worth nearly $10 billion bucks today. AirBnB co-founder Nathan Blecharczyk hosted the site on Amazon Web Services during its inception in 2008 – providing a massive cost saving, as noted in Businessweek, which would help the company get off the ground. India’s Aadhaar project, a tech initiative to provide electronic IDs to the entire population, is a cloud-based system which has now registered 99% of its citizens and is actively being used to open first-time bank accounts. Enough said: the cloud has been the backbone of all sorts of amazing progress and ideas – barely a decade and a half in.

Importantly, Wall Street is paying attention. Microsoft’s Azure (its cloud computing service) showed a 93% growth rate last quarter, and received more press coverage than any other segment when it reported results last week. Amazon’s (AMZN) profitability has been nearly completely driven by Amazon Web Services, and it has a solid 30%+ market share in the field; patient investors have multiplied their money many times over since it launched. Cisco (CSCO) and Citrix (CTXS) have been dominating the communications-as-a-service concept, with a highly watched change of their business models to adapt to the new industry. In other words, all – absolutely all – of the larger players have pivoted to the cloud, and smaller, specialized ones including VMWare (VMW), Workday (WDAY), Salesforce (CRM) and others have carved out solid niches. Some of the firms aren’t profitable yet, but investors have faith in the potential; the BVP Cloud Index encompasses a strong list, and has returned over 180% since Jan’11, over double the returns of the S&P 500.

What it means for you: Today, we’re looking at a world where there is hardly any internet-based activity that isn’t using the cloud in one way or the other. Scaling your business on demand, collaborating on ground-breaking research with scientists worldwide, enhancing political transparency through electronic records – all of this random, amazing stuff and more can be done through this platform. So if anyone says the future is dark, think again – because looking up to the cloud, things are looking extremely bright. We’re only getting started with the applications of this computing frontier. Technology has paid amazing dividends to society over the decades, and investors should take note: by embracing the cloud, Wall Street, along with the world, will gain handsomely in the years to come.

It’s a bird! It’s a plane! No, it’s the Dow Jones Industrial Average!

And Donald Trump!

2016 is ending with those two icons totally dominating financial media. Why wouldn’t they? Wall Street loves hope, and Trump’s bringing a whole lot of it with potential reforms. That works for the Dow, and the timing is quite good…the year-end season is adding to the good spirit, and with the post-election rally, the closeness to 20k is providing a solid round number that everyone can discuss over holiday dinners.

Most projections for major political events were totally off this year – note Brexit and the US election – and so were the worries that a Trump win would catalyze a Wall Street apocalypse. Since November 9^th, the major indexes are up over 5%, with the Dow up nearly 9%. The general optimism goes way beyond the Hudson and East Rivers; consumer confidence indexes, manufacturing surveys, employment numbers and so much other data indicate America is in pretty strong shape.

But wait, it’s not like we woke up last month – and were like viola – it’s a strong economy! The progression’s been happening over several months. So, is the (massive) post-election rally providing incremental gains based on Trump’s new cabinet and reform ideas? Or have investors simply pulled gains from 2017 into 2016?

To attempt to answer this, let’s first look back into 2016. Wall Street consensus estimates were looking for mid-to-high single digit gains (similar to pretty much every other year) for the market. This time, they were quite right – the S&P 500 is returning nearly 10.5% YTD.

I, personally, wasn’t as optimistic. Earnings would grow and inflation would rise, but I felt a P/E multiple contraction would lead to muted gains, if any, for investors due to tighter financial conditions as the year went on. That didn’t happen. We started 2016 at around 14x forward earnings; today, we’re sitting at 17x (FactSet data). Is it warranted? Some of it, maybe: through the year, oil has stabilized, domestic wages started growing quicker, and earnings growth went back to positive in Q3; a much-hyped rate hike didn’t scare off investors either, indicating confidence in the economy. On top of that, equities have absolutely been the place to invest if you wanted some yield; the S&P 500’s 2% dividend yield was higher than that of the 10-year Treasury for a majority of the year.

Ok, so those are some facts that favored market gains. Now, on to the gloomier side – the role that speculation (at least, that’s what I call it) played in the expansion. If you blinked, you might have missed it – since Nov 8^th, the banking sector has been resurrected, literally from the ashes; Goldman Sachs and others are up over 30% in a single month…much of it based on potential deregulation once Trump comes in office.

30%? In a month? For a Dow component, based on possible policy changes? Ok…enter, uneasiness. Small caps, meanwhile, are up over 20% in the same span; a big part of it has to do with corporate tax reforms, which could add between 5% to 25% to their earnings, per estimates. To find the exact figure, we might need about…another year. Again, possible policy changes – but why wait and see if you can buy now? That’s how the market is thinking, at least.

Moving along…infrastructure spending could spur construction and engineering firms. Roads? Airports? Rail? Time horizons? Unclear. A worst case scenario could use the example of Boston’s Big Dig – delivered 8 years behind schedule and nearly 4x over budget. So, expenditures that will happen over many years – with unsure returns. A 9% Dow rally in a month – to 14% YTD – strikes me as a bit premature. And if that’s not enough, nearly 40% of S&P 500 revenues originate overseas. If trade agreements are renegotiated, ripped up or kept, who gets hurt? Who wins? We don’t know! It’s too early!

My bottomline: It’s great to be optimistic – I definitely am, and also with this new administration. But I believe the optimism is heavily based on speculation – and that’s not good. It’s why this recent run up has me worried about next year. Were things so bad up until November that investors just needed some out – including a political outsider who would definitely bring change, but with no market expert having the credentials to predict to what extent? And once the results came in, why did investors pile in to equities as if there was no later train leaving the station? Let’s not fool ourselves – the past decade’s bull market has hardly been a euphoric one, but it has returned nearly 280% since the ’09 bottom. Greed isn’t ever good for your returns. Stocks are expensive, and I still believe the P/E contraction is overdue; therefore, 2017, to me, holds very little hope for the broad indexes to begin with. I say ‘to begin with’, because we’re looking at a total wild card – a sort of binary approach where there may be major policy revamps, or just minor ones – and that clarity will only come as Trump settles in to the White House. 2017’s market will be heavily fiscal-policy and regulatory-driven. Of course, amid the waves up and down as investors trade on Washington news, the smart ones can definitely look for bargains, because there might just be a whole lot of babies being thrown out with the bathwater on Wall Street next year.

Anyway, enough year-on-year talk. In the long run, this will all be noise. Let’s talk multi-year trends – ones that have proven over history to lead to both progress for the world and prosperity for investors.

For 2016, the key themes were highlighted in the year’s outlook; demographic behaviors (environmental awareness, social impact, valuing time, etc.), the rise of artificial intelligence and fintech, an emphasis on autonomous driving, and a drive towards automation all panned out as expected; each has provided 20%+ growth markets in numerous subsectors, including robotics, sensors, and machine learning, etc. Other ideas yet to enter mainstream markets include blockchain-driven platforms, alternative energies (for example, hydrogen power), and chatbots (atleast, not yet in the US).

For the trends above, numerous stocks uniquely indicated them with outperformances – including iRobot (IRBT), Teradyne (TER), Facebook (FB) and Amazon (AMZN). A key tell, however, was Nvidia (NVDA), up a whopping 205% in ’16 after 60% in ’15. Here’s a company that has positioned itself for multiple major trends that Wall Street likes – including VR, autonomous driving, and artificial intelligence. Investors rewarded it well, and even after its massive run, Fortune is highlighting it as a top stock for 2017.

Key stock disappointments included Twitter (TWTR), Under Armour (UA), Nike (NKE), and Starbucks (SBUX). All have unique, differentiated products in growing markets with high brand equity. Consider Twitter. Twitter handles accompany names wherever they are displayed, be it on television or on billboards; it’s also the preferred mode of communication for the incoming president, as well as real time journalism and media. Under Armour and Nike pulled back from expensive valuations; Starbucks had slowing same-store sales growth and macro worries. Patience is a virtue here; each of these companies should be able to bounce back in the long run after temporary rough patches. We’ll talk more on these and others in the coming posts.

And then, for 2017, some final thoughts on trends to watch for:

Look for science to lead the way: I believe that in 2017, VCs, growth investors and the media will focus less on revenues and profits (yes, this may sound ridiculous), and more on breakthrough technologies which may be several years out from, if even, delivering a product. What am I talking about? Firms focused on curing cancer, backed with strong science. Firms revolutionizing transportation, such as Hyperloop One, which is talking with governments for trial tracks as early as next year. VR and AR firms such as Magic Leap, which, per Forbes, could entirely disrupt the $1 trillion consumer electronics industry by beaming a screen right on our retinas instead of mounting the television on your wall. Or ultra-fast air travel via firms such as Boom Supersonic, which is aiming to reduce travel time by 60% across continents. The bottomline? Firms which are focusing on far-flung frontiers will attract smart minds given today’s generational mentality of making an impact. Wall Street’s attention will follow.

Look for people to understand their health better. We all love food, but which food suits us better than other foods? Probiotics and liquid nutrition might gain prominence. And, with augmented reality and smart appliances, the availability of continuous streams of vital data – say, heart rates, oxygen levels and blood pressure – will help provide direction to healthcare workers and ourselves on staying healthy.

Look for geopolitically insensitive companies to prosper. Social media has no boundaries; nor does the concept of sharing, being ‘live’, or utilizing idle assets. Companies that can satisfy certain social and daily tasks that don’t change across countries – say, buying food, commuting, or communicating, for example, will continue to get highlighted as the value of time and quality of life takes priority. Alongside, artificial intelligence will keep ramping up. Alphabet (GOOG) bought Deepmind in 2014, per The Economist, to keep researchers away from competitors. IBM (IBM) bought The Weather Channel. And the CEO of Palantir, a $20 billion big data analysis firm that barely anyone outside the industry knows about, was part of the tech summit with Donald Trump this month. There’s no stopping these trends. More data, more intelligence, and a better life for all is the objective, and it’ll keep gathering pace.

What it means for you: 2017’s going to be a strange year. Washington will probably dominate all headlines. Policy changes will keep investors on edge, and make them run for the exits and entrances en masse. And we’re coming off of a long, long, bull market into a tighter rate environment, a stronger dollar, higher inflation and an elevated risk of overseas turmoil (think emerging market debt concerns, currency issues, etc.). Consensus estimates from Wall Street are looking for approximately 5% in returns. Things might change drastically, though, based on the new administration’s behavior; Q1 will be a great indicator.  Keep the vision, keep the faith, and know that companies that have a meaningful mission and great products will always prevail in the long run. We’ll highlight these as the year begins. Wall Street is well known to reward the brave, and investors should remember that in 2017.

By: Neel Kulkarni    Post Date: November 6th, 2016

Investors, rejoice! A long, scarring campaign season is about to end, and the next US president is imminent. The media will be freed from the shackles of covering politics on a minute-to-minute basis, and a divided nation can go back to finding common ground. Wall Street will be downing some martinis in relief as well – simply because of better clarity on what’s ahead, regardless of who wins: a combination of a tight race and Fed rates over the past month has caused the S&P 500 to lose nearly all of its 2016 gains.

What should investors expect? The general consensus is that a Trump win will catalyze a short, Brexit-like downward shock. In the longer run, infrastructure, defense-oriented and domestic firms would do relatively better. With Hillary, there’s a continuing-as-status-quo feel to the deal – the gains may be capped in the short run, as the focus will shift to more mature subjects such as rate hikes in the face of inflation and tighter labor markets.

In any case, the world moves on. Does a 4-year presidency matter in the face of structural, behavioral trends and demographic changes? In theory, yes – given the power it has to influence them. But are you really going to stop ordering clothes online, binge-watching Netflix, eating quinoa and watching your carbon footprint based on who’s in office? Unlikely. In the long run, rest assured that the fertile ideas-to-capital meeting grounds will continue to make the world a better place by facilitating innovation and wealth generation, regardless of who’s in office. Invest, and rejoice – in general. Not because the election season’s over, but because there’s tons to look forward to.

Through 2016, we’ve elaborated on virtual reality, robotics, space, and healthcare in detail. Today, we’re taking some time to talk about time.

Aha! What was that, you ask?

Time is money. Let’s begin. The concept of spending time productively has driven decision-making for decades – for people and firms alike. However, how does one value time? Scientifically speaking, you could think of it as the opportunity cost of doing something else in that same span. A minute’s cost in traffic could be time away from family, or maybe from a sales deal for work. It’s also relative. The last time you walked from your airport gate to baggage claim, did you feel like you wasted time? Would you have felt far more restless if you had spent the exact same time simply standing at baggage claim, assuming the distance from the gate was shorter? Likely, yes, per a study quoted in Businessweek. Therefore, the perception of value addition matters too.

How does this matter for investors? I believe the emphasis on personal productivity – in other words, using technology to eliminate non-value-adding activities – will be a key driver of the next phase of the internet revolution, through the intersection of artificial intelligence, automation and the Internet of Things. The opportunity cost of time, therefore, will shoot up tremendously. Each minute, in today’s Amazon era, has greater value than before, and companies that help give time back to us stand to gain Wall Street’s attention.

Why? Consider the demographics. The instant gratification mindset of millennials and Generation Z kids is a well-known characteristic; Netflix, Amazon, and messaging apps have all catered to this need – and practically molded it. In doing so, however, routines that classify as ‘unproductive’, such as being stuck in traffic or in a check out line, become all the more taxing due to the opportunity costs involved. That’s where certain firms that tackle the time quotient stand to gain. Think about Starbucks (SBUX). Buying on its app (1 in 5 customers use it) provides valuable minutes back; order on the way, and just pick up it without any counter time. Instacart delivers groceries from local stores so you don’t have to get them. Take it to the next level: Amazon’s (AMZN) Alexa is essentially a virtual assistant that you can quickly mention your shopping list to – no need to even go on the Amazon app to order anymore. Last year, per the WSJ, the company actually filed a patent for ‘anticipatory shipping’ – a way to ship products before customers even think of buying them! Other examples? iRobot (IRBT) has Roombas that vacuum, so you don’t have to; the stock is up nearly 60% over the past year, likely because robots-as-assistants are now on trend – again, for convenience and time. Mobile payment methods shave valuable seconds away from plastic card transactions – which at times take nearly half a minute. Journalism’s no different: Buzzfeed and Wired’s articles are shorter, more opinionated and targeted towards specific audiences; theSkimm, meanwhile, is a fascinating service that delivers key, critical insights in a spunky way to millennials on the go; it has over 4 million subscribers, per Businessweek, since starting in 2012. Ever thought about the hyperloop? The idea proposed by Elon Musk is a fascinating technological frontier, but to practically everyone, what drives the excitement is that travel time may be cut by over 70% between distant destinations.

My point? Convenience is important, but time is critical – and the opportunity cost will, as a result, heavily drive value. The Economist stated it perfectly: Walmart (WMT) taught us the value of money…Amazon (AMZN) has taught us the value of time.

For readers that are nerds, what intrigues me is how this will factor into equity prices. Traditional discounted cash flow models for valuing stocks focus on free cash flows, risks, and growth rates; comparables, meanwhile, are based on earnings, etc. Will opportunity costs start incorporating themselves into cash flows? If Priceline (PCLN) is able to understand your travel ideas – general costs, dates and preferences, it could just book for you when it sees a deal that’s perfect. Can the hours it saved you get quantified into cash flows as well – so you can actually incorporate time into models? It’s worth thinking about.

Will we go back? It’s unlikely. Data supports our behavior: Gallup polls indicate that employed American adults worked approximately 47 hours per week last year, which was 1.5 hours more than a decade ago; we’re also taking far fewer vacation days than international peers. Add to this the substantial debt burden that millennials face, and doing more with less becomes critical. Our average attention span is now 8 seconds, compared to 12 seconds in 2000, per data from Microsoft and Time – mainly due to smartphone usage; the study elaborates that while multi-screeners have a harder time removing irrelevant information, we have absolutely become better multi-taskers. Again, time is money.

On a broader note, such circumstances have also initiated the on-demand economy: with a size of nearly $57 billion, per Harvard Business Review data, it has become a mainstay in today’s asset-light world. Why buy a car if you can just Uber it? Why not sell off your unneeded assets for some extra cash on Etsy? And why not explore more by staying in unused rooms via AirBnb? Per a fascinating study by Cristobal Young, highlighted in the New York Times, free time is essentially a network good – something that derives value from being widely shared. That’s where Instagram, Facebook (FB), Twitter (TWTR), and other social media come into the picture. Add all of these factors together – a connected, time-deprived and technologically enabled generation that loves customization and instant gratification: firms that save us time will do well. The ones above are just a few of them; with artificial intelligence just ramping up, this wave is only beginning.

What it means for you: The holiday season’s on deck. American consumption is a massive driver of the world economy; given healthy personal saving rates, unemployment levels near post-recession lows, stable oil prices and good consumer confidence, we should be in for a solid Q4. Dark clouds, however, remain. After the election, rate decisions, China debt concerns and European bank problems will all rear their heads. Patience is a virtue, and now’s the time to channel it. In the long run, great companies will always prevail – as will those who stick by them. Watch for companies that make great products and provide time back in the process. The value of time will keep increasing, both at home and on Wall Street. Investors should take note.

By: Neel Kulkarni    October 8th, 2016

Q3 ended, and we got 6% from the S&P 500. Not bad, right? If you’d gone into hibernation in mid-January  while your fellow bear brethren were wreaking havoc on Wall Street, you would have basically woken up last week to find that:

• OPEC hadn’t decided on an output cut
• The Fed hadn’t raised rates
• Britain hadn’t exited yet
• Earnings were still negative
• There was no US presidential favorite
• The financial system hadn’t collapsed

So on paper, it doesn’t seem like anything really changed for equities to run up so much. 6% is a high number…are investors really that confident in near-future cash flows? There are reasons to think this may be short lived. Equity prices have been heavily driven by multiple expansion rather than earnings growth. Fiscal policies from the strangest US election ever show full signs of loading up on debt, no matter who wins. Rate expectations are building, and quick moves in bond yields will hurt; a 25 basis point change on a 4% base wouldn’t matter much, but today, that base itself is 25 basis points. Factor in dicey European bank balance sheets and pressure on the same sectors that have been bid up for their dividends; investors should hope those airpods are good at cancelling noise – we’re going to need some help in separating it from longer-term fundamentals as the year ends.

In any case – this is as good a time as ever to think long term. So many interesting things are going on regarding human progress in a global, connected marketplace; the last 30 years have shown higher life expectancy, information access, poverty reduction, more financing capability, greater gender equality, and numerous other positive trends. Technology and open markets have heavily driven them, and in hindsight, it isn’t all that difficult to comprehend. The world is changing rapidly, and it’s likely the rate of change will only increase given tech continues to embed more and more in our daily lives; we may want to reconsider it not being a standalone sector…in a few years, every company out there could be classified in a part as a tech firm, if you think about it.

The last two articles here focused on technology trends in healthcare, and the potential for the space economy. This post covers manufacturing – a subject I believe to be highly underappreciated on the current disruption party scene – it isn’t as glamorous as VR, AI, driverless cars, the cloud, space, or big data – but that’s partly why everyone is speaking about them, and not the humble factories that churn out the goods we love. After all, each of the trends above are based on physical entities: a car, a server, a headset, and a machine, for example. The kicker? You’ve got to make them! Here are my thoughts on why investors might want to start thinking about manufacturing in the next wave of change:

First, the context. Manufacturing consists of the production of goods. So, while one might instinctively zoom in on the industrials, note that over 70% of the S&P 500 firms are actually manufacturers, given they actually make products. As of a couple of years ago, manufacturing comprised over 16% of global GDP and employed over 15% of the developed world’s population, with a higher percentage in the emerging and frontier world – including informal employment. Exports, R&D, trade deficits and regional economic epicenters are all highly related to it – the same factory that employs people also creates the need for laundry, food, housing, transportation and pretty much everything else that mayors could dream about in the area. So, it’s a pretty large and influential playing ground. Industrial growth, including manufacturing, was always a mainstay on the path to development for countries: you start by reaping natural resources through agriculture or mining (and battle off colonial rulers, if applicable), then move into industrialization, and then – after years of labor – reach the holy grail of services. Over the decades, steam, electricity, automobiles and other catalysts helped trudge the world along; the 1990s ushered in the era of low cost manufacturing as nations opened borders: China rose with low wages, and today, numerous countries including Bangladesh and Vietnam are banking on the same kick start. India has made it a mission as well – use low cost labor and locally educated workforces to attract capex and stimulate growth. The phenomenon is hardly only in emerging regions; Trump, Brexit, and German ADR supporters have made it pretty clear that the whole idea of such jobs moving abroad is a no-go.

I believe, however, that the concept of manufacturing as a whole may be totally overhauled in the next decade. What if you just don’t need people? What if the need for faster speed to market is too high for the current setup? What if you don’t need numerous assembly lines?

What if you just don’t need factories at all?

Bear with me here:

Imagine a regular production floor. Some assembly areas, a few workers per line, churning out products at a less-than-100% output rate; the downtime goes to machine breakdowns and changeovers for different product specs; a 24×5 setup, which goes into day 6 – overtime – in case there’s additional demand. Is this methodology fit for the future?

First, let’s consider demographics. Millennials and Generation Z folks are known for needing customization; mass market products just don’t cut it if you want to express yourself. In that case, does a low cost factory have any edge? Fixed/variable costs considered, churning out the same piece en masse might be warranted – that’s what the era of Walmart ushered in – but that concept doesn’t apply anymore. One also has to consider instant gratification – an equal necessity to today’s consumers. As The Economist put it, Walmart taught people the value of money; Amazon, however, taught people the value of time. An hour is the new going rate for deliveries; 2 days is the norm. Waiting 1 week for a new jacket? Ridiculous!

In that case, combine instant gratification and customization: how does a supply chain ranging multiple continents deliver? The answer: it just can’t, and that’s why the current model is inadequate for this world. We’re going to need local factories that are more nimble and on-demand, are able to double-up as R&D centers, and can generate with more efficiency and less waste; sustainability and carbon footprints, after all, are other characteristics people will watch for. Adidas, highlighted in Bloomberg BusinessWeek, is a study on how things might get done: it introduced a new product recently called Futurecraft, knitted by robots in a new German factory to reach buyers right away; a second factory is opening in Atlanta next year to run limited quantities of shoes, to be close to the key American market. In-store robots might be next, with the ability to assemble shirts for a perfect fit. The strategy’s got game – and the stock price has shown it, having doubled over the past year. You can bet that every consumer firm out there is watching and thinking similarly. In other words, time is money, and to cater to today’s needs, overseas manufacturing might just be too far away.

Costs, though….Adidas can pull it off given its size, but doesn’t cheap labor justify going overseas for margin-constrained firms?

Sure, but headlines often ignore productivity: when factoring that in, China’s low wages are barely 4% lesser than the US, per Oxford Economics. Enter the next generation competitors – Thailand, Vietnam, Bangladesh, etc. As more service jobs open, the pay is at least 10-20% higher than manufacturing jobs in emerging regions, per NBER data. Service jobs are arriving: there will be more McDonalds, more banks, and more airlines. Why wouldn’t people switch into them over manufacturing? To prove the point, per a recent BCG study, factory jobs are shrinking pretty much everywhere worldwide as a share of total employment – service jobs, meanwhile, are increasing. Goods producing firms that choose to stay with the status quo manufacturing ideology will be faced with union issues, higher wage concerns, speed-to-market worries, and random stuff including massive container ship companies that seemingly go bankrupt while millions of dollars’ worth of goods are on board in the middle of the Atlantic (the case of Hanjin). Last year’s Los Angeles port disruption was another wake-up call. So, it’s fair to say that most CEOs out there are rethinking their global supply chain: wages have risen, productivity hasn’t kept up, and there’s too much uncertainty in logistics when time is precious.

Enter automation. This is the answer to the issues above, and in my opinion, companies will enable much higher capex to it moving ahead.

Keep the factory – but can’t the same line just adjust itself to make a shoe of size 10 after a size 8 rather than 2 hours of manual changeover routines? Do you need multiple lines for multiple products; can’t the same line just make them all? Can’t sensors detect malfunctions right before they occur, and a 3-D printer on-site create the replacement part? And if not, can’t the cloud beam down historical data on equipment maintenance times to the original manufacturer, to ship over replacement parts before things go downhill? If a Tesla can get software upgrades while the owner is sleeping, why can’t manufacturing lines? And if all of this needs to be done, doesn’t manufacturing also fit well in the developed world, where IP can be protected, skilled labor is at hand and your test market is easily accessible for new products? I believe yes, and therefore, we’re in for a structural change. Investment will be necessary, and Wall Street’s attention is slowly coming around to this.

Now, the shift is definitely happening – both geographically and technologically. However, given the tectonic size of manufacturing, the entire move is barely in its infancy. The current industrial robotics market, for example, is around $40 billion, per some estimates; that’s less than what Apple makes in a quarter. While projections currently have it doubling in the next 5 years, I find a 15% growth rate is highly underestimating the potential: a 10-year approach might show massively exponential growth here. Why? Consider the sheer size: the S&P 500 engages in approximately $600 billion in capex annually; remove, say, 30% of it as the energy sector plays an outsize role, and we’re still rolling in $400 billion of spends. In a world where growth rates are projected to be 1-2% lower than the pre-recession era – assume, say, 4% globally, firms will be laser focused on market share growth, more cost-saving and productivity boosts. Again, this points to supply chain overhauls, given the vast potential. The BCG estimates that automation will cut labor costs by as much as 30%, while boosting productivity by nearly 35% in developed regions. Wall Street emphasizes a focus on R&D costs, debt levels, and free cash flow for obvious reasons; costs of goods sold, however, sometimes fly below the radar, as does productivity, or revenue generation per employee. The advent of AI – to be specific, machine learning, alongside data analytics and the cloud is perfectly placed for the next wave to involve a manufacturing transformation: make it quicker and more efficiently. How can this occur? With robots, sensors, and peripheral systems that can utilize all the data generated before…if a manufacturing trial has done well in one region, does another continent really need to repeat it? In precision-based industries, can’t sensors just figure out defects on the line, rather than during finished product testing? The answers are fairly straightforward, and cost-reduction will drive the change towards automation.

So, where are we today? The International Federation of Robotics tracks robot shipments, and as of 2014, they were up 29% YoY to 229,000 – the base being 60,000, back in 2009. Again, these are incredibly low numbers given we’re looking at multi-trillion dollar markets. What’s interesting is that while Asia showed the most growth, 70% of the robot sales went to 5 nations – China, Japan, the United States, Korea and Germany. Leaving aside China, which has very distinctly started to enter advanced manufacturing, almost all of the others are developed markets…consequently, one could presume that as the trend continues, industrial robotics investment could catalyze the shift in manufacturing back to developed regions. The IFR is calling it Industry 4.0, linking real-life factories with virtual realities, and human-robot collaboration leading the way. Should emerging markets be reconsidering their thrust? Absolutely…to compete, the regions will need a higher skilled workforce, a domestic consumption appetite, and an emphasis on intellectual property rights. In either case, technology’s impact on manufacturing will be tremendous – and global in nature.

Robots, of course, form just a segment of industrial automation – you have sensors, physical equipment and the systems industry all alongside. For those, the estimates range wildly – IDC estimates the total market to be nearly $150 billion in 5 years, but again, any watcher should not be hung up on a linear growth pattern. In 1980, McKinsey had predicted there would be 900,000 cell phone users in 2000; that lowballed it by about 99%. The key is that it’s not just the existing firms that might convert – you also have to imagine that small companies, or service oriented ones, could start manufacturing their own goods rather than buying them from other firms. Thinking further, it could be as basic as using 3-D printing or a different form of automation to create a shelf in your own home. Wouldn’t you want a butler-robot roaming around? iRobot’s Roomba was a hit, and so has been Amazon’s Alexa. What’s to stop a more advanced physical version? Expect manufacturing to evolve with AI, data, speed-to-market needs and demographic trends all combining at the same time.

Enough of that. Who’s involved? The giants provide a solid start here. ABB (ABB), Siemens (SIEGY) and Rockwell Automation (ROK) have all made their intentions clear in the automation space; on the smaller side, you have companies including Teradyne (TER) and Sensate (ST). The basics here all involve their industrial automation strength, productivity enhancement products, existing networks in the global supply chain, and substantial R&D budgets to define what can and can’t be done on the manufacturing floor. Others include Fanuc Corporation (FANUY), which is a much purer robotics play, Yaskawa Electric (YASKY), and Kuka – each of them has revenues above $2 billion, so don’t expect any magical returns, but unlike other sectors, clients will likely be willing to pay up for these guys given their existing brand equity and intellectual property; robots, after all, are a very long term investment and not worth the short-change from poor quality. The cloud, of course, provides lucrative potential – customer relationships and enterprise resources aside, it’s only a matter of time until collaborative machines, empirical data usage, machine learning via artificial intelligence and equipment communication through the internet of things gathers speed here: SAP (SAP), Salesforce (CRM) and Oracle (ORCL) might enter the field, and iRobot (IRBT), Faro Technologies (FARO), and other sensor and peripheral hardware systems that currently serve computers are all fair game around the broader space. The field is surely expanding. Amazon (AMZN) acquired Kiva systems in 2012, which designed robots for warehouse goods transportation. Logistics and distribution enhancement has made the front pages; the focus will slowly begin shifting to the assembly line.

From the outside, the industrial world can be perceived as massive, complicated and at times as a ‘back-end’, if you will. The next technological wave, however, is likely to substantially alter manufacturing – and the regions and companies that are ahead of the game will be best prepared, as will the companies that supply the automation.

What it means for you: China property bubbles, a strengthening dollar, rate hikes, valuations…numerous headlines out there are pretty concerning. Then again, do they really matter? There’s enough data to show that short term trading doesn’t pay off for most humans – the average investor, for example, has made 2.1% annually over the past 20 years, compared to the S&P 500’s 8%. Why? Perhaps because they’re running with the herd, trying to capitalize on momentum, and following emotions, among other reasons. The deceptive nature of noise as a replacement for information will never go away. What does work, though? Long term investing. The markets have always had a positive bias – always – and in a world where capital continues to widen its reach, access to information continues to improve, and technological progress continues to break barriers, market participants should stay invested, and stay optimistic. Manufacturing is a key area to watch. The world is transforming before us, and Wall Street is set for a fascinating ride in the global supply chain in the coming years. Investors should gear up.

By: Neel Kulkarni    August 28th, 2016

While Wall Street finds itself contemplating rate hikes and politics in late summer, investors should be content. The S&P 500 has already delivered over 6%, earnings are set to rise, and the global economy isn’t collapsing with Brexit.

Of course, an argument could also be made the other way: stocks are expensive, a rate hike could have all sorts of international consequences, and the bond market is in a massive bubble.

In the end, fundamentally strong businesses and long term trends aren’t going anywhere. As the world becomes more integrated, more educated and richer on average, the increasing emphasis on banking, consumption, and infrastructure will persist. One other field that’s likely to make waves? Healthcare!

A recent injury provided a fascinating exposé on the healthcare industry – a vital component of our lives, but which usually is an afterthought for the common individual. After all, when you’re sick or need medical attention, it’s all encompassing, but if all is well, a simple stroll past a local hospital or doctor arouses little emotion or thought, compared to, say, consumer goods or technology. When you go to the doctor, the implicit feeling remains that you’re in the hands of an expert who knows all, and as a result, you are mitigating your health risk as best as possible. Is that the best approach, though, to tackle health?  Money or happiness didn’t make the cut on Maslow’s hierarchy of basic needs…what did? Food, warmth and rest – all aspects of survival, which can be distilled down to the simple concept of staying healthy. Over the decades, the medical field achieved significant milestones: the introduction of anesthesia, penicillin, x-rays and transplants all changed the ballgame. Could the current generation of entrepreneurs and scientists take it to the next level? I think yes: technological capabilities, data and medicine find themselves at a fascinating intersection today, which could totally transform human capability. Sure, that sounds optimistic, but if capital finds a way (which it will), anything is possible. Here’s my take on where we can go with this subject:

Let’s begin with the basics. Healthcare is an industry seemingly fraught with hidden detail – what happens at insurance firms, behind hospital walls and inside devices remains at the bottom of the common person’s priority list until – say, one gets detected with a condition or disease – after which the discovery begins. What’s more important than life, after all? The US healthcare industry is gigantic – at $2.8 trillion in size; globally, the field has a roughly 5% annual growth rate (Deloitte data), varying significantly by region. So, the size and employment impact is significant.

Next, we’ve got 7.1 billion people on Earth. 55 million die each year; the World Health Organization estimates non-communicable diseases are responsible for nearly 68% of them, up from 60% back in 2000. That makes sense, given science advancement, vaccinations, and education have mitigated most epidemic issues with time. Alongside, once can’t argue against the fact that life expectancy in the US in 1930 was around 50; today, it’s nearly 80, and better in quality than your great-grandfather may have found.

Back to the size. Per CDC data, the total hospital outpatient visits in the US last year totaled around 125 million. The number of physician visits? 928 million. The total percent of adults who contacted a healthcare professional in the US? A whopping 84%. So, if it wasn’t obvious, we can pretty much say that this industry’s total market size is basically every human…and the data being generated in aggregate is tremendous.

Given the gigantic size, however, I find it curious that technological integration into the market remains relatively small: the global healthcare IT market was valued at only $41 billion in 2013; the healthcare cloud computing market, meanwhile, is worth just $5 billion today. Granted, estimates show expectations of 20%+ in growth rates – but it’s still minor compared to other industries. Electronic data remains another black box. Imagine a visit to the doctor. Upon arrival, patients are required to fill a whole stack of forms involving rights, allergies, and personal information…and for each new doctor visit, they’ve got to rinse and repeat the same information. Surely, there could be a more efficient way: a Jason Bourne-like chip or online health record which could just extract your information from a database – maybe as simple your smartphone? What if someone checked a wrong allergy box on the paper because they were in too much pain? We already have an issue, so isn’t paper just increasing the risks?

Then comes the diagnosis. You explain the symptoms, and the doctor prescribes next steps. Let’s take the example of an x-ray; one of the most routine, common procedures. Some Google scouring reveals that roughly 70-100 million chest x-rays are taken each year in the United States; over 750 million originate in the dental sector. The doctor looks at yours, and makes a conclusion.

Let’s take a pause here. One could argue that the doctor – or more importantly, the patient – is making a decision based on a single data point (an x-ray), from a single opinion (the doctor). Surely the concept of crowdsourcing could be incorporated, especially if such massive data sets are already available? Imagine if your x-ray gets beamed into the cloud. An artificial intelligence system combs through millions of other fibula fractures, finds a relatable, statistically significant number which are precisely similar, and analyzes previously recorded outcomes: 99% of the time, this specific fracture required surgery, and 95% of the time, the patient recovered fully, and within 3 months. It could also outline the complexity, failure rate, recurrence potential, and relate it with the age, weather, and all sorts of myriad factors that would take months for a single person to crack.

Essentially, my point remains that no matter how smart an individual doctor, the combination of large data sets with that same human mind could provide far superior results. The facts back this up: a recent Carnegie Mellon study highlighted in The Economist outlined that doctors were able to predict heart attacks with a 30% accuracy; for the same attacks, a machine-learning algorithm had an 80% accuracy, with 4 hours of advance notice. A Stanford study highlighted by Vinod Khosla showed that two highly skilled pathologists assessing the same genetics slide agreed only 60% of the time. In a world where six-sigma errors are getting challenged on the manufacturing floor, the medical industry – while certainly more complex, could surely push the boundaries ahead. The leading causes of death in the US are heart disease and cancer. That may not be news, but one may find the third cause to be surprising: medical error, as highlighted by studies from NPR – we lose nearly 250,000 patients because of it each year in the US alone. The leading sub-cause? Misdiagnosis.

The numbers bring us to the intersection of Silicon Valley, Wall Street, and information. The concept of combating aging and defying death was unlikely to be a casual discussion in previous decades; today, it is. With more and more eyes on this fascinating subject, investors should be optimistic about the opportunities. Here’s why the numbers above may seem totally astounding to future generations looking back on why their ancestors died:

First, data. The generation of data is straightforward, but the aggregation and analysis is critical. 3 years ago, a Microsoft (MSFT) executive detailed that the usage of electronic medical records was incredibly low simply because doctors generally didn’t find them useful. However, the subject has changed since – prescribing systems, lab information, clinical systems and records have all caused the software-as-a-service component to start getting heavily incorporated into the field. Athena Health (ATHN) remains at the forefront of this; others include CareCloud Corporation and ClearData Networks; IBM’s (IBM) acquisition of Merge Healthcare showed that the big players are turning their head here too. Washington has actually pushed for a transition to all electronic records, and per Forbes, spending on IT per physician is up over 40% from 2010 – it’s still at barely $35,000 per physician, but one can surmise that if diagnosis becomes quicker, it only helps turnover and as a result should continue to increase, helping market efficiency overall. With the advent of fitness trackers, smartphones, chips-in-shoes, etc. the non-medical data generation is also bound to explode, and the combination could prove all sorts of links between exercise, diet, sleep, and health conditions. The fun part? This may be just beginning. PwC estimates that nearly $1 trillion of the existing market is at threat due to new entrants; this includes diagnostics, record keeping, and data generation; given the current size, at $41 billion, technology spending is still a fraction of the entire healthcare market. I believe the growth rate and cost-saving potential for companies is being heavily underestimated at the moment.

Then, of course, come the technologies that could change the game completely. Editas Medicine (EDIT) focuses on gene editing, while Illumina (ILMN) deals with gene sequencing. The costs are negligible compared to a decade or so ago; as results begin entering clinical use rather than just research, the entire concept of reacting to defects or conditions could be a thing of the past. What if hereditary links and consequent changes could iron out the problems before they cause issues? Sure, we’re looking at a whole host of moral and ethical discussions ahead, but the concept is not far-fetched anymore; DNA sequencing originated in 1992, for example, but is commonplace today, only 24 years in. Regarding cost justification, a USA Today article quoted a federal study stating that 5% of Americans accounted for nearly half of all healthcare costs; more targeted data and treatment would have tremendous scale effects.

Investors are taking note. Theranos came and went, but the excitement around the concept of microfluidics remains very real. ZocDoc, despite looking like a straightforward scheduling service, explained that previous to its existence, 10-20% of appointments used to be made and canceled a day before the actual date; the inefficiency was obvious (especially consider the many minutes on the phone wasted in making them). That’s quickly getting eliminated; service, as a result, is getting smoother and removing barriers. Fortune recently reported that Apple (AAPL) was working on a healthcare device that could monitor all our vitals. Peter Theil is backing Stemcentrx, a startup attempting to kill cancer cells (he also wants to live forever), and Google (GOOG) has a DeepMind medical division, alongside backing over 14 life science companies, per Recode. There are too many other examples to list, but essentially, we are looking at an overall quantification of health, where data and objectivity could remove biases and mistakes, and allow experts to focus with the aid of machines and intelligence. The Economist stated last week that curing cancer would only add about 5-7 years to life expectancy averages – the frontier, however, lies in how to get to decades more – and that’s what these firms will end up targeting in aggregate. With data sets, artificial intelligence, the focus of new-age entrepreneurs who want to live longer, and the increasing interaction of technology in our daily lives, the time is right for this quest. Imagine if your ring – a lifeless rock or band – could actually track your blood pressure and heart rate; your contact lenses could provide any info to you immediately, and your belt could track your weight or body mass index. Static data points could be replaced by dynamic ones; you wouldn’t be misled because you took your blood pressure after eating a salty lunch. The opportunities are tremendous.

What it means for you: Such a quantification of health has huge potential. Wall Street, as usual, is stepping up to be the catalyst to channel capital to life – literally, in this case. The reception by asset managers, both public and private, to the numerous companies leading technology into healthcare has been largely positive and long term in nature; investors should absolutely consider exposure to such technologies after research. Sure, new entrants will face significant competition from larger players, cash burn will be plenty, and the hurdles will include intellectual property challenges and regulatory changes. However, it would be wise to bet on a longer, healthier, and happier future ahead, given life will absolutely prevail.

Turkey, Nice, the Brexit, China’s debt, Italian banks, and a severely divided US political and civil front, among others…the headlines are heavy with human losses, discontent and questions. One could surmise that the concept of government globally, which includes foreign policy, domestic focuses, and fiscal plans, could all do with some reflection. Something’s not working.

And then, there’s monetary policy – working in overdrive due to the lack of its fiscal counterpart (not just my opinion, but also per hints by Draghi, Yellen, and others). It has driven investors in the elusive quest for some – any – returns, by continuing to bid up whatever has yield across asset classes. In what is possibly the strangest post-recession statistic to date, the S&P 500 was making all-time highs last week just as the 10-year Treasury yield made all-time lows; alongside, Germany and Switzerland set records in issuing negative-yielding long-term debt. And, as the BOE’s Mark Carney signaled rates would remain low due to the Brexit, stocks worldwide recovered all their Brexit losses and emerging markets continued to get capital inflows – again, for the yield. Concerns including Zika, heavy debt loads, and persistently low oil prices aside, the best performers YTD in fixed income have been emerging market debt, both local and dollar denominated, up over 10%, and the same on the equity front, with emerging markets up nearly 6%.

It’s scary to think how quickly things might reverse when rates rise.

Given the mounting importance of global risks for the Fed, it got me thinking: as investors, it’s becoming imperative to weigh geopolitical risks more than ever before, given its significance these days. Sure – through finance theory, one could find this in the country risk premium in CAPM models, using government yields. However, today, in a world where Treasuries and sovereign bond yields are in completely strange, never-before-seen territory, does that concept still hold? After all, if there’s one thing economists agree on these days, it’s that finance textbooks all need a rethink in this low rate era.

Perhaps gold would be a better reflection of risk…it is up 26% YTD, after all – with the only outperformers being other thinly traded commodities, excluding oil. However, a percentage of gold’s rise is likely reflecting inflation expectations – and that contribution is dicey to dissect. How about the VIX? Interestingly enough, that’s nearly 70% below its long-term average – despite all the turbulence. The bottom-line: market participants seem to love equities – and while rates stay low, it seems they will, also, stay undeterred. 2016 will perhaps be sent to the books as another year of Wall Street speculating on monetary policy projections. Whatever happened to the concept of capital flowing to ideas that genuinely deserve it, staying there with patience, and dynamic companies and innovative breakthroughs making the headlines? It’s still happening, of course – but amid all the other information, investors may be missing it, and perhaps investing for a myriad of different reasons. Here are some other thoughts to ponder on 2016’s market state:

Cash, cash, and less cash…much has been said about buybacks and their impact on creating a floor for the markets. That definitely has some truth to it: In 2012, quarterly buybacks averaged $90 billion and have steadily risen since; in Q1 this year, they set a post-recession record of $161 billion for the S&P 500, per S&P data. The source of the funding, however, remains concerning. While the large caps reflect nearly $1.5 trillion in cash on their balance sheets, per Yahoo Finance, as of Q2’s end, operating cash flow was flat YoY. However, the growth rate for cash was 5.7%; debt, meanwhile, grew nearly 10%. Low rates were intended to stimulate investment – capex, however, has fallen nearly 8% YoY…and buybacks have soared. So, there’s clearly some misalignment, in that the average firm doesn’t seem to be seeing investment opportunities – choosing to return more and more cash instead. This is likely to come to an end once tightening occurs; investors should note that Q3’2007’s buybacks, at approximately $170 billion, were slightly higher than Q1’2016. The year after was pretty rough.

IPOs are back…Q2 showed a good rebound, which is a heartening sign; per Renaissance Capital data, 34 IPOs raised $5.5 billion, compared to the barely $1 billion raised in Q1. The returns were pretty solid on average, but Twilio took the cake, up over 100%. In my opinion, the success was partly due to it being one of the few ways public investors could also make a play on Uber, which uses Twilio for alerts to riders. In any case, the state seems healthy. Healthcare, meanwhile, continued to top the charts with nearly half of the IPOs; next up was financials, followed by technology. That sector IPO trend has been pretty solid over several quarters, and the reason it is important is one can extrapolate where the VC world and entrepreneurial mind is headed: the elusive, fascinating goal of increasing life expectancy, a revamp of the banking intermediary for more direct-to-consumer interaction, and the overall use of technology to make pretty much everything we do more efficient – right from asset utilization, data analytics, faster communication and productivity. Some data points on this? Approximately 21 million WhatsApp messages, 2.4 million Google searches, and 350,000 tweets are sent each minute, per Excelacome’s statistics. Talk about connectivity and information transfer. Note the renaissance of Nintendo with Pokemon GO, which could heavily speed up the incorporation of augmented reality in our daily lives in the coming months. Importantly, most of these activities – and sectors – are heavily shielded from geopolitical turbulence, which gives them a much clearer runway for growth. The trailblazers remain at it – Amazon’s Prime Day set retail and e-commerce records, and with R&D spending at the top tech firms also running at a faster pace than ever, amid all the risks and concerns in the world, one should remain confident that the long term looks extremely bright for investors, firms, and consumers, including society as a whole. If one needed convincing that innovation or the markets matter, the simple statistic that global poverty is on track to fall below 12% this year, from over 37% in 1990 (that’s about when Eastern Europe, India and China joined the global market party), per the World Bank, provides some solace.

What it means for you: That’s the long run. Now, back to today. The S&P 500 finds itself at roughly 17x forward earnings, slightly more expensive than its 14.5x 20-year average. At the beginning of the year, my belief was that a P/E multiple contraction would lead to headwinds for stocks in 2016. Over the past week, the US economy provided numerous data points that signaled that economic growth, while slow, was alive and well stateside, with rising inflation expectations. That, again, brings back the Fed. If it tightens, will capital move out of emerging markets too rapidly for their foreign exchange reserves and currencies to handle? Will the Italian banking conundrum, with absolutely no painless solution per The Economist, unravel European banking, which is already suffering tremendously? And, will investors be able to swallow the numerous geopolitical events (‘Amid Terrorism, Stocks Rise’ was a pretty discomforting Barron’s headline) that keep cropping up, for the sake of yield? Equities are primed for an impact if sentiment takes a downturn. The rest of the year is likely to be very uneasy, given the distinct question that waits to be answered: how many more straws will it take to break the camel’s back on Wall Street in 2016? My concern is that it’s not too many.

By: Neel Kulkarni    May 30th, 2016

Wall Street finds itself in strange waters. We’re in the seventh year of the second longest bull market ever – and while equities are up over 230% since March 2009 – that sounds normal – 10-year Treasury yields, instead, have moved from 2.8% to 1.8% during the same span. Usual late expansion characteristics such as high inflation, commodity spikes or overheating credit are nowhere to be found, and amid a massively polarized opinion base, a possible 25 basis point rate hike has created a frenzy such that the media only seems focused on will-they-or-wont-they debates with any strategists gracing the stage. Move over, Drake – monetary policy’s topping the charts, and it’s likely to continue doing so until the June 15^th Fed press conference.

And why not? Multiple asset classes are certainly moving to the Fed’s rhythm. Notice that with the higher rate talk in recent weeks, the dollar has gained over 3% in May per the WSJ Dollar Index, the DJIA has backtracked on its YTD gains and is now up only 2%, financials have gained over 11% in the past three months, and short-term yields have jumped, noting investors are taking this stuff seriously.

What else could have caused these moves? Labor markets remain pretty much as tight as they were seven months ago, the S&P 500 remains fair-to-expensive, at 16.7x forward earnings (FactSet data), and 10-year yields, usually showing inflation and real growth projections, are at the same levels they were in early 2015. In fact, the S&P 500 is virtually unchanged since late 2014 – which is when tapering began in the United States. May’s moves definitely reflected changing rate expectations.

Moving ahead, Wall Street is likely to keep in mind that Canada, Israel, South Korea, and even the ECB had to reverse course around the 2011-span when they hiked earlier than their economies were able to handle; it was followed, in some cases, with quantitative easing – the opposite extreme action. Also, the pain of January’s collapse after one rate hike in December remains fresh. And, beyond the United States, can emerging markets handle currency moves favoring the dollar? It isn’t unreasonable to think that rate hike conversations are dominating East Hampton’s grilling scene this weekend.

With monetary policy reigning the headlines, the confusion may make you find yourself in Frasier’s shoes, where you don’t know what to do with those tossed salads and scrambled eggs. Here are four points investors should keep in mind, while acknowledging that this summer may be a rough one for equities:

1. Macro Trades Have Been Driven by Currencies: 2016’s favorite international trades have fallen flat YTD; Europe is down 5%, Japan is down 12%, and India is barely scraping positive. Meanwhile, the much-ignored markets of Russia, South Africa, Turkey, Argentina, and Brazil have had solid years (in local currencies). So, crowded trades can hurt. 2016’s moves seem highly noise-driven – it’s not like some of these countries are doing something revolutionary to spur economic growth – it could just be easing and currency fluctuation. Both the euro and yen have gained against the dollar YTD; the negative correlation with local market returns is distinct. Emerging markets have done great, but mainly because the dollar stopped weakening and the danger of capital flight reduced, and also because of oil’s meteoric 100% rise in two months. The 2^nd half may pan out extremely differently if rate hikes occur, and if oil’s run ends via supply coming back – not something fiscal policies can necessarily dictate. Country fundamentals will take a backseat this summer; if you’ve invested for the long run, buckle up.
2. New Money Shows Reason For Optimism: Now, let’s look at the IPO scene. The US Renaissance IPO index is down 2.7% YTD. The firm’s data shows a 55% drop in IPOs from last year, and a 57% reduction in capital raised. However, five IPOs raised cash last week – the busiest week of the year so far. Tie this together with VC data: in Q1, per NVCA data for the United States, $12 billion in funds were raised by VCs (the highest amount in 10 years), even though actual investments were only $14.8 billion compared to $18.2 billion in Q1’15. So, the focus on startups, brave ideas and alternative venture investment remains steadfast, despite volatile markets and passive migration. Important to note: software, healthcare services, and biotechnology remain among the top four sectors for deals. Tech has rebounded over the past 3 months, and it’s barely trading at 16x forward earnings compared to its 20-year average of 20x in the S&P 500. If that sector continues to rise and the IPO market continues to strengthen, VCs can cash out and fund more ideas; the cycle will continue. It seems realistic, given on the public side, firms including Salesforce (CRM), Facebook (FB), Amazon (AMZN), and Nvidia (NVDA) are significantly outperforming the NASDAQ YTD; investors, thankfully, have not lost their taste in fine companies amid monetary churn.
3. The S&P 500 Needs A New Leader: And then, while the S&P 500 may be up 2% YTD (a massive rebound from February), the sectors leading the index are utilities, energy, and telecommunication services – up 12%, 11% and 10% respectively. All are pretty expensive on a forward multiple ratio, and if rates rise, it’s fair game that these get hit given the reason investors have gone to them is for substituting non-existent coupons with great dividend yields and stability. In that case, which sector will step in to provide a floor to the S&P 500? Consumer discretionary stocks? Technology? Both have historically been poor in the late-cycle span, per Fidelity Business Cycle data; this case may be different for tech, though, as it may be simply undervalued. Industrials? Difficult to think, given their heavy international revenue streams coupled with a strengthening dollar. The financial sector strength would be key – especially considering they have been, by far, the worst-performing sector over the past ten years – the same span as record low interest rates have existed. Therefore, investors should watch financials and technology to see if a successful baton transfer occurs.
4. The 10-year Must Rise…Or Should It? Finally, the yield curve. 2-year Treasury yields have jumped significantly, from 0.7% to 0.9% through the beginning of May to date, but 10-year yields have remained flat over the same span, yielding 1.8%. That yield suggests that long-term inflation expectations or real growth – or both – are weak in projection. However, sovereign buying or selling overseas by Saudi Arabia, China, and other emerging markets to shore up currencies, raise cash, control rates, etc. may be distorting that historical logic. Whatever the case, the curve has definitely flattened – and the previous three recessions were preceded by inverted curves. Therefore, this is a data point worth watching.

What it means for you: Due to the weight of monetary policy on investors’ minds, asset classes all over are likely to significantly adjust following June’s Fed meeting; the BOJ actually follows the day after. The second point above, however, is what investor should remember – there’s plenty of capital out there, and it’s going to be invested sooner or later. Companies that define trends and revolutionize industries will almost always prosper in the long run, and that’s an investment you can control. Investing in Nike or Microsoft in the 1980s would have returned over 35,000% by now; selling midway because of some minor policy change and panicking with the herd would have killed it. This applies more than ever today. The coming summer is likely to be historic, and may provide significant churn for the world’s markets. That’s fine, because volatility is driven by new information, and it’s natural for prices to take some time to adjust when there’s a whole lot of it. Let investors sort themselves out; scoop up bargains as they appear. And if you don’t know what to do with those tossed salads and scrambled eggs…don’t worry, you’re not alone. Wall Street is, in that way, distinctly different from Frasier’s profession: doing nothing can actually be a good approach!

Weak earnings, low oil prices, unexpected currency trends, unicorn valuations, a Brexit…2016 has provided plenty of subjects for Wall Street to ponder on.

Is inflation, however, getting the attention it deserves?

This is purely a thought, but one that could be worth contemplating. Essentially, we may be coming to a binary juncture in the markets, in which inflation could catapult to becoming the defining factor for 2016’s returns. The outline is as follows: the inflationary trend defines US monetary policy, which, in turn, dictates capital flows – which influence asset prices in the short run. In other words, macro moves take precedence over company fundamentals, and short-term outcomes would be binary – with asset classes moving in tandem – all based on inflation data. Ok, that’s quite long-winded. Let’s lay this out:

The Context: The Federal Reserve’s mandate involves maximizing employment and promoting price stability…aka inflation, with a stated 2% goal. By several measures, including March’s U3 5.0% unemployment rate, recent weekly jobless claims, and an upturn in labor participation, one could argue that the first objective has essentially been achieved. The focus, then, should turn to inflation for defining the next hike – especially so, given it has significantly underwhelmed during this expansion; headline CPI was still at 1.0%, and core PCE, while trending up, was still at 1.7% as of February (BLS data). Alongside, we can assume that inflation is not skyrocketing anytime soon, given commodity prices are still under pressure, emerging markets’ import demands remain lackluster, China’s debt concerns linger and a generally deflationary global environment persists. Meanwhile, the ECB and the BOJ are continuing to ease with full steam through negative interest rates, wholesale bond buying, and potentially even expanding to ETFs and other assets. In other words, without inflation reaching or passing 2%, if the Fed were to tighten rapidly, it would essentially be the only large central bank doing so – a massive international divergence which could cause all sorts of confusing results in the markets and economy.

Under these conditions, the Fed has refrained from hiking again after December. I remain of the opinion that this action (or lack of it) has been the key factor for explaining almost all major asset class returns YTD. After December’s hike, interest rate expectations were massively diminished by January’s volatility; since then, emerging market equities (via EEM) have returned over 7%; the euro and yen have strengthened by over 4% and 7% respectively, and the dollar has weakened against all major currencies except the peso, pound, hryvnia and the ruble – notable exceptions for country-specific reasons. Alongside, local emerging market debt has been by far the best fixed-income performer, returning 9.1% (JPM Data) YTD; high yielding debt, despite February’s plunge, was up 3.4% as of April 1^st, and since mid-February, US equities have delivered well over 10% in returns as well. So, we’ve seen a very obvious move toward risk(ier) assets given diminished US rate hike expectations – all in sync with the dollar’s weakening. Dividend-paying stocks further attest to this – the utilities and telecom sectors are up over 10% YTD. It’s not like electricity and water consumption just decided to zoom higher; in fact, earnings growth overall remains quite weak, if not negative, in most sectors. As a result, one can surmise that investors are just looking for an income stream of dividends when there’s virtually none in fixed income; the 10-year Treasury’s 1.7% yield is way below the S&P 500’s 2.3% dividend yield.

Now, amid the recent diminishing returns and potential limits (as could be argued with NIRP’s effects on the yen) of central bank actions, credibility remains of paramount importance – and currently, the BOJ’s policies are under the microscope. The US Fed is still far from being questioned, but it’s unlikely Janet Yellen would risk any such damage – especially after the reception of September’s minutes, where the emphasis on global conditions caused all sorts of reactions on Wall Street. My point? If employment remains solid (which it should), and regardless of global conditions (which are unlikely to change over a few weeks), if inflation picks up, the Fed would have a very strong case to raise rates.

Presenting Inflation: Now, assume inflation picks up. Rates rise. Should one expect a reversal of much of the behavior above? In my opinion, yes. Here’s what one could expect:

As rate hike expectations increased in 2015, the dollar strengthened; post December, it weakened. If inflation picks up and the next rate hike appears on the horizon, the dollar could repeat this trend; the yen and euro would correspondingly weaken, aiding European and Japanese equities. US multinationals would, then, turn downwards – the DJIA would likely underperform domestic firms – reversing Q1’s trend while the dollar weakened. Banks would be the outlier, likely gaining due to the relaxation on their net interest margins. Small caps in the US would do better citing domestic strength – again, a reversal from their underperformance YTD. TIPs would extend gains, and emerging markets would sell off – beginning with oil-exporting ones, as commodities, mostly priced in dollars, would also come under pressure. This would again hurt high yielding debt – over 25% of which is in the energy space, per JPM. Essentially, we may converge back to January’s behavior – indiscriminate sell-offs across classes regardless of the quality of individual assets. The domino effect could spiral into emerging market currencies – enter China – would the pressure on the yuan lead China’s PBOC to sell foreign reserves? As of February, the stash was approximately $3.2 trillion (JPM data); the IMF has stated $2.8 trillion to be the critical safety limit. What if it gets breached? Could the stronger dollar trigger a yuan depreciation? Similar situations were making headlines in January – right after December’s rate hike. And we know what happened in the five weeks after. All in all, we could see some pretty serious moves repeating themselves if the Fed raises rates upon inflation picking up.

And then, the reverse. If inflation does not pick up, the Fed would stay put, and the current trend of investors seeking yield wherever possible would continue. This could occur if the US economy were to slow down – say – if oil collapses again, banks suffer more than expected, capex spending never picks up, and wage growth stalls. However, this would just mean kicking the can down the road…someday, you’d think rates would have to rise given another need to deleverage, diminishing policy impact, and perhaps even new political leadership.

That’s why I think we may have a binary outcome in the short term – all based on inflation. Now, a quick thought on that. Amid the hype around high yields and equities, note that TIPS have returned 4.5% YTD – the 2^nd best fixed income class. Gold is up 16% as well – strangely contrary to all the other risky-asset strength. Both are solid inflation hedges. Other data points resonate as well – core CPI was up a solid 2.2% in March; alongside, existing home sales were up 5.1%, with the median price up 5.7% YoY. While average hourly earnings grew 2.3% YoY in March, per the Atlanta Fed, the three-month moving average of median wage growth was up 3.2% – looking at historical data, that’s nearly equal to December 2003’s 3.3% value. Yesterday’s unemployment claims were at their lowest level in 42 years, per the WSJ, and oil seems to be holding steady, despite Doha’s lack of outcome. So, there is a fair case to assume inflation will pick up, and the Fed, as a result, will hike in the coming months.

What it means for you: Of course, this is all just a scenario. But it does beg the question of whether company-specific trades aimed at short-term gains within 2016 are possible, given the throwing-the-baby-out-with-the-bathwater mayhem is quite likely if monetary policy holds sway – as it seems to have had in the recent past. For long-term investors, of course, such times provide phenomenal bargains on amazing companies – and frankly, this just is how markets function. Investors shouldn’t complain – we’ve had significantly above-average annual returns in equities during this expansion compared to long-run averages, that too, amid lackluster global growth. The bottomline? Wall Street should keep in mind that while certain asset classes will continue to make waves in 2016, the reason for many of the individual moves may not be due to stellar cash flows or sparkling management…it might just be inflation.

Imagine going for an all-star movie, with the lead roles played by oil, a few monetary policy makers, and a handful of large technology and industrial firms. It turns out to be quite the film, ranging across suspense, drama, action, and a good dose of horror. Once you step out of the theater, however, you find that nothing much has changed on the roads.

That’s one way to put how investors felt at the end of Q1 on Wall Street. While the S&P 500 gained a seemingly nonchalant 1.8%, January had just delivered the worst US market open in history, alongside oil plunging over 20%, China over 15%, and Europe, Japan and the United States over 10% in a span of three weeks. And then, as quickly as things went down, it all reversed; in just over five weeks starting February 11^th, all the losses were regained, and the S&P 500 ended March in positive territory. Wait, what just happened?

Q1’s drastic moves were heavily macro-driven. While we started January with modest earnings growth expectations (0.3% for Q1, per FactSet), China’s yuan depreciation kicked off a massive sell-off; it was compounded by oil’s continuing pursuit of a bottom, and a plunge in high yielding debt. Across the ocean, European bank stocks delivered arguably the greatest shock, with concerns arising around cocos and insolvency that very few had highlighted at the beginning of the year. The speed of all this unfolding was the most surprising factor; recession talk began filling the media waves immediately, compounding the fear.

The drama came to a head in February, when global monetary policy makers stepped in to save the day with a series of dovish remarks. Starting mid-February, value investors, alongside rebounding oil, led an amazing comeback story that lasted all the way through March. So, we’re good. Or are we? While things may seem normal, earnings expectations have kept deteriorating, and we ended March with Wall Street expecting a 9% drop YoY for Q1. In that case, was the rapid rebound of equities fully warranted? Here’s my take on why 2016’s market remains a work in progress, with two themes highlighted.

Central Bank Influence: In January, the Bank of Japan instituted negative interest rates – another milestone in expansionary monetary policy. The ECB and other peers weren’t too far behind; with more easing abroad, the Fed was essentially forced to back off from the original 4-rate hike projection for 2016. One has to believe that such unchartered territory, with easing all over, has to end someday. How will investors react when it does happen? In the United States, stock markets have essentially tripled since 2009, with labor markets tightening to near-full levels, and wages growing at a 2%+ YoY rate; core PCE is hovering around 1.7% as well, indicating inflation is alive and well if it were not for weak energy prices. However, today, we find over 30% of global government bonds (per the BofAML GG Bond Index) are now yielding negative, and there are valid concerns about an actual shortage of applicable debt left to buy, creating potential liquidity issues given so much has been bought up already by central banks abroad. While well intentioned, the effects of such policies remain up for discussion, given growth continues to remain weak – the United States is tracking at just 0.4% for Q1, per the Atlanta Fed’s GDPNow model; Japan’s tracking at -1%, and the yen and the euro have both strengthened in Q1 – the opposite of what policy makers ended. Could Q1’s results be indicating a central bank bubble for equities? I remain in the ‘no’ camp (for reasons detailed in previous posts, summarized in that there is no other alternative for investors looking for growth exposure), but what worries me is that the policy influence is stretching far across asset classes, beyond the extent of previous booms, such as the dot-com and housing bubble; today, currencies, bonds, equities and commodities are all involved, and global capital flows seem dependent on each word of policy and press conferences.  The emphasis on structural changes, fiscal reforms, fundamentals and economic growth seems lacking; investors should be concerned about the direction of Wall Street if Q2 shows more of the same influence by central bankers.

The Leaders Are Mixed: Moving on to the indexes, note that despite the iconic equity rebound, the S&P 500 sector leaders for Q1 were essentially the defensive ones; utilities and telecommunications were up nearly 15%, followed by consumer staples and energy. While a risk-off nature seems apparent, a rate-hike delay likely attracted investors, given these sectors’ dividend yields as substitutes for bond coupons. Industrials also gained, likely to good balance sheets, the desire for value and quality, and as they were beneficiaries from the dollar’s weakness given large international revenue streams. Financials disappointed, down 5%, largely due to their relationships with European banks – some of which were lower by over 20%, high yielding debt exposure worries, and rate hike delays. Alongside, gold gained, up over 16%; this was interesting, as while the safety trade was apparent, I still believe some portion of the rise was due to rising inflation expectations. The US 10-year Treasury yield fell from above 2% at the beginning of 2016 to 1.7%, and the 2-year, more sensitive to rate hikes, fell from 1% to 0.7%; again, explainable by rate hike delays and safety-seeking – and contrary to most investor expectations leading up to 2016. Alongside, crowded trades unraveled; Wall Street had heavily emphasized Europe and Japan as outperformers in 2016 against the United States. This fell flat in Q1; the Stoxx 600 was down 8%, and Japan’s Nikkei 225 was down 15% compared to the S&P 500’s 1.8% rise.

At the same time, investors were not entirely defensive. Emerging markets were up approximately 6% for the quarter, and after the near-apocalyptic jump in high yields in January, junk bonds stabilized, with prices rising over 8% within a month. Small caps also staged a comeback in March, with the Russell 2000 rebounding by 8%, and outperforming its large cap equivalent. So, we saw an interesting risk-on and risk-off blend. Also worth noting is that the sell-off in high yield bonds may have been overdone; spreads were at 7.5% as of March versus a historical average of 5.9%, but the default rate was just 3.2%, versus the historical average of 3.9% (JPM data). I find this to be a good sign, in that investors are being cautious. Overall, the S&P 500 finds itself trading at 16.6x forward earnings (FactSet Data), and the NASDAQ at 18.5x – slightly higher than historical norms, but certainly not stretched.

What to expect in Q2: As Alcoa kicks off Q1’s results on Monday, the markets will look for earnings and guidance to clear up the murkiness around oil and monetary policy influence.  Expect the latter to remain in the headlines, especially if inflation does continue to tick up in the United States – a very likely scenario. The pressure on the yuan isn’t going anywhere, either; January’s market reaction to the depreciation greatly resembled August’s, and another episode later in the year shouldn’t be ruled out. Politics will also take center stage in late Q2; while the Republican convention will dominate, a Brexit potential may keep European stocks in check until the results come in. The bottomline? While the bar has been set quite low for earnings, investors shouldn’t hold their breath for good returns from indexes in Q2 – there are too many outside factors impacting returns. Selectivity will count, and Wall Street will remain a work in progress as it tries to find direction in the near term.

However, don’t let any confusion blind you; things are actually clearer regarding the longer term, and there’s a whole lot to be optimistic about. Innovation continues to amaze, and its relationship with Silicon Valley finds no barriers; Berlin, Sao Paulo, Bangalore, Sydney and others are rapidly positioning themselves as tech hubs with great reception. The world finds itself with an average demographic age of 29.7 (IndexMundi data), primed for consumption from emerging markets. And forget the market moves – the astounding number of Model 3 orders and excitement around Tesla was arguably the greatest highlight of Q1, showing that a revolution in transportation may have begun. Editas Medicine (EDIT), a gene-editing firm, had an extremely successful IPO in early Q1, and has delivered 122% since. Facebook’s Oculus Rift saw phenomenal demand, and Boston Dynamics’ robot running through the woods caused YouTube to go wild. Alongside, artificial intelligence continued to make waves, with machine learning and chatbots gaining significant attention. Argentina rejoined the global debt markets, and it was found that the Indian government’s recent banking initiative had created over 200 million accounts for citizens over the past year. Anyone who thinks that things are all doom and gloom is at risk of missing out on such amazingly positive developments. It may be wise to keep expectations low for Q2, but staying optimistic for 2016 and beyond is advised. Wall Street is at center of deploying capital to ideas that are transforming the world more rapidly than ever before, and patient investors will be handsomely rewarded with society’s corresponding progress.

While the markets tread water this week, an upturn that began as a stealth rally in mid-February has delivered over 12% for Wall Street in just over a month, bringing the DJIA and S&P 500 into positive territory for 2016. The rise could be heavily attributed to oil’s 50% move and accommodative monetary policies worldwide, given earnings expectations continue to be revised lower, now at -8% YoY for Q1’16 (FactSet data). Alongside, the emerging markets index (EEM) is up 4% YTD, and the DJ Transportation Index is also up over 20% from its lows. While things may look ok for now, it’s also worth highlighting that value is outperforming growth YTD; numerous analysts have suggested that a successful baton transfer is critical for continuing the bull market after the outperformance of growth since the depths of the recession.

In my opinion, some underperformance is fine, because growth isn’t going anywhere given the phenomenal disruption happening in numerous industries – aptly dubbed the Industrial Revolution 4.0 across cyber-physical systems led by the cloud, the IoT, data analytics, robotics, etc., which are all projected to provide a double-digit CAGR in the coming decade. Today, we’re highlighting another field to watch, and that’s space – an ‘industry’, if you will, that may be set to skyrocket for another leap for humankind (literally) in the coming years. Here’s my take on why it has so much potential:

Overview: Space, by itself, is an extremely broad concept. Essentially, we’re looking at everything above 62 miles from the Earth’s sea level – a boundary known as the Karman line. While space exploits over the previous fifty years seemed highly government-driven, the past decade has seen a new wave of collaboration in the industry, with numerous private firms driving innovation, excitement and opportunities along with the public sector. To be sure, NASA’s budget isn’t going anywhere – the $19.3 billion for 2016 is 7% higher YoY, with projects ranging up to 2035 and beyond. The European Space Agency’s budget, meanwhile, increased by 18% this year, and China, Russia and India all have extremely ambitious plans with their own programs. The US dominates overall space spending, with NASA’s $19.3 billion nearly 3x that of the ESA. What’s nice is that NASA’s budget is unlikely to be threatened – as per estimates by Scott Hubbard, a professor at Stanford and ex-NASA director, for every dollar spent on the space program, the US receives nearly 8x in economic benefits, along with a massive stimulus in kids’ interest for the STEM subjects. Scott Kelly’s return after 340 days in space two weeks ago was heavily covered by the media, and per The Economist, over 18,300 people have applied for NASA’s next astronaut class, nearly 3x that of 2012. So, all promising signs for the industry, given where talent, resources and capital go, big things tend to happen.

From a market perspective, the global space industry was approximately $322 billion in size in 2014, per the Satellite Industry Association’s 2015 annual report. While the 10-year CAGR was a robust 8.5%, I believe the next decade could deliver an even higher number, with specific sectors having the potential to shine given today’s emphasis on connectivity, technology and information. Here are some sectors to think about:

Earth Observation & Communication: The satellite sector comprises the majority of the space industry, with over $203 billion in revenues and a 9% 10-year CAGR; there’s over 1,250 of them zooming around above us as we speak. Within the sector, we have Earth observation at $1.6 billion; consumer services, including TV, radio and broadband form essentially the rest of the market, with over $100 billion in revenues. In my opinion, Earth observation is a key field to watch. With Silicon Valley’s advent into space, companies such as Planet Labs and Spire Global now have over 130 shoe-box-size satellites taking images by the second, and distributing them to clients including governments, corporations, and researchers. Imagine knowing where oil tankers are docked, which crop fields are water-starved, and what manufacturing locations are showing lights on for an additional shift. Such information would be priceless for investment purposes; importantly, it could enormously aid broader market efficiency and information transparency. As Wall Street races for the next edge, this field has serious potential given the extent of information mining possible; for reference, the International Space Station orbits the entire planet over 15 times each day – that’s a whole lot of data generated per minute. Alongside, commercial broadband via satellites has existed for a while; it saw a 6% rise in revenue over the past year, per SIA data. However, the costs remain prohibitive and a mass-adoption, in my opinion, is difficult in the short term unless there is some major breakthrough. Enter ideas such as Project Loon – a Google X venture which involves space balloons orbiting at the edge of our stratosphere and beaming down Wi-Fi to remote regions, by partnering and sharing spectrum with telecommunication firms. Currently, less than 40% of the world’s population has internet access, per data from their website; the balloons essentially connect those without access to the global internet back on land. A little closer to Earth, airlines including Delta are now offering trans-ocean Wi-Fi services via satellite as well. To summarize, the essential market need – and ‘moat’, if you will – of satellites and their corresponding services remains unparalleled. The potential for data generation and connectivity is massive – and barely tapped as of today.

Travel: Commercial aviation continues to grow at a healthy 1.5% rate above global GDP growth, per Morningstar data. But what about space? So far, less than six hundred people have traveled out there. Essentially in a vacuum, an average satellite orbits the Earth at a speed of around 18,000 miles an hour. Meanwhile, to reach orbit, NASA’s STS Space Shuttle, for example, needed around nine minutes. Doing the math, is it completely unrealistic to think that space could actually be a viable method for shuttling between cities on Earth itself? Think about the Hyperloop; Musk’s 57-page paper reveals what is essentially a frictionless tube, with air pressure aimed at being one-sixth of that of Mar’s atmosphere to reduce the drag. By all means, implementing such a principle ex-tubes is a while away – especially in space. However, given the media attention that the leisure segment of space travel is generating, it may be worth thinking about short-haul commercial applications as the natural next step. The Virgin Group’s Virgin Galactic, Jeff Bezos’ Blue Origin and others have very real plans to bring people to space in the coming years, at around a manageable $250,000; Arizona’s World View Enterprises plans to send travelers through capsules to over 100,000 feet above Earth, for approximately $75,000. The TAM of consumers would certainly be substantial for such prices. While these remain discretionary activities lasting for some hours, ventures for travel on the commercial front are very likely; Elon Musk has gone as far as to establish the goal of colonizing Mars in the next 15 years. However difficult such plans may seem, if Richard Branson, Jeff Bezos, and Elon Musk are thinking on similar lines, it’s worth paying serious attention. Importantly, elongated spans in space would need all sorts of solutions for potential bone loss, vision impairment, radiation exposure, and other health risks, as identified by NASA; this, in turn, opens the door to all sorts of new technologies and innovation from firms focused on the next frontier. More on them below.

Exploration & Research: Next, let’s tackle the research sector. We began by outlining the key role of national space organizations in exploring space. However, note that SpaceX was the first player to deliver a private cargo load to the International Space Station via its spaceship – the Dragon – back in 2008. There’s an entire fleet of firms which are key providers for such technologies; satellite manufacturing is a $15.9 billion industry, while ground equipment and launches are around $58 billion and $16 billion respectively (SIA data). And then, of course, there’s collaboration adding value; Planet Labs, for example, makes its doves hitch a ride with outbound launches by other firms rather than blasting off on its own. Last week, according to an article by the WSJ, an industry trade group of aerospace firms and government officials were in Washington to discuss a worldwide standard for navigation – essentially a global network of satellites operated by different nations. Safer and more precise skies via government and private sector collaboration…what more could one ask for?  And then, there’s asteroid mining – an incredibly fascinating field, and one dubbed to be, in theory, around $100 trillion in size, per TechCrunch; firms such as Planetary Resources, backed by investors including Larry Page, and Deep Space Industries are uniquely focused on deriving value via precious metals from space rocks, while refueling using asteroid water – all by just 2025. Meanwhile, we have NASA’s Voyager 1 and 2 spacecraft, which lifted off in 1977 and still continue to transmit radio signals from the boundaries of the solar system. The information gained through such continuing missions is just enormous. We conclude by highlighting the reusable rocket – among the most important subjects for the future of the industry, and one so powerful that it has been dubbed the ‘holy grail’ of space travel, per space.com. Essentially, previous shuttle missions – which had to deal with expensive single-use equipment – costed anywhere around $1 billion; launches needed well over $100 million. However, 2015 saw major breakthroughs in reusable rockets, with the success of Blue Origin’s New Shepard followed by SpaceX’s Falcon 9; the latter’s launch costed only around $60 million, per DefenseNews. Elon Musk has estimated that reusable rocket launch systems could reduce the cost of spaceflight by a factor of 100. That’s a serious game changer.  With such initiatives and rapid progress, one can only imagine the potential the private sector can realize through research and exploration in the coming years.

The Players: And now, the investment perspective. We begin with the usual innovation suspects. Jeff Bezos’ vision is phenomenal, and although Blue Origin is private and not, per say, owned by Amazon (AMZN), one could reason that Amazon will gain in one way or the other through such ventures by its CEO. With over $107 billion in revenues last year, there’s plenty of cash for Amazon to fund future innovation, including space ventures, if Blue Origin takes off. Alongside, we have Alphabet (GOOG) with its Project Loon – probably with other space ventures in Google X that we don’t even know about. Alphabet remains another solid bet for future growth in diversified fields, including space; the firm remains the among the most feared competitors for CEOs of practically all industries, while only trading at 19x forward earnings. Facebook (FB), meanwhile, is involved with space through its Free Basics mission, in which it has collaborated with Eutelsat for renting satellites to bring the internet to parts of Africa. Although Facebook has a $320 billion market cap, it trades for only 30x forward earnings with a 3-year revenue growth rate of 52%; it has every incentive to build on its massive social platform through space with the mission to connect everyone. Eutelsat (ETL.PA), itself, is a 20-year old French company with a $6.6 billion market cap and an operating margin of 44%, already providing broadcast and media services through 37 satellites; one could expect it to come closer on Wall Street’s radar if such partnerships work out. ViaSat (VSAT) is another interesting space play. As a $1.4 billion provider of wireless applications and services for satellites, private networks and governments, its focus on commercial aeronautical Wi-Fi and long-ended government contracts makes it interesting given an environment of increasing surveillance and the need for a decent connection while traveling. While the competition is fierce in this space, its contracts make it worth thinking about.

In to the rocket sphere, while SpaceX is a private firm, Orbital ATK (OA) is a $5 billion competitor that develops aerospace technologies and products; it recently signed an 8-year contract with NASA to supply the International Space Station, and has stated the ability to recycle old satellites as well; trading at 14x forward earnings, Jeff Moser of Wells Fargo recommended it a couple of weeks ago in Barron’s, citing reliable earnings and low volatility. Aerojet Rocketdyne (AJRD) is a rocket and propulsion manufacturer; per its 2015 annual report, the total contract backlog grew over 20%, and the firm is working on the Orion propulsion system to carry people farther into space and for longer spans, significantly outperforming the technology that carried the Apollo missions.

On the Earth observation front, DigitalGlobe (DG) is an interesting firm with a market cap of approximately $1 billion; according to CNBC contributor Constance Gutke, it recently won contracts with Yahoo and Apple, and already operates five satellites with Google; Planet Labs and Spire Global, its competitors, are still private. Intelsat SA (I) is another general space play given its involvement across the whole spectrum through services and consulting. It has lost nearly 80% of its stock value over the past year, but its forays into broadband connectivity and recent collaboration with Gogo (GOGO) are worth watching for value.

Among the large caps, we have Boeing (BA), Airbus (AIR), Kratos Defence (KTOS), and others involved with space. Boeing is working on its own CST-100 spaceship, with the ability to carry up to seven astronauts; it also got over $4 billion worth of NASA funding last year. Lockheed Martin (LMT) has a stated focus on deep-space exploration. Last year, it bought Astrotech Space Operations, a satellite launch and services company. Honeywell (HON), Rockwell Collins (COL) and others are on the technology side. Healthcare and biotechnology firms including Amgen (AMGN) and Regenetech, which is private, could also benefit given their ventures with NASA. While interstellar returns from these firms aren’t likely given their diversified revenue streams, the risk is also lower. As usual, it’s not worth going all-in on any of the firms above given the early stages of the industry, but these are among the key players to think about as space gains more and more importance on Wall Street.

What it means for you: Space never seemed so close. What makes it ever so fascinating is the immense level of collaboration between the private and public sector, as well as between national governments. Think about Scott Kelly’s return, in which he – a NASA astronaut – landed in Kazakhstan, or how the US and Russia have been collaborating for seats on Soyuz missions; the International Space Station, by itself, is a wildly successful venture involving over a dozen nations. Space truly seems to display an industry where market competitors and public entities work together on pursuing common interests – a very heartening thought amid the negativity and polarization on so many global topics these days. Today, it represents a fascinating investment frontier; the beauty is that even four decades after landing a man on the moon and the first spacewalk, the industry can still be considered embryonic considering the massive potential it offers. Wall Street should gear up, as space is amazingly placed to deliver returns that are out of this world – for both investors and humankind – in the years to come.

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Trying to figure out if Wall Street’s showing some bargains? You’re not alone. Amid all the negativity associated with recession talk and oil’s lurches up and down, a rapid market upturn is silently waging a battle against the pessimism in Lower Manhattan. The situation begs the question: can you recollect days when the market shot up on good news (real good news, not the bad-news-is-good-news type of news)? It may be hard to, compared to the flash crashes, multi-hundred-point losses and high-volatility days that tend to etch quickly in our minds. In other words, the 14% drop for the NASDAQ this year remains pretty vivid, but in my opinion, investors may not be giving due credit to the stealth rally under way; the same index is up over 6% since its low in barely 7 trading days. Are the fundamentals in better shape than investor sentiment may feel? It’s a difficult question to answer, but surely there are some reasons for optimism. Here’s my take:

The sector winners are showing resiliency: During the downturn from the beginning of January that bottomed February 11^th, the sector winners were telecommunications, utilities, and consumer staples – the usual risk-off equity shelters with their dividends, non-cyclical nature and relatively stable cash flow. Nothing new there. Industrials, however, fared not nearly as bad as one would think considering the prime reasons for Wall Street’s worries revolve around overseas uncertainty and commodity pressures; as of Feb 22^nd, the industrials were only down -3.7% YTD, outpacing the S&P 500, which is down 6.2%, and even consumer discretionary and healthcare stocks. The DJIA, in fact, has outperformed both the S&P 500 and the NASDAQ YTD – an interesting argument in favor of multinational strength at a time when investors assumed that the US was doing well and the rest of the world wasn’t. Alongside, note that last week was the market’s best performance in 2016 – the indexes were up roughly 3%. Who were the winners? Technology, up 4.1%, followed by consumer services, up 3.8%, industrials, up 3.4%, and healthcare, up 2.7%. As a result, investors don’t seem to be averse to any specific sector – and nor is this recent equity upturn being driven by the safer ones. In my opinion, these are all fundamentally strong signs regarding market resilience.

Gold’s not all about fear: Gold presents another interesting case. As a well-known risk-off trade, gold, represented by the SPDR Gold Shares (GLD), is up 14% YTD – understandably so, given 2016’s carnage that led to corrections in US stocks and bear markets abroad. At the same time, January’s CPI data was quite positive; the fact that inflation was unchanged amid an oil collapse of roughly 20% was in favor of rising inflation. Core CPI, meanwhile, was up 2.2% since a year earlier – the highest rise since June 2012. The Fed may be on to something. Alongside safety, gold is also used as a hedge against inflation. It’s possible that a portion of gold’s performance in 2016 can be attributed to expectations of higher inflation, and not just investor fear.

Growth is getting rewarded: As much as momentum stocks were hammered in January, look! They’re back!  Facebook (FB), is now flat for the year, Shake Shack (SHAK) is only down 2.4%, and Amazon (AMZN) and Netflix (NFLX) have both shot up from their recent lows, down 20% YTD, but really not bad after counting their stellar performance in 2015. The NASDAQ Composite, as a whole, has rebounded 6.6% since February 11^th. Things may not be all that bad given that in a low-growth world, the fact that investors are willing to get back into high-growth, well managed disruptive companies at the sign of market upturns shows optimism.

The dollar is holding steady: An appreciating dollar was meant to pose headwinds to multinationals in 2016. However, YTD, the WSJ Dollar Index has weakened by 1.2%; the dollar is off 2.7% against the yen, and 2.4% against the euro. Sure, this may change if rate hikes get back on the table or things abroad go downhill, but in the interim, companies with international revenue streams can breathe easy. Alongside, while the dollar’s gain in emerging markets isn’t exactly news, the main emerging markets it has lost value against are Indonesia and Thailand; at the same time, these are also the only countries that have positive indexes YTD among their peers. Consequently, some international markets may be more resilient than Wall Street thinks.

And, rounding it off with politics: Last week, Barron’s and the WSJ both highlighted the impact of Bernie Sanders and Donald Trump on the markets. Sanders’ polling in Nevada, however, is likely to reduce Wall Street’s worry for the time being – another positive albeit minor sign for equities. That being said, let’s note that activities across the pond are likely to bring back some of the anxiety; the Brexit just got a lot whole lot more curious with London’s Mayor, Boris Johnson, now opposing PM David Cameron’s EU-friendly position. Wait and watch this subject – things will become clearer as the June 23^rd referendum comes closer.

What it means for you: When times are tough, investors can easily feel down and out. However, the reasons matter. Since February 11^th, Wall Street has rebounded significantly; earnings season has also ended, with  68% of firms reporting earnings above their mean estimates (FactSet data). Granted, oil’s volatility isn’t going anywhere – and nor are the financial sector woes…so the cautious environment and hurdles will continue to exist. However, several indicators suggest things may not be all doom and gloom. Follow the details beneath the headlines and consider the long term as investors figure out their direction on Wall Street this week.

It’s getting real. Yes, pun intended. Virtual reality, as a concept, has enormous potential, and the world seems to be noticing. Apart from an increasing pace of media articles churned out daily on the subject, the recent CES in Las Vegas, Silicon-Valley-giant focus including Apple’s presence around Stanford’s VR labs, and Wall Street’s outlook have placed a significant spotlight on the subject. Is it warranted? And if yes, what’s next?

To begin with – yes, it’s warranted – and heavily undervalued, in my opinion. The concept may be well-known, but the application is still in its infancy – both from a consumer and enterprise perspective. Let’s take a step back. VR, in essence, is a computer-simulated reality that replicates physical locations for the user to immerse in; sight and hearing is a part of it, other sensorial experiences may soon follow. Good enough. Have you ever wanted to skydive, but were too terrified to do so? How about visiting a Brazilian rainforest immediately, or piloting a jetliner? VR can do all of it. Ok – none of these excursions add substantial value apart from some pleasure and cortisol…so take a step ahead. How about performing a procedure on an accident victim – with directions from a doctor unable to be present, but recreating the situation in a VR headset? Kids learning about space straight from the experts? The ability to train better for risky jobs, such as firefighting, or working in confined spaces? VR’s the answer. Enterprise applications are already being seen…Lowe’s now provides visitors views of potential home interiors; Ford, per Tech Republic, has ‘Immersion Labs’ to understand how customers experience their cars, and gaming, of course, leads the pack in obvious ways. Currently, Facebook’s Oculus Rift, HTC’s Vive, Sony’s Playstation VR, along with Samsung, Microsoft, and now Apple and Google dominate the hardware and software space; competition is escalating, but so is growth, given the enormous application potential.

The concept has existed for several decades. However, so has 3D printing and graphene – and none have achieved mainstream adoption despite supposedly tremendous potential. Why is now the time for VR? I outline three reasons.

1. A ready target market: Millennials are set to comprise over 75% of the world’s workforce in the next 5 years, with over $2.5T in purchasing power….this is demographic mentioned time and again in this column – one that is driven by sustainability, and has a preference on spending on experiences versus accumulating assets – criteria that VR can fulfill. Millennials also wants to make a positive impact on the world – carbon footprint reduction et al, and is an extremely social group…for example, 70% of them are more excited about decisions that their friends agree with, compared to 48% of non-millennials (Forbes data). Generation Z, of course, takes similar attributes to another level with tech immersion – and it wouldn’t be outlandish to say that the drivers of Snapchat and Instagram would prefer immediate experiences and spontaneity – again, up VR’s alley. Such a combination of attributes and behavior patterns among the population with spending power fits VR’s capability. Costs are a separate hurdle, but one that can be overcome; more on that below.

2. Capital spending changes: This is an interesting one. Per McKinsey data, I’ll reiterate that western corporations derived over 60% of the world’s profits over the past 30 years and tripled them in size, from 7.6% of GDP to 10% of total GDP over the span. Baby boomers entering the workforce around the 1970s, the unification of eastern and western Europe and China’s addition to the global economy – both in the early 1990’s – were all gamechangers with respect to the worker population and consumer needs. Consequently, the rise of cheap labor and global supply chains aided corporations which were large, and ones that could derive economies of scale and executional efficiency – think the DJIA components. Today, however, it’s a different era. Post-2008, the entrepreneurial drive of Silicon Valley, the ongoing information age, data-driven enterprises and the focus on ideas and asset utilization will define corporate behavior. With the rise of competition globally (in particular, Asia), McKinsey predicts corporate profits will erode back to the percentage levels seen in the 1980s. As a result, nimbler, more efficient corporations may shy away from traditional capex, training needs and perhaps even travel spending due to smaller sizes and an emphasis on lower overheads. VR will be able to substitute each of these activities extremely effectively – and therefore, the time may be right for a mainstream enterprise adoption.

3. A complementary ecosystem: Now, let’s think broader. VR doesn’t need to stay just VR. Other major structural trends taking off include the internet of things, artificial intelligence and robotics. Some stats? The IoT solutions market may be worth $7.1T (trillions, not billions), by 2020, per IDC. Per McKinsey, the US economy is only recognizing 18% of digitization’s potential. And today, robots perform roughly 10% of all manufacturing tasks, but the number may jump to 25% by 2025, per the BCG. There’s plenty more proof, but the point is that a convergence of advances in VR, the IoT, artificial intelligence and robotics may lead economic advances that are far beyond what each technology may contribute individually. VR could train machines to function by themselves, and sensors may monitor behavior and feedback, for example. The TAM, as a result, may be much larger than what current projections as a sum show. This concept requires a vision, but it certainly isn’t far fetched, and is in favor of VR’s adoption. Now, a look at the numbers.

The potential: Show me the money, right? The range of estimates for the VR market is pretty wide – but the lower limit is around $5B in 2016. Recode estimates a market size of nearly $70B by 2020 – over 10x that of today, so a ~15% CAGR for both VR hardware and software. TechCrunch goes further, estimating the augmented and virtual reality space at ~$150B by 2020, with VR around $30B. I believe that in the short term, hardware will dominate, but a few years out, the market will focus on the software, with ecosystems evolving to include more apps, open-sourced platforms, and significant indirect, yet tangible benefits – say, a reduction in workplace injuries due to better training. According to Goldman Sachs, major hardware devices have experienced pricing declines in the range of 5-10% annually over the past 20 years. So, while the headlines may be around the Rift today, the real innovation is just beginning.

In any case, the CAGR for VR and absolute size potential resembles that of the IoT, big data or the cloud – and yet, the VR space is hardly ‘proliferated’, in comparison with the numerous cloud firms riding the market coaster at the moment. Even though the life cycle stage may be considered embryonic (usually characterized with new entrants, no profits, explosive growth stories and some implosions), VR is different, given the major players are established mega caps, with billions in cash at hand; the leaderboard is hardly counting on VR for free cash flow – and as a result, can focus on longer-term innovation and large client relationships. At the same time, according to CB Insights, there were 91 investments totaling ~$1.1B in the VR field in the 18 months after Facebook bought Oculus, compared with 50 investments of $316 million in the previous span. So, it’s game on.

The Players in VR: OK – everyone and their investing mother knows about Facebook (FB), Apple (AAPL), Microsoft (MSFT), Samsung and Alphabet (GOOG).  A Lynch-style-10-bagger due to VR isn’t happening with this list – but their leadership is certainly worth some rewards. Sophic Capital estimates that Samsung’s Gear VR may conquer the mobile gaming space, since 78% of the world’s 1.2B gamers are mobile; Oculus Rift is expected to ship 3.6M headsets this year, per Piper Jaffray.

The details, then – the breakdown of the OculusRift, courtesy iFixit, shows an involvement with Toshiba, STMicroelectronics (STM), Samsung, Spectra7, and InvenSense (INVN). Invensense has a market cap of about $640M, trading at 14.7x forward P/E. Relationships with Apple cause the stock to lurch up and down, but the motion sensing technology is something to watch in this space. Equally intriguing are smaller firms, including Leap Motion and Sixense, both private currently, with leading forays in hand motion and motion tracking across both virtual and augmented reality. Intel (INTC) has been making graphic processing units for headsets as well, and has RealSense, its depth-sensing camera technology; it has outperformed the NASDAQ over the past 2 years. Nvidia (NVDA), meanwhile, with a $4.8B revenue, 5.4% 3-yr growth rate and a manageable forward P/E of 19x, was recommended by Oculus to consumers for an ‘optimal experience’ due to its GPU technology. In fact, the firm has smartly positioned itself for artificial intelligence, virtual reality, and driverless cars – all phenomenal structural trends with serious tailwinds. Another interesting firm is Sony (SNE). Sony has underperformed the NASDAQ by 95% over the past 5 years, but Piper Jaffray estimates it will be shipping 1.4M Playstation VR headsets this year – as an established gaming firm, there’s more to come here. To summarize, going all in on these stocks may not be too wise – but these are definitely some of the firms to watch. Software, meanwhile, is a whole untapped story, barely starting. VR is an incredibly interesting and unchartered public territory, and the disruption potential across sectors is likely to become extremely attractive for Wall Street in the coming months.

What it means for you: In a market where growth remains elusive, oil continues to coat stocks and emotions run high, fascinating ideas may be getting covered up behind the gloomy forecasts and bears running around. Virtual reality is one of them. In the next post, we’ll look at another subject with enormous potential: space, involving satellites, reusable rockets, and the players involved. Investors should stay strong – there’s plenty of innovation all over the place, and a whole lot of brightness to look forward to after the storm recedes on Wall Street.

January was rough on Wall Street. Kicking off 2016, the S&P 500 ended down 5.1%, the DJIA ended down 5.5%, and the NASDAQ ended down 7.9%. That wasn’t all; oil had lost nearly 18% as of January 26^th, and junk bond yields touched nearly 10% mid-month, highlighting an ominous 8% spread over treasuries – one that has indicated recessions in the past, per analysts. Similar quirky statistics continue to be circulated – it seems, with greater velocity – each day, in articles arguing why a US recession should or shouldn’t occur in the coming months. Here are my two cents.

To be or not to be…in a recession: Should investors fear a recession? Why not? Having caution and acknowledging risks is always useful. Consider recent economic data. We’re in an earnings recession, and corporate revenues seem to be following the trend down in Q4 alongside heavy foreign exchange headwinds, given the trade-weighted dollar is up 20% over the past 14 months. US industrial production has declined in 10 out of the previous 12 months, and profits last peaked in the summer of 2014. Alongside, the small cap Russell 2000 index is already well into a bear market alongside the Dow transports, and they’re in the fine company of numerous large emerging and developed markets abroad. Meanwhile, China’s debt ratios remain, to put bluntly, extremely scary, and Wall Street is gearing up for a battle with the yuan. If the hedge funds win, a depreciation would cause a turmoil potentially of proportions we have never seen, given China’s $11.4 trillion economy wasn’t nearly as big in the 1990s, when past emerging market currency crises occurred. So, yes, it would be wise to be concerned about 2016 for the economy.

Anyway, that’s the gloomy part. How about the bright side? The US has essentially full employment, unemployment claims are maintaining a healthy level, and the yield curve is pretty resoundingly upward. There’s no perceivable demand shock, given higher rates or credit crunches are nowhere on the horizon, and consumer debt levels are resoundingly solid; JP Morgan data shows debt payment as a percent of disposable income is at a multi-decade low of 10%. Cars are selling, houses are being built, and consumer confidence is high; household net worth is at all time highs, too. From a supply perspective, there’s essentially no inflation or commodity spike; rather, the opposite is happening with oil’s collapse. With the US being a net importer of oil, consumers, in theory, should have more to spend – and if they don’t now, that’s fine, because at least they save and can spend later. Importantly, services employ over 80% of the population, but with some data from Deutsche Bank, we see that 70% of the S&P 500’s earnings come from goods-manufacturing firms; as a result, a large-cap profit recession may not necessarily lead to an economic recession. American banks are also looking solid; per Barron’s, fewer than 5% of their loans have energy sector exposure, which means a collapse in junk bonds would remain muted; alongside, capital requirements have led to extremely robust balance sheets (and also a low return on equity, as we know well). Overall, there is no obvious euphoria – or, say, ‘irrational exuberance’ in the stock market; the S&P 500 is trading at roughly 15.2x forward earnings, per FactSet, while the NASDAQ finds itself at 17.1x – essentially in line with historical averages.

To summarize, the recession call is a toss-up – plenty of evidence to back up both sides. As you can probably tell, I’m in the no-economic-recession-upcoming camp. Bear in mind that bear markets are a different subject. Time will tell, but in the meantime, here are a few more curious points to keep in mind as February unfolds:

The Monetary Disconnect: The Fed is pricing in 4 hikes for 2016, while the market is pricing in essentially none. Where there’s a disconnect, there’s uncertainty, and where there’s uncertainty, there’s volatility. The BOJ’s negative rate decision last week, potential  emerging market currency wars and weakness abroad is already leading to tightness in America, and until we have more clarity from the US Fed (perhaps when Chairwoman Yellen speaks next week), expectations from the market should remain low. We’ve highlighted earlier that QE led to significant equity gains, including multiple expansion; since it ended in October 2014, the markets have lost value. The relationship cannot be disregarded. Further tightening will uncover whether the market fundamentals are solid enough to withstand higher rates; right now, things look a bit dicey in the global context.

The Political Situation: Have you noticed Bernie Sander’s epic rise in the Democratic race? Likely, yes – and so has everyone else, including Wall Street. Despite all the rhetoric, it’s common knowledge that the markets would prefer, and were expecting, Hillary Clinton to be the Democratic nominee until a few weeks ago. If Iowa and New Hampshire feels the Bern, so will the markets. Watch this space. The election season is just beginning, and given the implications of oil, immigration, corporate tax, and foreign policy, there is no doubt that America’s votes will be closely watched by investors.

Earnings Season: Yes, and finally, the fundamentals. Foreign exchange headwinds, macro weakness, and iPhone saturation is hurting the markets; at the same time, Facebook, Under Armour, Google, and several other growth stocks have blown through the roof. Investors are starved for growth, and as a result, be prepared for continued major moves amid surprises in earnings. Innovation and structural trends don’t stop for market corrections, and investors that stick by the firms that define tomorrow will be rewarded; there’s plenty of phenomenal stuff going on in all sectors of the S&P 500 today. But more on this subject in the next post. As of Feb 1^st, 40% of the S&P 500 had reported Q4 earnings, with 72% exceeding earnings estimates, and 50% exceeding sales estimates, per FactSet. The guidance from the remaining firms will be of particular interest as analysts dissect where the year is headed for corporations.

What it means for you: Would it help to have energy experts, geopolitical analysts, economists, corporate executives, and consumer representatives together to understand what’s going on? Perhaps, but there’s an easier option…and that’s Wall Street. The beauty of stock markets is that all the information comes together to drive value and returns; emotion, of course, adds to the charm in the short term. 2016 is proving to be an incredibly complex market environment – watch Q4 earnings and the January jobs report on Friday, and maintain low expectations regarding the direction the market takes as February unfolds.

Wall Street just got taken to the cleaners. Unless you were a clinical short-seller positioned perfectly last Monday morning, it’s likely you’re feeling pretty battered and confused after what turned out to be the worst start to a calendar year ever for the US stock markets. There are 51 more weeks to go in 2016…now what?

Here are some points to keep in mind as we battle through the storm:

Overvalued, with no place to go: Last week’s 0.5% on-shore yuan devaluation was nothing compared to the off-shore devaluation, where market forces caused it to fall by a much greater 2%. A continued downturn for the currency remains the inevitable path…and only when this is over, will equities to find their footing. Take last August’s example…the yuan’s devaluation caused the VIX stateside to touch 40 and equities worldwide to tumble; last week, a similar episode occured, with the VIX jumping to over 27 by Friday’s close, from 22.3 on Monday. Ripping the band-aid on the yuan’s value will hurt in the short term for many reasons – exporters to China will counteract, and global trade may face some hurdles…but at this point, there may be no alternative. So, brace yourself…until the currency valuation is sorted, this ride may not come to an end.

A bite out of Apple: Concerns around China are significant for Apple, given over ~60% of its revenue growth and ~75% of operating income growth, per some estimates, were derived from there as of late ’15. Apple is down around 30% from its peak in July. Even so, it still covers over 3% of the S&P 500’s market cap. As a result, a downturn in China will influence Apple, which will pressure the US markets.

The S&P 500 is actually outperforming: Note that the S&P 500 actually outperformed several of its developed peers last week; the Stoxx 600 was down 6.82%%, the Nikkei-225 was down 7.02%, Germany was down 8.32%; meanwhile, the S&P 500 was only down 5.96%. It may be a testament to the strength of the US economy and relatively insulated nature, given less than 1% of its GDP is derived from exports to China.

The 10-year yield fell…but only a bit: The 10-year yield ended at 2.12% on Friday, down around 14 basis points from Monday’s open. Being a favorite safe haven during rough times, the drop was expected…but just 14 basis points amid a 5 day, 6% collapse for equities globally in the first trading week of the year? That seems small. The reason may have been selling pressure from China or oil-producing nations to raise cash, which may have created a floor on the yield. As a result, gold may be a better barometer to watch investor fear, along with the VIX. On a side note, a continued US tightening as the year continues should pressure the 2-year T-yield upwards. As a result, the yield curve is likely to get extremely interesting given the numerous forces acting on both the long and short end. Watch this space.

Bear territory: The S&P 500 may be only off ~11% from it’s highs, but the average stock is already in bear territory, according to Bespoke Investment Group, highlighted by Barron’s. Mega-performers, such as the FANG stocks, can take credit for keeping the broader index from hitting the 20% down mark through 2015 and so far. As a result, their performance will be critical in determining whether the slide gets stemmed in the coming weeks.

Is QE’s influence going unnoticed? Data shows that during each QE round, equities did quite well. The 3^rd round of QE ended in October 2014, and since then, the markets have actually not moved. Is the influence of QE-induced liquidity more on the markets than Wall Street thinks? If yes, the tightening cycle may be even rougher than expected.

What it means for you: The points above may be helpful to keep in mind as Wall Street opens on Monday. We’re dealing with an extremely complex situation where geopolitical events, commodity prices, China’s economic reorientation and currencies are playing a key role in driving equity prices. Until the yuan has a price discovery moment, don’t have high expectations.

Has anyone seen the reset button? December has been quite iconic, considering the enormous market activity around central bank policy changes, a continued oil collapse, heightened equity turbulence and credit market turmoil…quite unlike the reduced trading and holiday season behavior one would expect. That being said, the S&P 500 finished up 1.5% last week, and ending 2015 in positive territory is no longer far-fetched.

The new year always brings new opportunities, and with 2016 forecasts rolling out across Wall Street, our take on what to expect next year begins with a macro outlook, and concludes with key trends to watch. Changing monetary policies have triggered a new financial era, and alongside, massive disruption amid consumer and enterprise behavior is under way. Opportunities are all over the place, and Wall Street remains as fascinating and as critical a destination as ever for connecting capital with ideas. Here’s our take for 2016.

The Macro Outlook

The Global Take: Yes, growth is slow. In fact, lower for longer, sub-par output, secular stagnation, lukewarm – call it whatever you wish, but the global economy is certainly not growing as rapidly as it used to pre-recession. However, the argument of ‘things aren’t the way they used to be’ could have been made in 2009, and even in 2002, when the Fed Funds rate was brought to near-zero and the 10-year yield fell to around 3%. Consider this – since the March’09 recession bottom, US growth stocks have outperformed their value equivalents by nearly 30 percentage points, hedge fund AUM have doubled to $2.7T even amid significant market underperformance, and the dollar denominated emerging market debt, high yield, and local emerging market debt asset sub-classes have delivered the highest 15-year annualized returns in fixed income. The private space, meanwhile, has thrived, with over 120 $1B+ companies worldwide as of October, per CB Insights. Our point? Low Fed Funds rates and treasury yields since 2002 have pushed investors out on the risk spectrum in search for yield; barring the 2004 tightening cycle, the December rate hike is likely to welcome investors back to the real world with a bang. Or, in more technical terms, greater volatility.

This tightening cycle is unique. In the previous US rate hike span, domestic inflation was above 2%, monetary policies were converging, commodities were in bull markets, and emerging market capital investment was surging; alongside, global growth was accelerating to 4%. Today, each of those characteristics are noticeably absent. As a result, past precedents may not provide significant insights into investor reactions now that the tightening cycle has begun, so be prepared for greater volatility. More on this below, but with that backdrop, we think the key themes to watch for in 2016 are potential geopolitical implications (in Europe, Russia and the Middle East) and their impact on the markets, the economic landing and reorientation in China, the search for commodity price floors, and importantly, the influence of diverging monetary policies on asset prices, including currencies. Wall Street’s consensus is calling for a modest increase in global growth next year, from 3.1% in 2015 to the mid-3%s in 2016. Here’s a further breakdown of some regions to watch:

Europe & Japan: With the noted success of QE in propelling equities upward in the US, the $1.1T program initiated by the ECB last year has had a similar effect on European indexes in local currency terms, with an outperformance by the STOXX 600 (7% YTD) over the S&P 500. Seeing a continued accommodative stance, the equity boost is unlikely to disappear in 2016. Alongside, as a net importer of oil, the benefits of an oversupplied market should also remain a tailwind for the region’s growth. The Eurozone grew by ~0.9% in 2015, and Wall Street is expecting an increase to ~1.5% in 2016. A key highlight is that household spending contributed nearly 75% of the total GDP increase in the region over the past year (BofA Capital Markets Outlook data). This is an incredibly positive sign – because alongside showing domestic strength, it makes the region less reliant on exports, especially amid continuing emerging market demand weakness. As a result, equities are relatively well placed to benefit in 2016.

We find risks for the European markets to be heavily stemming from the geopolitical front. Amid the migrant crisis, the growing popularity of extreme-end parties and consequent fiscal uncertainty may prove a major headwind, with Spain, Poland, Hungary, and other regions all displaying some divergence  from northern European nations. Alongside, we see that Wall Street’s banks – for several  weeks – have continued to beat the drum for an overweight position in Eurozone equities, therefore risking a crowded trade; the same goes for the euro’s weakness against the dollar. Feel free to invest, but note the caution on the political front. Germany remains our relative favorite in the area.

Japan is expected to grow at 1% in 2016, compared to 0.6% in 2015, per consensus estimates; similar views on the yen, meanwhile, expect it to weaken further, potentially reaching 130 against the dollar. We feel that Abenomics, while seemingly working, is yet to prove sufficient amid demographic headwinds alongside continued low inflation. In our opinion, private sector investment remains the key to sustained economic growth; the quality of earnings and capex, as a result, should be evaluated while considering investing…being selective may be preferred over just buying the NIKKEI and hoping that QE delivers.

China: China would likely take the crown for causing the most lack of sleep on Wall Street. As an $11.4T economy, nothing here goes unnoticed, including the ~250% debt-to-GDP ratio – which will need help sooner than investors are factoring in, in our opinion. We remain skeptical of investing in equities here in 2016 until there is greater clarity around monetary policy. As the nation steers itself towards a domestically oriented, service-and-consumption-driven economy, watch for PBOC’s policy changes around the yuan in 2016; further weakness will help given the current overvaluation (in our view), but the consequent impact on other emerging markets’ competitiveness as well as the US 10-year yield may be significant. That being said, China is a solid structural long term investment play; by 2030, over 50% of the world’s middle class will be located in emerging markets, from approximately 20% today, and China’s potential for driving the 45% of spending coming from emerging markets – also double the percent of today – is tremendous. The country remains a major wild card for 2016, but don’t worry about missing anything, because every bit of data originating here is sure to be dissected at length by investors worldwide.

India: India’s growth since its market liberalization in 1991 has been fairly robust and structural in nature, albeit, slower than China’s. The young demographic age and room for growth provides significant potential for the long run. The pro-business Modi government, elected last year, has yet to deliver on some of the promised reforms, but overall signs remain encouraging. Importantly, the economy is relatively less dependent on foreign conditions, with less than 15% of its GDP derived from exports. The relative outperformance against peers in 2015 is noteworthy, with the rupee down only ~5%, and the Sensex off -7.4% YTD, compared to the EEM index, off -15%. As a net oil importer, it was handed a bonus with oil prices plunging in 2015; expect inflation to tick up next year as oil prices find a floor and businesses acclimatize. Amid the global monetary policy emphasis, the RBI’s policy will continue to be heavily scrutinized; interestingly, the RBI recently signaled that its policy will be dictated mainly by domestic growth inflation dynamics, rather than US Fed tightening, which is ‘materially different than other emerging market central banks’, as highlighted by JP Morgan’s Global Data Watch team. Furthermore, government spending grew from 1.2% YoY to 5.2% YoY from Q2 to Q3; this is likely to reduce in 2016, and private investment and consumption will need to take the reins quickly to deliver on the 7%+ growth expectations. While challenging, India remains a structural win for the long term, and investors can expect an outperformance against its peers in the coming year.

Emerging Markets: As noted in August, 44 nations consider China their largest export market, per Forbes data. Currency headwinds, foreign exchange reserves and debt-to-GDP concerns will catalyze divergence in performances in 2016 from the asset class. Nations with notable exchange rate links to the US dollar will likely see significant pressure, especially if they are commodity-driven economies; Chile, South Africa, Columbia, Peru and others have already initiated rate hikes to deter capital flight, which will likely dent economic growth. Nigeria, Russia, Venezuela, and several others, meanwhile, are suffering from fiscal constraints due to low oil revenues. Political reforms may cause surprise winners; watch Brazil. Overall, corporate debt stands at 75% of GDP for emerging markets – double the percent of 12 years ago, and dollar denominated debt has doubled from 5 years ago…not a strong balance sheet when US conditions are tightening, global growth is modest and commodities are weak. We expect a continued underperformance from the emerging markets in 2016.

The United States: And finally, we turn stateside, where over half of the world’s market capitalization resides. Domestic conditions are robust; labor markets find themselves at near-full unemployment rates of 5% (U3) and 9.6% (U6) as of November; core CPI, meanwhile, is at 1.9%, and core PCE at 1.3%. While still lower than the 2% inflation target, the trend is positive. Furthermore, the NFIB Small Business Survey found in November that the percent of small firms planning to raise compensation has jumped to the highest level since 2006; given its robustness as a leading indicator, the Bank of America is projecting wages to rise to 3% from the current 2.5% as the year proceeds; we concur. With favorable oil prices, an ongoing auto and housing boom, a deleveraged consumer base with a high savings rate and a modest ongoing recovery, a profit recession currently under way in 2015 is unlikely to cause an economic recession next year; ex-energy, in fact, S&P 500 profits are actually up 2% YTD (Yardeni Research data). Per FactSet, consensus estimates are calling for $128/share in S&P 500 earnings in the coming 12 months, which would imply a forward P/E of ~16x – hardly ‘stretched’ by any measure.

At the same time, credit spreads in the high yield segment have rapidly widened, and amid higher costs of capital, record shareholder-friendly dividends and buybacks (estimated at $1 trillion in 2015, per Barron’s) should reduce substantially in 2016. The 2-year yield has nearly doubled to 1% in 2015 amid the rising rate environment, while the 10-year has essentially remained stagnant, at 2.20% – against Wall Street’s estimates calling for a much higher year-end yield back in January. A continuing flattening of the yield curve could cause concern. It is also important to note that shareholder returns and M&A activity, meanwhile, last peaked in 2007 – and you may recall what happened in the following year; the previous M&A record was in 1999, and the year after also had a similar story.  Therefore, the post-zero-interest-rate era will likely require a significant recalibration of shareholder expectations.

Historical forward P/E data shows that multiple contractions have occurred over the past 2 tightening cycles. This time, the situation may be dicier. Experts continue to argue on whether tightening is necessary, and we find essentially no developed world tightening success post-2008, with reversals in  Sweden, Israel, the ECB and Canada. Previous tightening conditions, as noted above, are noticeably absent. As a result, volatility is likely to be higher in 2016, and we believe a forward multiple contraction from today’s 16 to 15.3 may occur. We estimate negative single-digit S&P 500 returns in 2016, with a projected year-end value of 1960.

However, amid potential market weakness, individual stocks should show significant divergence amid structural market trends; there is plenty of outperformance potential from certain sectors, similar to this year. In a contrarian play, we prefer growth stocks over value stocks given the lack of growth worldwide may continue to crowd investors into rewarding stocks that do show growth. Alongside, we prefer less leveraged over more leveraged firms, domestic US over international assets, and TIPS over HY debt and short-term treasuries. All of this, of course, amid greater volatility.

Trends To Watch

Away from macro, the perspective changes dramatically when you consider how a firm with a ~$300B market cap firm and 1.5 billion users can have a 30% sales CAGR (Facebook), a $30B consumer-oriented firm founded in 1964 can continue to display an 8% 10-year CAGR (Nike), or how a  streaming network which began as a DVD-service 18 years ago is upending decades-old media firms today with a 24% quarterly YoY sales growth (Netflix). Did someone say we’re in a slow growth environment? Think again.

2015 delivered massive disruptions in entrenched sectors, with the advent of AirBnB, Uber and others on the private side, and exceptional performances by Facebook, Netflix, Amazon and Google on the public front, to name a few. We felt the winning characteristics in 2015 could be distilled down to data analysis, information transfer, and asset utilization; firms which effectively delivered at least 2 out of the 3 themes gained serious value…of course, the product had to be good to begin with. A significant number of these companies were in the consumer discretionary and technology sector; consequently, both were among the top three performers in the S&P 500, up 8.8% and 5.6% YTD respectively. Here are some trends to watch in particular in 2016.

Demographics will greater influence business models. Millennials just outnumbered baby boomers in the US; in the coming 5 years, the world will have over 2 billion people in this group, commanding over $2 trillion in spending power and consisting over 70% of the total labor force. The generation is characterized by the highest debt level of any US generation, shows a weariness of stock markets after seeing 2 brutal crashes while growing up, and is hell-bent on staying healthy and making the world a better place (less carbon footprint, more kale salad, etc.). Furthermore, millennials prefer experiences to assets, desire customized products, and need instant gratification, per research from Cassandra Reports.

With such characteristics, firms and brands that prefer localization over globalization (for speed to market and relatability), those that identify themselves as promoting sustainability or being environment-driven, and those that can create tailor-made products have competitive advantages over those that don’t. We’ll expand more on particular firms to watch in the coming weeks.

E-commerce will keep booming. Brick and mortar sales were negative, while e-commerce grew at approximately 15% in 2015, per ComScore. Even better, e-commerce constitutes just 8% of US retail sales so far, per the US Census Bureau. A WSJ interview with a shopper last week summed it up, stating ‘pile the whole family in the car, fight the crowds with the stroller, and what if they don’t have what you [want]?’. There’s no going back…welcome to the Amazon world. Be careful regarding upstarts in the space, however…Amazon’s really, really good at its game.

Supply chains will transform quicker. Additive manufacturing (3D printing) will continue to move into the limelight. With the global working age population set to slow in the coming years, amid wage pressures and logistical complexities underlying global supply chains, companies investing in capital equipment will continue shifting towards robotics, faster speed to market and new technology; look for 3D printing to deliver for more firms in the way it has for Boeing and Alcoa so far.

Artificial intelligence, block chain technology and digitization will gain focus. The potential for the trio is tremendous; AI could rapidly change machine interaction, block chain technology could remove intermediaries from all sorts of electronic transactions (think credit transactions), and digital analytics could seriously enhance productivity. According to McKinsey, online talent platforms, big data analysis and the Internet of Things stands to add up to $2.2T to US GDP by 2025. Furthermore, healthcare, construction and the hospitality sectors are among the least digitized, while utilities, mining and manufacturing are in their early stages; overall, McKinsey states that US economy is only realizing 18% of its digital potential; firms have realized this, and the number of connected devices in the world are expected to triple to nearly 40 billion by 2020, per Juniper Research. The potential extends to the public sector, including initiatives for smart cities. Watch for firms including Palantir, Google, as well as the older guard of Microsoft, IBM, and others to move such ideas ahead. We’ll elaborate more on this subject in January.

Alongside, expect decentralized currency talk (regarding bitcoin, etc.) to make a resurgence amid central bank fatigue as 2016 progresses. We’re also keeping an eye on Facebook, given its track record of being ahead of trends…the timely purchase of Oculus gave it a headstart in the virtual reality space, and after Whatsapp and Snapchat, Facebook Messenger’s incorporation of Uber is also a potential game-changer. If the app-in-app trend takes off, similar to Tencent’s WeChat model, Apple’s App Store may stand to be impacted big time.

The real-time sourcing of data will start realizing its potential. Keep an eye on firms including PlanetLabs, Orbital Insight and Descartes. If hundreds of tiny satellites – the size of shoeboxes – take images of Earth each minute to watch shopping mall cars, construction site shadows, crop yields and oil tanker locations,  information knows no boundaries. Speaking of which, the private sector is making major advances in space overall, including SpaceX and Amazon. The opportunities are just endless in this field, and the exploration is just beginning.

Alternative energy technology development will progress. Fusion energy development from firms such as Tri Alpha and Helion Energy has tremendous unrealized potential, while hydrogen cell technology, displayed by the Toyota Mirai launched in California this year, may begin to make inroads alongside the Tesla-led electric vehicle space. In general, renewable and clean energy should create significant news, especially with COP 21, originating from the Paris Climate Change Conference. According to the Blackrock Investment Institute, Norway’s $873B sovereign wealth fund will no longer invest in fossil fuels. The money has to go somewhere, right? Political incentives for renewable energy technology development and implementation should help move the field ahead.

Assisted driving will drive attention. And finally, we touch upon our favorite subject – assisted driving. Why? Because human error causes over 95% of auto accidents – and last year, killed over 33,000 people in the US alone. Apart from saving lives, over 6% of US GDP could be freed up for better use, according to the Boston Consulting Group. The stunning numbers, along with a greater emphasis on safety by the US NHTSA, will drive automakers to move into the later stages of Levels 1, 2, 3 and 4 ADAS technology. Expect greater collaboration between tech and auto carmakers; firms such as Mobileye, Tesla, and Google will remain in the limelight, alongside the usual manufacturers including Ford, BMW, and GM.

Financial technology will find its footing. Before we conclude, a quick thought on financial technology – a hot topic on Wall Street. Seeing Silicon Valley’s collaboration with the big banks, the potential for mainstream adoption is enormous regarding online lending, crowdsourcing, etc. However, in a higher interest rate world, lenders and borrowers will need to adapt to capital that is more expensive. The business models are yet to be tested in such an environment, and as outlined in the WSJ last week, firms such as Lending Club, etc. will face challenges…we stay incredibly optimistic on the potential, but would exercise caution while investing; the details are important and being selective will count. Digital wallets and mobile payments, meanwhile, are a more obvious bet; per predictions from Forrester, money spent in stores by these methods will grow from $4B in 2014 to $34B in 2019, and transaction volume growth is projected to be far over 20% annually in the coming years. The players include Apple, Samsung, Google, and others. More to come on this in January.

What it means for you: Wall Street links capital to the ideas that deserve it – and over the years, it has done a pretty phenomenal job. For 2016, we may see short-term ups and downs due to monetary policy changes, commodity price fluctuations and irrational investor behavior, but don’t forget that patient investors have been handsomely rewarded; long-term data shows annual returns averaging ~10% from the S&P 500 during the post-war era. Firms with visionary management teams and great products shape markets, and when they do well, so do their investors. Next year might be volatile, but the highway to prosperity wouldn’t be nearly as rewarding if there weren’t some challenges. Investors should gear up…Wall Street promises to be an incredibly fascinating destination in 2016.

As 2015 winds down on Wall Street, it’s always worthwhile to look back on projections from the beginning of the year.  Alongside the binary outcomes of whether they were right or not, the logic is equally interesting to think about, and extrapolate whether it applies for the future. The key themes seen throughout? A divergence among monetary policies, a continued search for growth by investors, the rising influence of technology in consumer and enterprise behavior, a collapse in commodities, and crowded trades alongside increasing volatility in the broader market. Here’s our recap of 2015.

To date, the Dow has returned -3.9%, the S&P 500 has returned -2.6%, and the NASDAQ is up 3.9%. What could be the takeaways? The index with the smallest median market cap looks to have outperformed its larger peers. Growth seems to have outperformed value, and domestic firms fared better than the ones deriving more revenues abroad. Also worth noting? A handful of market cap giants, including Amazon, Facebook and Microsoft, have contributed a vast majority of each index’s returns. Excluding them, the numbers look far more bleak; the Guggenheim S&P 500 Equal Weight ETF, for example, is down nearly 5% YTD. Overall, earnings for the S&P 500 are flat for the year, while revenues are projected to have declined 3.4%, per FactSet. Not quite what you’d expect in the 7^th year of an economic expansion and bull market…then again, the post-2008 era has been extremely unique amid near-zero interest rates, lower-than-historical average growth rates and a lack of worldwide inflation. Therefore, historical precedents may not be as applicable.

Anyway, back to 2015. At the beginning of the year, we outlined our bullishness on technology and biotechnology, as well as the consumer discretionary sector. The underlying logic alongside the details was that the first two sectors were less impacted by macro concerns, and were leading a structural market shift through innovation and entrepreneurship. Our ‘Why Technology Matters’ article in May summarized the thoughts. Both sectors have performed extremely well, up 2.6% and 9.3% respectively (with the IBB ETF representing biotechnology). Regarding consumer discretionary stocks, we felt that consumers were sitting on robust balance sheets and savings, and were well placed to spend. The recent auto boom as well as housing uptick shows this may be playing out; oil’s collapse has been another bonus. Consequently, the consumer discretionary sector – our favorite pick since January – is up 7.3%, the best performer of the year – and more gains may be yet to come in 2016, given spending has actually been pretty subdued so far.

Financials were also recommended in Q1 given a rising rate environment, and alongside, we highlighted cybersecurity stocks, amid an increasing need for firms to protect themselves (to put mildly – especially after seeing Sony’s hack). Both are underperforming the S&P 500 so far, with financials down 5.1% and cybersecurity down 3.9% (represented by the HACK ETF). The theses continue to apply for 2016.

On a broader note, we felt growth would outperform value. This proved out extremely well; growth-starved investors displayed resilience in rewarding the few stocks that have shown organic growth, with the Russell 1000 Growth index up 3.7% vs -6.3% for the value equivalent.

Another prediction was that small caps would outperform, given the US recovery and fragile international environment. According to the SBA, small businesses comprise over 99% of total US employers, and employ over 70% of the US labor force; with a proxy such as the Russell 2000, over 80% of the index’s revenues are derived domestically, according to research from the Bank of America. With a strengthening dollar further aiding our view, we felt this was a wise bet. However, this is yet to play out, with the Russell 2000 down -6.9% vs the S&P 500’s -2.6% – primarily due to expensive valuations to begin with. We feel the thesis remains intact, as again noted in our August 9^th article. Another quote we continue to emphasize is ‘bigger is not always better’, given the era of execution efficiency shown by the previous 30 years’ multinational titans may be ending, in favor of more local, nimble, and simpler business models, as seen by the disruption in asset utilization, data-driven decision making, entrepreneurial culture, and idea-intensive companies worldwide.

The year’s headlines were dominated in phases by Greece, China, oil, the high yield bond market, and the Fed. We raised red flags on the high yield bond market and China (ex-consumption stocks) in the beginning of summer. Both stories have proved out pretty well. China’s call was largely driven by valuations and the overload of debt. A timely report by a Barron’s journalist on how farmers were shunning their jobs to day trade stocks was one of the memorable moments, considering the lessons learnt in the dot-com bubble around less sophisticated investors joining the uptrend late. Stocks there have since corrected, and are at far more reasonable levels today as the $11.4 trillion economy moves into a new development gear. Alongside, our worries around emerging market debt and currencies in light of a tightening US monetary policy remain high on the radar for 2016. On a separate note, an attempt to call a bottom on oil when it had reached the $40s (WTI crude/barrel) was futile; realizing the efficiency of this commodity market, it’s best to go with the flow and take the price given the complex supply and demand scenarios, with geopolitical nuances involved.

On a macro perspective, meanwhile, we predicted a stronger dollar, and an outperformance by Europe. Both came true, with the dollar index up 10% YTD and the Stoxx 600 up 5.5% YTD, albeit, in local currency terms; a conversion would wipe out the gains. From a country perspective, our favorites included Germany, Mexico, Indonesia, the Philippines, India and South Korea. While the time horizon on these is far beyond 1 year, so far, in local currency terms, we’ve seen mixed progress, with the indexes up 8.2%, 0.8%, -14%, -5%, -7%, and 3.1% respectively. Much of the downside ex-Germany can be attributed to the overall negative emerging market sentiment amid a tighter Fed; domestic fundamentals remain strong, although as with all emerging markets, time and again, it remains obvious that political news matters – substantially. We expressed serious caution around South Africa (in the short term), Russia, China, and Brazil for 2015; each except China has played out, delivering -2%, -3%, 10.6%, -9.5% respectively. In dollar terms, of course, these move substantially lower.

Alongside, we also noted that markets would face higher volatility, which would enable stock pickers to have a far better year than 2014, where less than 20% of active managers outperformed, per data from S&P Dow Jones Indices. That has certainly played out; this year, with data from the CBOE, the VIX has averaged around 16.4, compared to the 2014’s average of 14. Active outperformance is projected to be over 40%; we’ll have a more accurate number at the end of the year.  We also projected that the IPO market would remain heated amid accommodative public markets, and M&A activity would continue to prosper amid a low growth global environment. The latter played out, but the former did not; IPOs are down 38% this year, per Renaissance Capital, and we feel good about it – the public markets are greeting sky-high unicorn valuations with serious caution, and that’s a very good sign against complacency. M&A activity, meanwhile, has shattered records, at nearly $4.3 trillion, per Dealogic, YTD. A key point to note is that the last time M&A activity reached relatively similar stratospheric levels was in 2007 and 1999, and  what happened in each of the following years can be vividly recalled. At the same time, with our preference for long term investing, the thoughts above are essentially data points to think through as the multi-year time horizon unfolds.

We conclude with the 10-year yield, which started the year at 2.17%, and amid increasing equity volatility and a rising rate environment, have ended essentially flat, at 2.20% as of Friday; Wall Street had predicted higher rates by the end of 2015. Another key data point? Last week’s first rate hike announcement, in fact, was greeted by falling yields, interestingly, into the weekend. 2-year yields, meanwhile, started the year at 0.67%, and ended last week at nearly 1%. Given their higher sensitivity to Fed Fund rates, it will be important to keep an eye on the yield curve, and whether a similar continuation in moves leads to a flattening into 2016.

What it means for you: All in all, the S&P 500 finds itself at 15.7x forward earnings (given an earnings consensus of $127.66, per FactSet), and the NASDAQ at 19.5x, per WSJ data – certainly not stretched per historical averages. However, in a rising rate environment and amid serious shareholder friendliness addiction over the recent years, investors should exert significant caution while positioning for 2016. We’ll deliver our outlook on next year in the following week. Wall Street’s capital markets  are entering a new era – one where the US is tightening but few others are, the emerging markets aren’t surging, and commodities are finding new levels alongside paradigm shifts in technology.  Be prepared for what should be an extremely interesting – and insightful – year ahead in the financial markets.

As Q4 heats up and the US economy enters what is arguably the most important 4-week stretch of every year, investors are busy deciphering the biggest risks facing the markets. Sustained weakness in commodity prices and geopolitics are occupying the top spots, but concerns around private valuations persist. It’s fully understandable, given the murkiness involved in distinguishing the worth of such firms because, of course, they’re private. Is a bubble lurking around the unicorn family? We don’t think so. Here’s our logic:

The Context: To begin, let’s lay out the background. Growth, as a whole, has had serious attraction to investors of all asset classes given negligible bond yields, a general environment of slow global growth, changing consumption dynamics and wide-ranging regulatory reforms in a post-recession world. Even 7 years post-crisis, we’re staring at a top-line decline of 3% for 2015 for the S&P 500, per FactSet data. Granted, the strong dollar, energy, and materials are all weighing…but excluding them would paint an incomplete picture. With growth in short supply compared to historical norms, investors are willing to risk crowding into asset classes that are categorized as growth-oriented. Note, for example, that the Russell 2000 growth index has outperformed the Russell 2000 value index right since the March’09 recession bottom, with a return of 271% compared to the 247% as of November. This year itself, growth stocks are up 6.9% compared to value stocks’ -2.1% return, and the S&P 500’s 1.5% return. In an uncertain economic environment amid continued geopolitical tensions, wouldn’t you expect investors to shelter amid value stocks? Apparently not…because, in our opinion, the low interest rate environment  has pushed investors out on the risk spectrum (some willingly, and some out of no choice) – and as a result, the few firms actually showing robust growth have shown equally stellar stock returns. Think Facebook, Apple, Netflix, and Amazon – each stock has performed phenomenally this year amid magnificent, totally macro-concerns-devoid growth rates of 20%+. Here, bring in the unicorns – the elite, $1 billion+ valuation firms in the private sphere, also showing similar if not higher rates. To summarize the point above, investors are scouring for growth, and consequently, the private world is also prospering. But more on this later.

The Size: Next, note that the Dow has returned -0.1% YTD. The S&P 500, meanwhile, is up 1.5%, and the NASDAQ is up far more, at 7.7%. Now, consider that the Dow has a median market cap of roughly $152 billion, compared to the S&P 500’s $18 billion, and even lesser for the NASDAQ 100. Can the Dow’s behemoths compete in today’s nimble, instant-gratification-driven, health-and-wellness-obsessed millennial economy? The long-running success of a majority of the Dow’s components was driven by operational excellence, phenomenal execution and financial efficiency under large corporate shields – think of the power of the GEs, 3Ms, and McDonald’s of the world. Historical data proves this. Per McKinsey’s estimates, as we touched upon in our Sept 28^th column, Western firms tripled their profits over the past 30 years, from 7.6% of GDP to 10%, and accounted for over 60% of profits worldwide. Long term investors were well rewarded, with the Dow moving from around 1,370 three decades ago to today’s 17,700+ number, amid countless dividend payouts. Post-recession, however, the situation is different. Not only has the Dow underperformed YTD, but importantly, it’s been a laggard right since the recession bottom in March’09; since then, the S&P 500 is up 176%, the Nasdaq is up 256%, and the Dow is up only 146%, per Yahoo Finance data, not counting dividends. Essentially, the large, corporate titans thriving on scale economies may be entering a new era – one where bigger is not necessarily better, and local may be better than global. Again, the unicorns are driving this change more than you may think – Uber, and Airbnb, among others, are at the forefront of asset utilization, data transfer and information analysis. On this note:

The Unicorns: Today, we’re looking at approximately 140 firms valued at over $1 billion in the private world, with around 70% of them American, according to CB Insights. By all means, the number is greater than ever before – the total valuation of these firms is roughly $505 billion. While staggering, it makes sense to take a step back here. Let’s put this in perspective, the $505 billion value is roughly equal to Google’s $511 billion market cap, and far less than Apple’s $680 billion. Facebook, by itself, is nearly $300 billion; in all, private valuations are approximately 2.5% of the total US public market sphere. Investors, as we discussed above, have willingly paid for growth in the public markets – why should the private space be any different? Importantly, here’s the kicker: the public market remains as diligent as ever – with the lukewarm reception to the IPOs of Etsy, Pure Storage, and First Data all showing that spillover effects may be minimal if private valuations implode. Despite the rise of the unicorns in 2015, the NASDAQ is trading at 19x forward earnings – certainly not stretched, and tech IPOs have reduced dramatically this year – down over 50% since last year, according to the WSJ. The dotcom bubble remains fresh in investors’ minds; back then, 261 companies raised over $53 billion in 2000 through public offerings. Last year, it was only 53 firms, raising around $10 billion. This year? Less than 11% of US IPOs have been tech so far – and many of them have been lackluster, with more than 40% pricing near or below their most recent private valuations, per Fortune. Square’s IPO was a litmus test last week, and the caution shown by the public investment world was worthy of applause, given that mobile payments is a massive secular growth story, but just because a company is in the space, it doesn’t mean it will thrive. The private market may think what it wants – but as long as the public sphere’s attitude towards IPOs remains diligent – the way it has shown to be in 2015 – investors shouldn’t be too concerned.

What it means for you: The success of the Dow’s global titans was symbolic of the US markets over the past decades. In today’s generation, however, such legacy stories don’t hold nearly as much sway as, say, Facebook or Netflix; alongside, several firms in the private sphere have disrupted a range of industries already. Investors are loving growth, and while good washouts are always in order – be it any asset class or business cycle phase – the disruption arising from the private world is real. Classifying the entire private space as a bubble can make for some good dinner-table talk, but smart investors should separate out the worthy disruptors and watch the public markets for signs of complacency. Until cracks start forming via unjustified P/E expansions, lesser scrutiny on IPOs, and recently public stocks moving up without reason, we’re staying happily invested on Wall Street, as the consumer takes the limelight in the coming weeks.

Wall Street’s reaction to the October jobs report has been pretty clear. While last Friday led to mixed trading as the market took in the details, the start of this week has shown significant evidence of investors positioning themselves for a December Fed rate hike. US equities have sold off in an orderly manner, global markets are trending down, and treasury yields – which had spiked on Friday – have stayed above 2.3%. Alongside, the dollar has gained in strength, with the euro nearing 5-year lows again at $1.07. Importantly, Fed Fund futures indications of a December rate hike are showing a 70% probability. That’s pretty high, and the data point has been a pretty accurate one so far this year. While the Street remains polarized regarding the need or benefits of an interest rate increase, investors will nevertheless have to adapt – and emerging markets will be heavily scrutinized against safer assets. So, here’s what we’re thinking:

Caution Abroad: As the end of the 7-year long unconventional US monetary policy comes closer, the repricing of assets has already led to significant volatility and divergence between developed and emerging market  classes YTD. The Fed rate hike – whenever it occurs – will potentially enhance capital outflows from the regions, where investors have sought returns in a low yield global environment – essentially all the way back since the early 2000s. Emerging markets greatly benefited with capital inflows after the Fed lowered rates in the aftermath of the dot-com bubble to stimulate the US economy; the BRICS led the world’s corresponding growth, and provided a cumulative stock market return of over 420% from 2001 to 2010, compared to a 44% gain for the MSCI All-World Index and approximately 15% for the S&P 500. Post-2008, the economic environment changed, but monetary policy remained accommodative. 2013, however, was a turning point – where the signaling of the end of Fed quantitative easing led to the infamous ‘taper tantrum’, hurting emerging market stocks and bonds all around. The emerging markets index (EEM) has returned approximately –15% since then to date, compared to the S&P 500’s return of nearly 30%. Net capital outflows this year have amounted to $540 billion, per the WSJ – the largest amount since 1988. Volatility, meanwhile, has been elevated, and we’re thinking the underperformance will continue until after the rate hike occurs.

Alongside, China’s economic landing remains a source of concern. With an $11.4 trillion dollar economy, the country was a leader in commodity consumption over the past decade, consuming over half of the world’s iron ore, coal, aluminum, and nickel, leading to the well-established commodity super cycle and benefiting markets including Brazil, Malaysia, and others. The super cycle began in 2000, and peaked in 2008; the Bloomberg commodities index is down 61% since then given slower global growth, the reorientation of economic drivers, and unconventional monetary policies worldwide that have led to currency moves, which, in turn, have pressured commodities that are denominated by them, including oil, for example. As a result, the 44 nations that consider China their largest market have also suffered, and US monetary tightening will likely only add to the complexity. As we’ve mentioned in our previous columns, emerging market debt has quadrupled since 2003, with bonds outstanding at $18 trillion today, while foreign ownership has also increased substantially. Emerging market debt denominated in foreign currencies has doubled over the past 5 years, to over $1.4 trillion. Overall, the EMD sector has delivered an annualized 7.8% return over the past 15 years – the best performer in the fixed income asset class. The data shows that investors have gone searching for yield with the expectation of low yields in the US. The 2013 taper tantrum was a wake-up call, and consequently, a future rate hike should, in principle, be navigated with caution around emerging market investments.

What it means for you: Emerging market investors should brace for some rough seas ahead in the short term. Furthermore, some divergence with the sector among nations is likely. Those with commodity-driven exports, foreign exchange reserve deficiencies, and high government spending remain the most vulnerable, while the implementation of domestic reforms, government elections, and state owned enterprise divestment signals may provide upside surprises. Morgan Stanley’s Troubled 10 list provides some names, and will be in the spotlight as the year-end comes closer. At the same time, note that 80% of the world’s population resides in emerging markets. To quote Todd McClone in a recent Barron’s article,  ‘if we can’t find companies that are benefiting from the spending habits of the 5.8 billion people living in developing countries, then I don’t know what we are doing here’. If emerging markets live up to their name and ‘emerge’ in the long run, the short term roller coaster rides will be well worth it for investors that choose to stay the course.

One of the of the most symbolic – and debated – characteristics of the post-recession financial world has been the influence of unconventional monetary policy on asset classes and corresponding returns. US and global growth has been below historical averages, economic leadership from the BRICS is no longer the fallback, the global working age population is increasing at a slower rate than the pre-recession era, and new technological breakthroughs and low demand have driven commodity price collapses, impacting budgets and sending the economies of nations worldwide scrambling for cover.

Amid such a unique economic environment, it is worth noting that certain asset classes, including US equities, have more than tripled from their recession bottoms. Last week was another interesting example of their interaction with monetary policy; as the ECB announced further stimulus potential and China lowered its benchmark interest rate, the S&P 500 finished up by 2.0% to reclaim positive ground for the year; the NASDAQ was up 2.97% alongside. As global easing measures further complicate the US Fed’s interest rate hike decision, the markets seem confident that policy divergence won’t occur for some time; Fed Fund futures are decisively pushing the first hike all the way back to March, with a 60% probability. Consequently, emerging markets are rallying, the dollar is weakening, and high-yield bond yields have also flattened out over the past two weeks. Do such indicators suggest that the coast is clear for equity investors in the short term?

We’re seeing caution. Playing equities by purely betting on the Fed rate hike may blind investors from the fundamentals – which continue to reflect warning signs. Our concern remains around the fact that the 10-year treasury yield – which had reached a high of 2.5% earlier this year – ended the week at 2.08% – essentially hovering around the year’s lows. Meanwhile, over half of the gains of the S&P 500 on Friday were driven by a handful of tech behemoths reporting incredible earnings – Amazon, Google, and Microsoft among the names – with Facebook entering the $300 billion market cap club alongside, per WSJ data. The success of such firms – and their size – can easily cause investors to glaze over the fact that revenue growth for Q3 so far has been missing expectations more so than expected, and earnings haven’t exactly been pleasant either. Per FactSet data, only 43% of companies that have reported Q3 earnings are showing sales above estimates, while the blended earnings decline is -3.8% – a back-to-back quarter decline. Corporate bond issuance, meanwhile, continues to show some cause for concern – companies continue to attempt to lock in debt at cheap yields while low rates persist; average corporate debt maturity was at 21.3 years in September, per SIFMA data, reported by CNBC – not only the highest length since record-keeping began in 1996, but also showing a 1-month jump of 39%, and a 45% gain from 2014. Again, the surge in corporate activity points to an attempt to capitalize on the rate hike window. Alongside, M&A activity – and the corresponding sizes of transactions – continue to overwhelm; the SABMiller-ABInBev merger valued at $104 billion, Dell’s bid for EMC, and other such transactions are significantly relying on debt for funding. Will investor sentiment remain bullish when the rate hike eventually occurs, and the cost of capital suddenly becomes higher?

What it means for you: Alongside capital appreciation, shareholder returns through dividends and buybacks, and corporate actions including capital structure changes, M&A activity, and real estate transactions continue to help corporations and investors maneuver through an incredibly complicated financial environment. It will be critical to distinguish – soon – between companies that have merely utilized the inexpensive liquidity to fund short-term activities versus those that have actually invested in decisions for the long term. Investors have been parched for yield for years, and equities have correspondingly been the go-to place. The risk remains that investors may have become short-sighted. A change in perception, expectations, and an ability to adjust will be necessary as and when a tighter monetary policy is implemented, and the next stage in the post-2008 recession era for the global economy begins. Thankfully, the market thinks this may not occur until March. As a result, staying focused on the corporate fundamentals to identify the real winners will be the key to returns, as investors swim through the choppy seas while Q3 earnings continue rolling out on Wall Street this week.

As Q3 earnings continue unfolding this week, the S&P 500 index stands down 2.0% YTD, and up 5.8% over the past year. It’s interesting to note that the top 3 sector returns YTD come from among the top 4 sectors expected to show the highest EPS YoY growth in Q3. So, regardless of the volatility in recent times, expectations may have been factored in pretty well into stock prices. Alongside, according to FactSet, if the S&P 500 reports a reduction in Q3 earnings, it will be the first back-to-back quarterly earnings decline since 2009. With relatively low bars set for results, here’s what we’re keeping an eye on this week:

The S&P 500 finds itself trading at 15.9x forward P/E – above its 5-year average of 14.1x and 10-year average of 14.0x (FactSet data). The index lost over 6% in Q3; at the same time, the dollar remained stable, and oil continued downwards. Q3 revenues are projected to decline 3.4% from the year earlier – following a drop of 3.3% in Q2, and 2.8% in Q1, per CNBC. As EPS growth drives stock returns, how companies cut costs will likely be the key focus for investors. Alongside, a slew of bank earnings this week should provide a critical data point on mortgage and housing trends. As of August, housing starts remained below historical averages, but US residential construction spending climbed above $36 billion – the highest monthly total since October 2007, per the WSJ. Auto sales, meanwhile, have also been robust throughout the summer – and alongside a 5.1% unemployment rate, a 10% U6 unemployment rate, and wage growth of over 2%, a tighter labor market should provide some optimism to investors.

Alongside, keep an eye on treasury yields. The 30-year yield curve began the year at 2.69%, and, in fact, finds itself at 2.9% today (unlike the 10-year, which has gone downwards). While the Fed Funds rate impacts the short end of the curve, long run expectations are driven by the market, and investors are still pricing in positive growth and higher inflation – albeit, lower than pre-recession levels. Things may not be all that bad. If you look further into sectors, IT spending is projected to outpace GDP growth by over 3%, and  companies will look to tech firms to enhance productivity. Alongside, in light of weak emerging market demand, reducing global trade volume, geopolitical headlines and commodity weakness, we’re thinking domestic consumption may, in fact, be the biggest support for US equities ahead in Q4 – and they may find inflows simply because of a lack of options abroad. P/E expansion, as a result, shouldn’t be ruled out, and may also drive returns as the year progresses, given that earnings expectations remain dim.

What it means for you: Q3 earnings are going to be weak – and the market seems to have accepted it. Rather than simply dissecting the past, watch the guidance for Q4. The year end is likely to be filled with rate discussions, holiday consumption, and volatility. The Fed will remain on the watch list for the entire world. Given the reactions to the September FOMC communication, it wouldn’t be outlandish to expect officials to provide far more clarity to the markets as Q4 proceeds – removing uncertainty, which never helps. Regardless of the Fed decision, the fundamentals of several sectors remain strong – technology, financials, healthcare, and consumer stocks, and even domestic industrials, to name a few. Lackluster earnings and revenue declines continue to capture the media’s and Wall Street’s attention; we believe it’s wiser to tune out and look ahead. With the consumer leading the way, think about taking advantage of the weariness around earnings reports to snatch up some well-priced opportunities as quarterly reports unfold this week on Wall Street.

As earnings season kicks off for Q3, the S&P 500 finds itself -5.2% YTD, with the NASDAQ off -0.6% and the Dow off -7.6%. In hindsight, the reasons are fairly clear – a slowdown in China, a collapse in oil and commodity prices, sustained dollar strength, interest rate uncertainty, and slow growth have all played a role in providing negative returns and volatility. Given this is a pre-election year, it’s uncommon to end it down. Optimists on the Street believe that the US consumer will come to the rescue in Q4 – but given the shaky jobs report for September, even that’s in question. Amid such times, does the technology sector deserve to be pulled down with the broader indexes? Here’s what we’re thinking this week:

Technology had a better Q3 than 7 out of its 9 peer groups, off only -3.7% compared to the S&P 500’s -6.4%. Today, it finds itself at a forward PE multiple of 14.4x, well under its 15-year average of 19.7x (JP Morgan data). Granted, trending with the market is natural for this sector, given that at 19.7%, it forms the largest component of the S&P 500 index; Apple, by itself, constitutes nearly 4% of the index’s capitalization. Also, it derives the maximum revenues out of any sector from overseas, and therefore is bound to suffer with a stronger domestic currency; the dollar index is up nearly 6% YTD. For long-term investors, however, stocks in the sector remain at enticing levels.

To describe the potential, let’s start with a macro perspective. GDP growth is composed of population growth and output growth. Over the next 35 years, the world’s population is set to grow to 9.7 billion from today’s 7.3 billion (UN Data). However, the working-age population growth is set to trail total growth – and given life expectancy is projected to continue its upward trend (today, it’s at nearly 70 globally compared to 50 about five decades ago), GDP trends are also forecasting lower. Per McKinsey, the next 50 years will deliver barely 2.5% in annual growth, compared to 3.8% in the previous 5 decades. As Ruchir Sharma stated in the WSJ recently, to achieve a 4% growth rate, output growth – or productivity – would have to contribute 3.5%, a ‘rate never achieved in the post-war era’ – to compensate for the working age population growth of just 0.5%.

This is where technology stands to disrupt. Think terms including Big Data, the Internet of Things, and the cloud – all are frontiers that currently roam in the regions of $10s of billions in revenue amid a handful of firms – but have a potential to transform practically every activity consumers and companies undertake. Given the slowdown in worker growth  described above, along with the advent of emerging market firm competition, it’s inevitable that developed-region companies will turn to technology for the next push forward. McKinsey estimates that the digitization of the physical world has the potential to create an economic impact of $11.1 trillion within the next 10 years – today, standing alone, it would be the 2^nd largest economy after the United States. Per McKinsey, barely a fraction of the existing data is currently utilized for real-time control by firms and individuals. And, according to a study by the HBR 3 years ago across 330 North American public firms, ‘companies in the top third of their industry in the use of data-driven decision making were, on average, 5% more productive and 6% more profitable than their competitors’. IDC, meanwhile, is forecasting worldwide cloud IT infrastructure to grow nearly 24% YoY in 2015. In a broader market where single digit positive returns are bringing sighs of relief from weary investors, such numbers are a breath of fresh air. In the short term, looking at sectors beyond technology, such as healthcare, estimates for Q3 show revenue growth for biotechnology to be around 18% and health care technology to be 40% (according to Factset) – again, enormous gains in the same slow S&P 500 marketplace. The key, again, is technology – and any industry embracing it is seeing notable growth. In the transportation sub-sector, meanwhile, UPS is now utilizing software through its Orion project, which stands to save nearly $50 million by reducing one mile off each of its driver’s daily routes by 2017. So, alongside revenue growth, there’s significant room for efficiency improvement and cost reduction – and the transformation is just getting started.

There’s enough evidence to suggest Silicon Valley – and some investors – are on to this. Phenomenal returns by companies such as Amazon, despite barely showing profits over long spans, are a key data point. At the same time, the word ‘some’ is emphasized – given that the potential remains significantly untapped. While the IoT, cloud and Big Data terms have been around for the past decade, the tech sector has returned roughly 260% since the March 2009 recession bottom – slightly higher than the S&P 500’s 220% return and nothing noteworthy; all of this while GDP has averaged 2.2% in the US economy. During the same span, companies such as Salesforce have transformed the ERP and CRM foundation, Apple’s relationships with IBM and Cisco are setting up to transform enterprise behavior, and firms such as Netflix and Facebook, meanwhile, are generating and using data like never before to track consumer habits. Alongside, the iWatch was introduced, Uber and AirBnB transformed asset utilization, PlanetLabs delivered images from shoe-box-size satellites to the masses by the second, and the largest, cheapest desalination plant was set up in Israel. Apple’s patent filing for a ring in 2014 was revealed this week – and given the potential for wearable technology, it’s just another sign that Silicon Valley’s thinking ahead – alongside making the case for equity investment.

To add to the benefits, the technology revolution also stands to positively impact the labor market in the long term. According to Gartner and IBM, data analytics job positions will reach over 4.4 million by the end of this year, but only 33% of them will actually be filled due to the lack of qualified job seekers.

What it means for you: Wall Street remains focused on subjects including interest rate projections, quarterly reports and China’s economic slowdown. The key for thinking long term, however, is to look beyond these topics. It’s inevitable that China will move towards a consumption-driven economy. Interest rates will rise at some point, and the markets will adjust accordingly. However, as a participant at the Dreamforce conference a few weeks ago mentioned, the visionaries on the stage weren’t thinking about rate hikes. They were purely focused on innovation and opportunities in the long term. Can it be a coincidence that stock markets have also, without any argument, delivered for those that have chosen to stay invested for the long haul? We don’t think so. At a time when volatility continues to captivate investors’ minds and the bulls and bears battle it out, look beyond the short-term chaos for long-term opportunities arising from technology, which is set to pave the path on Wall Street in the years ahead.

There’s a whole lot to think about in the markets at the moment.

While the Fed decision to not raise interest rates at the FOMC meeting in mid-September was greeted with volatility and down moves in the equity markets, Janet Yellen’s speech on Thursday at UMass – in which she made the indirect case for a hike later this year – reversed the trend. The corresponding 200+ point move up by the Dow, John Boehner’s resignation, Volkwagen’s headline shocker and Caterpillar’s unnerving guidance provided a whole lot of food for thought for the weekend. So, here’s what we’re thinking:

Investor sentiment around interest rates has been extremely revealing. The equity markets, essentially, have made it clear that they want a raise. Understandably so, given it would signal a robust US economy, a follow-through of the Fed mandate, and importantly, certainty around the cost of capital. By several metrics, the labor market is showing signs close to full employment, while inflation gauges including core CPI and core PCE are at 1.8% and 1.2%, respectively – moving closer to the 2% target. With Yellen’s speech, it’s fair to say that the hike is not too far out.

At this stage, we’re thinking buybacks and M&A activity – and the corresponding impact on stock prices – needs to remain on top of investors’ minds. Companies have taken massive advantage of the low interest rate environment to utilize debt to reduce outstanding share counts – and all’s well as long as investors don’t get deceived between long term and short term gains. Per Barron’s, over $1 trillion has been returned to shareholders by S&P 500 firms in the past year – the highest level since 2007. What’s important, however, is that the amount is more than the firms generated in free cash flow over the same span. The EPS impact has been significant, with 20% of companies reducing share counts by 4%, and adding the same 4% to EPS, as Barron’s notes. So, if rates rise, the buyback party should, in theory, reduce, and how companies adapt and invest money in a more expensive world remains to be seen – especially given that international conditions remain bleak. Caterpillar’s reduction in guidance and the announced layoff of nearly half of its workforce is a resounding reminder that the world economy is entering a new era.

M&A activity, meanwhile, is set to surpass the $4.3 trillion record set in 2007 this year as well – again, undoubtedly fueled by low interest rates providing cheap financing for deals. The corresponding premiums factored into stocks are hard to dissect, but certainly exist. The consumer staples sector, for example, remains a prime suspect as a beneficiary of this activity, in our opinion. The sector was trading at 18.7x forward P/E at the end of August, higher than its 18.4x 15-year average (JP Morgan data). Sure, it pays a hefty dividend, and has therefore been a favorite for hungry investors parched by low-yielding bonds. However, with negligible organic top-line growth, a strengthening dollar hurting overseas revenues and rapidly changing consumer tastes moving away from colas and packaged products, does the sector actually deserve the premium? Kraft, Heinz, and other firms’ shareholders in the sector have been rewarded handsomely through M&A activity. A downturn in M&A due to more expensive financing would certainly cause headwinds for target firms in the equity universe – the extent of which might only be understood after-the-fact.

And finally, there’s the bond market – a truly fascinating asset class that doesn’t get nearly the attention or respect it deserves from equity investors. Credit spreads for investment grade as well as high yield bonds have slowly been widening, with the WSJ noting on Sunday that ‘the US corporate bond market is starting to flash caution signals about the broader economy’. The root cause filters back to the same subject as above – concerns regarding companies’ ability to pay back the ‘massive debt load taken on in recent years’ with low interest rates, according to the WSJ. Granted, leverage ratios remain far, far below pre-crisis levels, but global growth isn’t nearly enough to provide a helping hand this time if things go downhill. Consumption might come to the rescue as the year goes on, but caution should prevail as interest rate hikes come closer and markets get choppier.

What it means for you: The world of higher rates is a storied one – not seen in several years in the US, and not remembered by many of today’s investors and bankers. In the past higher rate era, emerging markets were driving global growth through capital expenditure, infrastructure development and commodity consumption. On a broader level, corporate profits, as denoted by McKinsey Global Insights and The Economist, tripled in the phase between 1980 and 2013, rising from 7.6% to 10% of global GDP – with Western firms capturing over 60% of it; remember that all of this occurred while 10-year treasury yields averaged around 4%. Today, overseas growth is slower and international firms are far more prominent, with the 50 largest emerging market firms doubling the portion of their revenues coming from abroad in just a decade. With increasing competition, among numerous other factors, profits are set to decline back to the 8% range in the next 2 decades, according to MGI. Investors – large and small alike – will need some time to figure out the right prices for assets once rates go up, and also to understand long term implications in the new global economic landscape of higher rates, slower growth, and more diversified revenue sources and firms. The point? Have patience with your investments and be set to ride out the potentially rough seas ahead, because that the world economy today is far less charted than one may think it is, although as fascinating as ever.

The Fed decided to not raise interest rates last week, and the wisdom of the crowd deserves some applause here. Fed Fund futures had somewhat predicted the outcome, by denoting a hike possibility of under 30% in the days leading up to Thursday’s announcement. Meanwhile, bond market behavior was far more composed than would be expected in the face of tightening, with a prescient ‘markets may be flashing a wait sign’ column appearing in the WSJ two days before the decision. Tuesday’s data showed good retail sales numbers – in line with economic improvement and a case for hiking – but the markets went up. Then, on Wednesday, CPI data – an important inflation gauge, underwhelmed, and equities rallied again, projecting that the Fed would stay put. The S&P 500 was up 1.5% in the week leading up to the Fed announcement. On Thursday, the market proved right, and the Fed stayed on hold.

In that case, shouldn’t the upward trend have continued once the Fed confirmed that accommodative monetary policy was sticking around for the after-party?

What took investors by surprise, it seems, was the level of international concern that Janet Yellen provided in her press conference. The resulting pullback on Friday led to the Dow losing over 300 points, and overseas markets falling even further. Seeing that market volatility and international weakness may have now joined the Fed’s data points, we’re in for a pretty wild winter. Today, the markets are actually pricing in a 2016 hike, with opinions all over the place in terms of the first hike timing and length of tightening. Even the Fed’s dot plot shows a whole variety of opinions; one of the FOMC members is actually calling for negative rates, let alone tightening. The bottomline? The markets hate uncertainty, and it is going to be around for a while – given that global economic slowdowns don’t just reverse course in a few weeks with no identifiable catalysts.

What’s next? Popular terms including ‘secular stagnation’, a ‘new normal’, and ‘lower for longer’ come to mind even more so after last week’s outcome: a world with lower growth, lower inflation, and lesser growth concentration – a very bleak scenario where some, especially those with exposure to riskier assets such as stocks win, but many – including the middle class, simply survive. The Zero Interest Rate Trap theory mentioned in the WSJ paints a scary picture – where due to lower rates, the incentive to lend or invest reduces, causing a vicious circle where rates remain low, but inflation doesn’t rise. Companies, then, would spend less in capex, take fewer long term risks, and perhaps seek risk aversion instead of growth. Returning money to shareholders is an easy example; since 2012, quarterly EPS for S&P 500 companies has grown by 6.7% – with over 20% of that coming from buybacks, according to Deutche Bank. The long term impact remains to be seen over such decisions.

The Bank of England is up to bat regarding monetary policy, and may provide another data point on how developed economies react to tightening in today’s global era before the Fed’s turn comes again. Sweden and Japan, for example, both had to backtrack in the past 3 years on rate hikes when they turned out to be premature. All in all, the uncertainty’s going to remain, in our opinion, until the earlier of the following two outcomes occur: the Fed raises rates, signaling a strong US economy and international stability, or massive policy changes targeted at structural reform (immigration changes, spending on infrastructure, deficit reduction target changes, etc.) from influential economies around the world, including China, the US, Japan, and the Eurozone.

On a side note, we remain optimistic in the long term due to the potential of productivity in rescuing the world. Last week’s Dreamforce conference, for example, added another set of smart ideas that could define the future; the FOMC meeting’s media attention in recent times has helped the markets overlook the role and progress of concepts such as Big Data, the Internet of Things, and asset utilization being pioneered in Silicon Valley. The key for investors, of course, is to have the vision, and not panic when the times are tough on Wall Street. If you conform to that ideology, then the market continues to provide bargains on the companies that millennials love – and enterprises, and other investors, soon will too.

What it means for you: Long term aside – amid all the short term uncertainty, don’t discount US consumption. Oil price declines YTD set up well for a robust holiday season; note that the consumer discretionary sector is up 4.7% YTD – the best performer in the S&P 500. The recent pullback has caused stocks to price at a more modest 15.4x forward P/E (Yardeni data), and if yields stay lower for longer, the pressure reduces for firms with high yield debt, thereby limiting insolvencies and jobs losses; the same goes for emerging market nations and dollar denominated debt worldwide. Housing growth and auto sales should also continue to drive economic activity amid low borrowing costs; for example, auto loans crossed the $1 trillion mark for the first time ever last month, according to WSJ data. Next week, we’ll be reviewing a fascinating article in the HBR pointing to where corporate profits may be headed in the next 20 years. Earnings growth, after all, drives stock returns, and it’s best to think long term while short term uncertainty continues to guide investor sentiment on Wall Street in the coming week.

The week of the Fed decision has arrived, with all eyes set on Janet Yellen’s press conference Thursday. Wall Street – and global streets – await with bated breath and anxiety, if it wasn’t already apparent given the volatility in stocks over the past few weeks.  If you’re unsure of whether rates will rise, you’re not alone – the market is wondering the same thing.

The numbers speak for themselves. 46% of institutional economists expect a raise this week, per the WSJ – so opinions are torn. Traders, meanwhile, think there is a 26% probability, based on CME Fed fund futures – a number half of what it was a month ago. Several banks are ‘Septemberists’, while many, including Goldman Sachs, are ‘Decemberists’ – and others, such as Deutche Bank, are adding some spice by introducing an October hike potential. Many institutional investors, including Bridgewater’s Ray Dalio,  are talking about the opposite extreme – another round of easing, or no hike until 2017, per Komal Sri-Kumar. Note that the XLF financials ETF – expected to benefit with higher rates, was up over 2% through mid-August; it’s now -6.5% YTD. The wide range of opinions and uncertainty highlights the incredibly complex global picture the Fed is dissecting.

Does the Fed have reasons for delaying? Sure. Unlike past rising rate environments, there is no economic indication of overheating, inflation concern, evident sector bubbles, visible overleverage, commodity spikes, or wage pressure. Alongside, the entire planet’s financials are looking shaky, with Citigroup’s economics team even predicting a 55% chance of a recession in the next two years. If US rates rose, additional currency turmoil with debt obligations could push numerous nations, including Brazil and Turkey, to the edge of default. China’s summer market crash, the corresponding emerging market capital flight, the collapse in oil over the past year followed by numerous other commodities, and diametrically opposite monetary policies in Europe and Japan all point towards a rate hike being the last thing the world needs today from the largest, most influential economy.

The logic for raising? Near-zero rates are meant for emergencies, and have not budged since 6+ years; after first being implemented during the 2008 recession, they still remain at the same levels while equity markets have more than tripled, the US unemployment rate has halved, and the economy has, without a doubt, shown improvement. Keeping them at zero also depletes the Fed of ammunition in case the economy goes downhill again. The US, after all, must fend for itself – and given the U6 employment statistics, regional wage pressures, growth rates and signs all pointing towards a tightening labor market, the Fed  must look to fulfill the mandate it was designed to, with US employment and inflation at the forefront of its decisions. Overseas turmoil would have limited impact, considering exports form barely 14% of US GDP (World Bank data), and small businesses employ nearly 90% of the population (SBA data) – with a majority of their revenues being domestic.  Consumption is strong, and housing is on the mend. Retirees and pension plans have suffered in the current environment; riskier assets, such as equities, meanwhile, have prospered – helping the top 10% of the population that own over 80% of stocks outstanding, according to a study in 2010 by NYU’s Edward Wolff. An interest rate normalization would help level the playing field. It’s about time, and has been for months, according to several noted names on Wall Street.

Of course, it would be foolish to disregard international opinions. The IMF and World Bank have repeatedly warned against raising rates and destabilizing the world economy, as have several other finance thought leaders, including Indian Reserve Bank governor Raghuram Rajan. At the same time, numerous finance ministers have countered, asking the Fed to hike and rip the bandaid off – in effect, remove uncertainty, so companies, investors, and nations can get on with life. The bottomline? Buying or selling stocks by trying to predict the outcome of the meeting isn’t our best bet, given the market itself remains unsure of the decision, which is why the volatility persists. If you’re a long-term investor, use the time to scoop up bargains based on fundamentals. In the long run, 25 basis points is a drop in the bucket. If a hike occurs, rest assured that the highly accommodate Fed’s decision means the US economy is in much more robust shape than investors thought; any moves lower would just provide greater discounts. The quality of the business doesn’t change overnight, after all.

What it means for you: The uncertainty and divided opinions are heavy in the air. While many attributed the market’s summer downturn to China, the lack of significant change in treasuries, with the 10-year yield barely moving YTD, non-existence of bids for the ultimate safety play – gold (-6.5% YTD), and defensive sector underperformance, including utilities (-12.8% YTD) suggests interest rate uncertainty had a massive role in the action. This week, expect the volatility to continue until Thursday afternoon as the Fed decision takes over the media and investor attention. Keep cash handy, along with some popcorn – it promises to be an exciting week ahead on Wall Street.

Bracing for a Fed rate hike? You’re not alone. The US added 173,000 jobs in August, with the unemployment rate moving lower to 5.1%, and wages showing a 2.2% YoY growth – all signs that the domestic economy is alive, well, and prospering steadily. Still, major indexes finished down for the week, with the Dow off -3.2%, the S&P 500 off -3.4% and the NASDAQ off -2.9%. What’s worth noting is that China slowly receded from the headlines, and has been replaced by the Fed – for good reason, given that the September FOMC meeting and the interest hike decision is now less than 2 weeks away. What’s pretty certain is that market uncertainty will continue until that meeting. In the meantime, though, is there need to worry about the current market slide continuing into bear territory? Here’s why we’re thinking no:

The Fundamentals: The S&P 500 finds itself at a fair 16.5x forward earnings (Yardeni data). Corporate leverage remains at 20+year lows, operating profit margins continue to hover near record highs, and durable goods orders, capacity utilization, auto sales and housing trends are all showing robust improvement. Meanwhile, the consumer discretionary sector is now the best performer in the S&P 500, up over 2%, while the defensive utilities are -14% YTD (the 2^nd lowest performer, followed by energy, at -20% YTD due to reasons surrounding the oil price decline). In any case, the sector returns show that investor sentiment is certainly not negative, or bent on calling an end to the rally. We see that small caps are neck to neck with large caps at a roughly -3% return, and growth has outperformed value. Earnings growth ex-energy was 8.5% in Q1 (JP Morgan data), and Wall Street is still looking for mid-to-high single digit growth in the year. All in all, while the indexes may be red YTD, the fundamentals and investor sentiment certainly don’t seem to be pointing that way.

The Yield Curve: The yield curve shows the rates offered by bonds with different maturities. While the Fed may control its short end, the long end remains in the market’s hands. Despite all the recent equity turmoil, the curve remains upwards-sloping – indicating positive expectations of growth and inflation in the long term. Currently, the long end signals a yield of around 3%; this may slightly change after the FOMC’s meeting, but it is very unlikely to slide – given that if the Fed hikes, their incredibly accommodative nature that investors have gotten used to will certainly signal a far more robust economy than what many had thought. Given improving economic data and the current slope, a recession is extremely unlikely for the next 18-24 months – in which case, equities should, in theory, provide positive returns – seeing no overheating in the fundamentals. History provides some clues here:

Past Bear Markets: Using JP Morgan data, we see that eight of the ten previous US equity bear markets occurred along with economic recessions (a contraction of GDP over 2 or more quarters). In 2008, housing overheating along with bad loans, etc. catalyzed the market and economic downturn, while in 2000, extreme valuations in the tech sector caused both. In fact, 1987’s flash crash was the most recent situation in which an equity bear market occurred without an economic recession. It was essentially caused by program trading and market overheating – the economy proceeded to do fine after. And if it makes you feel any better, stocks more than quadrupled in the following 10 years. Turning back to today, if we’re worried about aggressive Fed tightening, the recession to look to is 1980, where rapid interest rate hikes catalyzed the recession and bear market. However, it was done to rope in massive inflation – a far cry from today’s opposite problem of lack of inflation alongside an extremely accommodative Fed. To summarize, commodity upturns and inflationary pressures, poor credit quality, or bank behavior isn’t an obvious risk today; a US – or global recession – is unlikely given the points above. Corrections or bear markets that occur without recessions in sight may not be as bad as they may feel. A continued equity market collapse may essentially be based on emotions, and as a result, be providing quality stocks at discount prices.

What it means for you: While stocks may be falling, we don’t see the factors that caused previous recessions around at the moment. Of course, it’s worth recognizing that today’s environment is a never-before-seen combination of slow global growth, low inflation, and near-zero interest rates amid a near-full employment rate in the US. Investors have gotten addicted to cheap liquidity for over 6 years. And, since the March’09 bottom, US stocks have returned over double the historical average annual returns, alongside an average GDP growth of 2.2% – far lower than the 3%+ historical figure. Market corrections have occurred every 1.5 years (Bloomberg data) in the past, but we’ve not seen one in over 4.5 years. To summarize, some profit taking or emotional twists are bound to occur leading up to the rate hike decision – we’ve had lots of gains with relatively little pain. In times like these, we think it’s best to stay invested, pick up bargains based on fundamentals, and avoid getting injured by finding yourselves between uncertain bulls and bears on Wall Street until there’s clarity on where interest rates are headed.

Last week’s market roller coaster was a story for the grandkids, leaving even the most seasoned investors trying hard to recollect the last time they had witnessed such wild swings and borderline insanity on Wall Street. With a 1,000 point plunge in the first 5 minutes of trading Monday morning, an apocalyptic, darkness-forever scenario wasn’t hard to envision, but mid-week countermeasures by Chinese authorities ended up stabilizing the global equity ship; the Dow actually ended up by 1.1% – an unimaginable thought given the previous few days’ events. It’s fair to forgive investors for the mayhem. After all, the new age mix of a connected global economy, currency warfare, international bond holdings, electronic trading, and liquid ETFs isn’t easy to handle when turbulence occurs…getting the kids ready for school may not seem so difficult anymore.

On a serious note, given last week’s market action, here are the three points we’re reflecting on:

While China’s turmoil and currency volatility dominated headlines, US economic data remained a beacon of hope amid overseas darkness. Q2 GDP was revised upwards to 3.7% – higher than expected – from the earlier 2.3%. While some may attribute it to inventory growth, the main sales-to-inventory ratio remains around the average post-recession level of 3.9, according to Barron’s Gene Epstein – signaling things aren’t really out of line. Alongside, July’s business investment showed the largest gains in the past year, jobless claims stayed around 15-year lows, and the core personal consumption index (a measure of inflation) was up 1.2% YoY. Consumer spending, meanwhile, was up 0.3% last month again, led by durable goods, up 1.1% – another signal of a housing upturn. Last week, we highlighted that auto sales, household net worth and consumer confidence was also looking pretty robust; all signs point to an underlying economic soundness and recovery. And while several of these improvements have come later than the usual expansion, they’re coming at a time when the world economy needs some serious stability and reassurance.

Investors are taking note. Take gold – an ultimate safe haven worldwide. It actually fell by 2.4% amid last week’s equity chaos. While we’ve heard the argument that the drop was caused by funds selling to get cash, it still shows that amid richly priced markets, the panic remains subdued; another sign was through the US utility sector, which also fell by over 4% last week. This doesn’t usually happen when the world is collapsing.

Treasury yields, however, signal some complexity. 10-year yields finished at 2.18%, up from 2.04%. Usually, in times of equity sell-offs, the opposite would occur as investors rotate out of stocks into safer bonds. The upside was largely attributed by Wall Street to China’s liquidation of a chunk of their $3.5 trillion foreign reserve (WSJ data) to raise dollars to aid their devalued yuan – we agree. Effectively, China has attempted to subdue local markets and create inflation – in essence, exporting deflation – something the entire developed world has been combating post-recession. As a result, this presents a fix for the US Fed – which has been looking to normalize rates while the world remains in a low demand, low growth, low inflation environment. The CME FedWatch is now predicting a rate hike probability of only 28% – far lower than the 60+% some days ago. The rate of change matters – and while we’re only talking about a 25 basis point increase, that’s effectively double the current 0.14% Fed Funds rate (NY Fed data). As a result, we think the uncertainty around interest rates until September’s Fed meeting will continue to hamper any market upside.

And finally, we consider oil. After reaching recession-level prices, WTI crude spiked up by over 17% in the past week on reports that inventories had been drawn down greater than estimates; short covering likely was a factor in the rebound. Again, while current WTI prices are only at $44.5/barrel, it’s the rate of change that matters, and the rebound will certainly draw investors’ attention – given the previous bottom was in the low $40s earlier this year. Schlumberger’s acquisition of Cameron mid-week was another catalyst, in our opinion. Given this may open the doors for more energy sector consolidation, M&A premiums will add to stock prices, and may even provide some breathing room for companies, leading to hopefully less layoffs, asset sales and insolvencies. In any case, several analysts have identified a 6-9 month lag in low oil prices leading to consumption boosts; we’ve been bullish for the same reason on consumption for a while now, and the recent WTI bottom lines up well with the upcoming US holiday season. Alongside, US BLS data shows that the mining, quarrying and oil and gas extraction sector employs only about 1% of the US workforce, furthering our thought that the benefits of low oil may be felt by consumers far more than the downside by firms. Could the equity catharsis have been the bottom for oil? It’s an enticing question; several nations and the US energy sector stands to benefit if yes. The fundamentals still don’t support a massive upside given supply – or demand – isn’t going to change overnight, but in any case, we think consumers will help the markets in the coming months.

What it means for you: It’s hard to expect any significant returns from the US markets in the coming weeks given increasing global policy divergence, continued liquidity splashing around, a lack of growth and demand worldwide, and China’s navigation towards a hard or soft landing. However, the US provides an incredibly compelling risk-reward ratio, including fair valuations, sturdy balance sheets, and downside protection with stable dividends from blue-chip firms; the S&P 500 earnings yield is at a 5.3% vs the long-term average of 4.9%. Overseas, we’re looking to markets that can feed themselves. India, Mexico, and Eastern Europe all boast a diversified economy with aspirational populations aiding domestic consumption, services and manufacturing. Brazil and Malaysia are now on our radar, given that unrest against current policy makers may lead to changes and reforms. At the end of the day, the big picture shows that a majority of the world’s population still remains below the middle class; as innovation, connectivity and consumption increases, staying invested has proven to be a sound approach to managing your money. Take advantage of the bargains, keep an eye on other asset classes, and watch for the bulls to feed on underlying economic strength as they fight some revenge-hungry bears on Wall Street next week based on Asia’s cues.

Last week’s worldwide market collapse was nothing short of spectacular, with waves of panicked participants selling en masse following the lead from earlier trading time zones in the east. All three US stock indexes ended significantly lower, with the Dow off -7.6%, the S&P 500 -4.3%, and the NASDAQ -0.6% YTD. The MSCI All Country World Index, meanwhile, is now -3.6% YTD . Here’s a summary of why we think the breakdown occurred, and what we’re thinking regarding investments ahead:

A Global Reality Check: There’s absolutely no doubt that the world economy warrants significant caution in the short term. European and Japanese growth has been slower than expected, at 0.3% and -0.4% respectively last quarter – even after currency depreciation, fiscal efforts and stimulus measures. China’s market collapse and slowing growth has shaken the faith of many, and given its global growth contribution over the past 20 years, nations ranging from Brazil and Thailand to Australia are now suffering due to the slowdown in commodity consumption. Alongside, oil’s supply glut has completely upturned regions and sectors; YoY, WTI crude is down over 33%, and essentially at recession levels seen in 2009. As a result, Middle Eastern markets including Saudi Arabia have joined Malaysia, Nigeria, Russia, and other oil-dependent nations, down over 20% from previous peaks. India, which was a bright spot among emerging markets last year due to its service orientation, new government and consumption potential has also reversed course, down 4.5% YTD, given that real reforms are yet to occur with major bills stuck in legislative gridlock.

Stateside, the US, with over 50% of the world’s market capitalization, finds itself in the slowest expansion since World War II, with an average GDP growth of 2.2%, ‘more than a half-percentage point worse than the next-weakest expansion of the past 70 years’, according to Barry Ritholtz, one of our favorite macro commentators via BloombergView. To summarize, we find that the lack of economic leadership from any specific nation has been a unique characteristic of today’s markets. Per the WSJ, the IMF is projecting an annual growth of 1.6% for rich countries until 2020, compared to 2.2% from 2001 to 2007; in emerging markets, growth is dropping to 5.2% compared to 6.7% in the earlier span. We believe this is unlikely to change unless major overhauls such as tax reforms, a reduction in commodity dependence for large economies, and an emphasis on education, infrastructure investment, to name a few examples, occur.

Currencies are adding to the uncertainty. China’s yuan devaluation 2 weeks ago has sent trading partners scrambling to remain competitive via their own currency devaluation. As is, the sustained US dollar strength has led to significant depreciation abroad with Fed interest rate hikes expected sometime soon. With further appreciation likely, currency turmoil is only set to grow, with weaker nations potentially struggling to pay for imports, dipping into their dollar reserves, cutting back spending and paying back dollar denominated debt.

At the same time, regardless of how rational market participants may be, the recent market collapse has been significantly emotion-driven, given that few issues above were actually a surprise. As a result, the strongest US and international firms – ones with sturdy cash balances, high growth potential and positive earnings, to name a few traits, have lost as much, if not more, than their weaker peers during the broad sell-off. Take the US, for example. The domestic economy itself stands on a much better platform today, with deleveraged consumers, a housing recovery en route, slowly rising inflation, and a tightening labor market with increasing wage tailwinds. Recent auto sales, at nearly 17.6 million (annualized), remain near 10-year highs, housing costs are increasing, consumer durable orders are showing good signs, and small business optimism remains high. To summarize, we believe that the recent sell-off has been triggered by the reality check that the slowdown in emerging markets is more than hoped for, compounded by currency turmoil.

Amid these trends, we think changing consumer behavior in the US should provide the next wave of upside, with firms that focus on the 3 concepts highlighted in our July 28^th column – asset utilization, data analysis, and information transfer – continuing to pave the path. Skeptics would continue to highlight that any recent gains by the S&P 500 had been driven by only a few companies (Facebook, Apple, Netflix, Google, etc). However, we feel the leadership occurred because they, themselves, have been at the forefront of defining the habits of new age consumption. While it remains to be seen where bubbles may exist – both in public and private markets, we’re not seeing any fewer people in line at Starbucks or Chipotle, wearing Under Armor, streaming Netflix, or scrolling Facebook. Long-term investors should buy a stock for the business, and attempt to ignore timing due to the market noise and sentiment that affects day-to-day stock prices. Let the markets play out  at the moment as investors take profits and absorb the news, but remember – annual S&P 500 returns have averaged 9.7% historically, including dividends, according to Dimensional Fund Advisors. It doesn’t make sense to fight consumption trends with the US and growing global middle class, and the recent sell-off is providing enticing opportunities for long term investors for both high quality firms across sectors (including financials, technology, and healthcare), as well as broad market ETFs given that the fundamentals remain good for the US economy. A bit more selectivity is necessary in the short term; we’ll be focusing on this next week.

What it means for you: After weeks of partying, a good laundry cleansing is always in order. The markets are experiencing a correction not seen in several years – that too, after the S&P 500 has gained nearly 250% since the recession bottom in 2009. The indicators of 10-year yields and gold prices have not moved nearly as much as the stock markets – meaning amid the massive selling, fear remains relatively contained. Focus on the fundamentals and be prepared to deploy some cash – albeit, very slowly, as the bears decide how much more wreckage to cause on Wall Street this week.

China’s surprise yuan devaluation was by far the major headline last week, with the government deciding to counter the currency’s recent appreciation due to the close relationship with the strong US dollar. The news unnerved markets worldwide as investors felt the move was taken in order to mask even slower growth than expected, but sentiment recovered as the week went on; among US indexes, the Dow was up a  refreshing 0.6% (although still -2% YTD), while the S&P 500 and the NASDAQ were up 0.7% and 0.1% respectively. In our opinion, the yuan devaluation was a step in the right direction, as the currency essentially went from a nearly fixed peg to the dollar to more of a market-driven, albeit managed float. Our concern now revolves around the potential for currency wars among emerging nations. A cheaper currency helps exports in the short term, and China’s trading partners will likely decide to take similar measures to remain competitive. We decided, therefore, to look into emerging market debt this week, as we believe there’s some risk in the dollar-denominated corporate segment. Here’s why we think so:

The background: Corporations and governments worldwide issue debt in local or foreign currencies. In the recent years, firms in emerging regions took advantage of the low US interest rates, greater access to international bond markets, and the risk-free dollar nature to load up on dollar-denominated debt; consequently, the emerging market debt (EMD) market issued in foreign currencies has more than doubled to over $1.4 trillion in the past five years, according to Bloomberg. The issuance has proved to be a good fit, as yield-starved investors worldwide have been more than willing to sign up. Overall, the EMD sector has delivered an annualized return of 7.8% over the past 15 years – the best performer in the fixed income asset class. YTD, however, it has slipped, and as of July, was up 1.7%, below high yield, which returned 2.5%. We think this performance downturn could continue further. Essentially, in the EMD sector, credit and currency risk are the obvious fears for investors. With sustained dollar strength combined with US interest rate hikes ahead, foreign currencies are likely to cheapen further, in which case international dollar-denominated debt becomes harder to service for domestically-oriented firms. Investors have been taking note; according to the WSJ, funds that invest in emerging-market corporate bonds have seen outflows for three consecutive months, withdrawing $556 million, according to data from EPFR Global. The bottomline? Given a history of outperformance, the sector could be primed to retreat if the conditions outlined below play out for a while.

China’s yuan devaluation: First, let’s factor in China. The debt-to-GDP ratio here is over 280% – higher than any other developing nation. 44 countries count China as their largest export market, according to Fortune. These nations, therefore, are exposed to the combined forces of a Chinese economic slowdown, debt-laden corporations that may consequently trim back on spending, as well as a cheaper yuan given the devaluation. To counter this, if the exporting nations engage in currency depreciation tactics as well, the dollar-denominated debt, as mentioned above, faces a similar headwind, as the risk of insolvency increases due to it being harder for corporations to pay down the debt or interest.

US rate hikes: With a strengthening job scene, labor market tightening and indications of inflation, the US looks on track to raise rates sooner than later. The combined prospect of a strong US economy with a higher yielding dollar is likely to reposition investors away from emerging markets, back towards US shores. Considering the yuan’s devaluation as well, the ‘Fragile 5’ currency list has now been expanded to the ‘Troubled 10’ by Morgan Stanley, with Peru, Columbia, Brazil and others joining South Africa, Indonesia, India, and Turkey on the country list regarding currencies set to face volatility. Each of these regions have significant dollar-denominated debt exposure among local corporations, and any signs of insolvency could set off a domino effect for stock markets there – none of which a slow-growth global environment, as is, needs at the moment.

Global growth concerns: Currencies apart, the sheer ability of emerging corporations to thrive needs to be reassessed in light of a weak global economy. European growth data released on Friday for Q2 showed a meager 0.3% growth rate (below expectations), while Japanese data released this weekend showed a contraction of 0.4%. The US economy, while growing, is certainly not anywhere close to pre-recession rates, and with low inflation and pricing pressure worldwide, regions dependent on commodities including oil have suffered significantly in terms of both growth as well as currency weakness. With oil prices less than half of what they were last year, and coal, gold, sugar, and other commodities also finding themselves in bear markets, each of these factors impact the ability of commodity-driven corporations to service their debt. Per the WSJ, JP Morgan is expecting the default rate among emerging-market high-yield corporate issuers to increase to 5.4% this year, up from 3.2% last year. Consider, meanwhile, that corporate high yield bonds and emerging market debt tends to move in sync, with a correlation of .87 (per JP Morgan). KKR’s Samson bankruptcy last week was an indicator that few firms are immune to macro conditions and commodity prices, and similar results could be in store for firms abroad. Looking deeper into the energy component of the high yield class, Gluskin Sheff’s David Rosenberg highlighted in Barron’s that that the average yield there has jumped over 1.2% since May – a move comparable to a 9% correction in stocks. The bottomline? Currency depreciation, slow global growth and commodity headwinds together could cause significant chaos in emerging market debt; yields here could serve as an early indication of where stocks may be headed in the regions in the coming months.

What it means for you: With global markets treading water at this stage, economic indicators continue to point to a US rate lift later this year. While stocks will continue to get the media limelight, it’s critical to watch across asset classes – especially, in our opinion,  emerging market debt.  If sovereign and corporate spreads here start to widen, it may be time to position accordingly and stay defensive in the short term against a perfect storm of rising US rates, low commodity prices, and slow global demand. Next week, we’ll be revisiting earnings reports to outline some consumer-driven stocks that we think could be more immune to the conditions above. The bottomline? Staying up to speed with capital markets worldwide remains critical as Wall Street gears up for the week ahead.

As earnings season begins to end, we’re feeling a bit mixed. According to FactSet, of the 436 companies that have reported Q2 earnings YTD, 73% have reported earnings above estimates and 51% have reported sales above estimates. Average guidance, however, has been worrying, along with the energy sector, which in several cases fared far worse than expected. Importantly, the percentage of companies reported above-estimate sales is below the 5-year FactSet average, further suggesting growth may be a higher concern than investors had thought. With this foundation coupled with a pending rate hike, we think there’s little to no upside for the markets in the near term. Consumer discretionary stocks, however, paint another story. Here’s why we think this continues to be an attractive sector for 2015:

The Fundamentals: The consumer discretionary sector is the 2^nd best performer YTD, up 8.3% – far higher than the S&P 500’s 0.9%, and only slightly behind the leader, healthcare, up 9.8%. The forward P/E for the sector is at 19.5x, compared to the 15-year average of 18.2x, according to JP Morgan data. Although this may signal a slight expensiveness, we think earnings growth potential is much higher for the rest of the year compared to conservative estimates, for reasons mentioned below. More importantly, the P/E comparison concept, as a whole, has been distorted due to the low interest rates we’ve found ourselves in during this bull market; the equity asset class really has no alternative – and the ‘expensiveness’ of this sector is nothing extraordinary compared to the broader market’s forward P/E of 16.6x over the 15-year average of 15.8x. Furthermore, as rate hikes come nearer, we think the rotation of investors out of higher dividend-yielding sectors into this one will occur, given that the consumer discretionary dividend yield is the lowest (at 1.5%) out of any sectors in the S&P 500. We remain of the opinion that stocks are bound to take a breather when rate hikes come to fruition – this sector, meanwhile, might be a beneficiary.

A Robust Labor Market: July’s jobs report was yet another sign of a robust US labor market, with 215,000 jobs being added. YTD, the growth in nonfarm payrolls has averaged 208,000 a month – above the 5 year average of 190,000, suggesting that job gains are joining the party late, but at a great time to give a prop up to a bull market running out of steam. Inflation, as well as hourly wages have also been creeping up – slower than investors would like, but at least in the right direction. As we’ve highlighted earlier, small businesses make up over 75% of the US labor force, and utilizing small caps as a proxy, over 80% of their revenue is domestic, according to the Bank Of America. As is, exports form only 14% of US GDP. The bottomline? A strong US jobs market will help drive consumption, and considering consumption forms over 68.4% of US GDP (JP Morgan data), we think  consumer discretionary stocks should be the rightful beneficiaries of returns.

Cheap commodities spurring consumer strength: Oil prices have been sliding, last settling at 43.87$/barrel for WTI crude, nearly reaching six-year lows set in March. Per our column on July 26^th, we don’t see a major reversal for the trend – the ‘lower for longer’ phenomenon is aided by the strong dollar, oversupply, and an attempt by emerging economies (including China) to divert attention away from infrastructure-related growth, due to evident bubble signs amid weak demand. With oil prices down over 31% YoY, US consumers have benefited massively as a result, and they’ve used the money to pay off loans; debt payments as a percent of disposable personal income is at 9.9% (per JP Morgan data), a rate lower than that seen in over 25 years. As a result, via a clean balance sheet, consumers are well-placed to spend, and considering the personal savings rate dropped from 5.2% to 4.8% last month, this may be starting to get occur. Another data point worth highlighting? According to Federal Highway Administration data, stated by the WSJ, through May, travel on all roads had increased 3.4% over the same span from 2014 – higher by 2.3% compared to the previous record set in 2007. Annualized car sales in July, at 17.6 million, only slightly trailed June’s, which were a 10-year high. All in all, oil prices have benefited the consumer, and the gains are slowly beginning to show.

Sector Specifics: Economic indicators continue to show tailwinds for consumer discretionary; new home sales are up 25%, consumer confidence is up 21%, and household net worth is up 5% YoY, according to Fidelity data. The laggards within the sector have included the auto industry, homebuilding, and household appliances, while quicker consumption firms including internet retail, hotels, and restaurants have pulled the sector ahead. We think the latter group has room to catch up; Masco’s strong results over the last quarter, along with consumers locking in low rates and purchasing homes before rate hikes, all signal that durable goods firms should do better as the year goes on. It’s worth remembering, of course, that large durables firms have significant exposure abroad, and currency moves significantly hurt them in the first half of the year – but as a result, that’s already factored in to the stock prices. As is, according to Yardeni Research, the forward P/Es for homebuilding and household appliances are 13.4 and 12.7 respectively – very attractive ratios. Importantly, seismic changes in the way companies approach consumers is defining trends today; Google’s Nest, iRobot, Uber, among other firms, are all focusing on dissecting behavior, rather than spending. We think there’s a ton of efficiency to be derived regarding consumption. The FANG leaderboard (Facebook, Apple, Netflix and Google) have all led efficiency through technology, and there’s no reason why consumer discretionary firms can’t start doing this; those that have done so (Amazon, for example) – have shown significant upside. The bottomline? The stage is set to deliver, and we think spending tailwinds should help a sector that is ripe for disruption by focusing on consumer behavior.

What it means for you: As the Dow Jones Industrial Average continues to trail the S&P 500 and Nasdaq in YTD returns, it is a telling sign that bigger is not always better in today’s economy. With pending rate hikes and quantitative easing abroad, the strong dollar isn’t racing off anywhere soon. It makes sense to focus on the US consumer, given the domestic economy continues to show an extremely strong foundation. The consumer discretionary sector is one where growth is driven by consumption – and that’s a switch that can be turned on or off much easier than, say, manufacturing or infrastructure stocks. At a time when the markets are looking more and more directionless, it’s worth looking at the consumer to provide some momentum to Wall Street in the coming weeks.

As Greece’s markets reopen this week and quarterly reports continue to get dissected, the focus of  investors will move to the June jobs report on Friday and its implications on the Fed’s rate hike timetable. So far, according to FactSet, of the 354 companies that have reported earnings for the past quarter, 73% have reported profits above the mean estimate and 52% have reported sales above the mean estimate. All in all, with weak but positive numbers, we believe rate hike discussions will define market movement in the coming weeks. One sector, however, remains a solid buy, in our opinion, due to its massive role in today’s functioning as well as the seemingly immune nature to interest rate changes – technology. Here’s why we think so:

Slim pickings: Unlike the previous decade, there are no BRICS to pave the path ahead for global growth. Europe and Japan are slowly recovering from very low baselines, the US economy remains in the slowest expansion in recent times, and businesses have cut costs, built up cash, but remain cautious regarding spending. Commodities are in a slump, worldwide inflation is at barely 2.5%, according to Yardeni Research (excluding 2009, that’s the lowest level since 1999), and global growth is projected to be only 2.5% this year, according to JP Morgan data. In a yield-starved environment, technology is really one of the few spots where growth – organic, we might add – has been evident – and as a result, the NASDAQ finds itself up over 8.09%, compared to the S&P 500’s 2.14%, the Dow’s -0.09% return, and the MSCI All Country World Index’s 2.97% return YTD.

Now, positive returns are all well and good, but such crowded trades can be worrying. When investors so distinctly rush towards the winners, minor signs of weakness can cause panic among the masses. The thinning breadth of the market winners is a worrying sign, considering the tech giants (Amazon, Apple, Facebook, Google, Netflix along with Gilead) have accounted for over half of the Nasdaq’s gain this year, according to the WSJ. A similar tale exists for the S&P 500, with the addition of Disney. The tech sector itself comprises the largest share of the S&P 500 today, at nearly 20% of the total market weight. However, our worry around overenthusiasm remains capped. Essentially, out of the drivers of growth (say, utilizing the Solow growth model, we take capital accumulation, population growth, and productivity as the three main contributors), we think technology’s role in increasing productivity is incredibly undervalued – simply because there aren’t well-established ways to measure it yet. The boundaries that technology has broken through – essentially in the last 2 decades – is greater than what many would have ever expected. According to the US Chamber of Commerce, 90% of the world’s data was produced in the last two years, while as noted by The Economist, in 2000, 400 million people worldwide had internet access; by the end of this year, it’ll be 3.2 billion people. Mobile payments, health tracking, genome sequencing, cloud storage, remote access, cybersecurity, and other such words have become commonplace – and the markets are paying attention.

Essentially, what we’re seeing is that firms in this sector don’t go about their business model focusing on the traditional for-profit metrics of return on equity, market share, or, say, volume or pricing power – all bedrock corporate focuses for decades. We find that the new age tech firms are greater focused on different drivers – the top three being asset utilization (for example – the sharing economy), data analysis (understanding each action), and information transfer (meaning getting the right information to the seeker – faster). Firms that focus around  2-3 of these three activities efficiently, seem to be the winners – Uber, AirBnB, Dropbox, and the firms noted above all have these traits. Take another example – PlanetLabs. Profiled in Bloomberg Businessweek, this Silicon Valley firm takes pictures from shoe-box sized satellites in space for clients – helping dissect everything from parking lot occupancy signaling sales in far-flung Walmarts, lights in Myanmar showing manufacturing overtime shifts, and crude oil shadows depicting tank levels. The power of data is incredible – and if it can be analyzed and transferred back to the right people (say, government agencies or investors), the potential of value-creation remains massive. An example back on Earth – Taco Bell’s online app is seeing 20% higher bills compared to orders placed in-store, as customers can place them more leisurely, add topping combinations without confusing the counter-staff, and browse a more user-friendly menu. Undoubtedly, the success of Taco Bell (part of Yum Brands) will be replicated by other apps in the future. Another major foray – driver-less cars, are set to make up over 10% of global sales by 2035, according to the BCG, highlighted by Forbes. Road accidents – with 95% caused by human error today, stand to plummet – and as a result, their total cost to society today ($948 billion, or 6% of GDP per year), could be put to far more productive use, according to their analysis. Investors should take note – there’s plenty to come from this sector.

The numbers: Fundamentally, we think the tech sector continues to look solid (on the public side, at least). The sector’s correlation to treasury yields is essentially 0 (JP Morgan data) – meaning it is one of the few fields that could remain immune to Fed rate hikes in the coming months. As of June 30^th, the forward P/E for tech was 15.2, signaling an undervaluation compared to the 15-year average of 20.2, and the dividend yield, at 1.5%, was over double its 20-year average of 0.7%. The numbers show that firms are more diligent about returning capital to shareholders – signaling, if anything, additional maturity around cash usage. Take Google, for example – with Ruth Porat’s joining as the CFO, we’re willing to bet that the firm will join the ranks of dividend payers such as Apple in the coming months, further signaling a coming of age for the tech titans.

Granted, caution due to the 2000 bubble experience should remain high, but we aren’t seeing similar warning signs at the moment. Companies are generating real earnings, the cash burn rate is far lower, and P/E ratios remain closer to Earth, unlike back then. As Jim Swanson pointed out in an interview with Barron’s, in March 2000, tech provided 13.5% of the S&P 500’s earnings, but was 33% of the entire market value. Today, it’s 20% of earnings, and just 19% of the market capitalization. Meanwhile, we have been concerned about  private valuations, as denoted in our  March 8^th column – and that still remains. However, we’re less worried in the long term, and would utilize any short term dips to buy the public side for the reasons above.  The relationship between developed economies and efficient markets is pretty evident – the more developed the region, the more efficient the market (and vice versa), as assets are priced more appropriately considering the information is greater in quantity, more accessible, and at faster speeds. Technology will drive this efficiency. Last year, according to The Economist, 20% of US business school graduates went to work in technology – the highest level since 2000. 3 of Fortune’s world’s most admired companies are tech firms (4, if you count Starbucks) – and while it’s difficult to value what we call the reinvestment of talent, it’s a simple thought – if the currently-top ranked firms attract top talent, you have to think they’ll be stronger positioned to remain at the top and deliver breakthrough innovations.

What it means for you: The structural trends favor investment here; dips should be treated as long-term buying opportunities for this sector. Consumers and businesses have shown their continued preference and increasing dependence on technology. There’s no reason to think Wall Street’s direction would be any different. Next week, we’ll be visiting the consumer discretionary field, given the data around the reduction in the US personal savings rate from 5.2 to 4.8% in the 2^nd quarter and the potential to add to the already-robust 10% YTD returns for the sector. The trends are looking good – stay in sync with them as the markets prepare for the June jobs report on Friday.

Earnings drove the headlines last week, along with some minor updates on Chinese market concerns and commodity worries. Meanwhile, Greece has practically vanished from the news to make room for fundamentals, and the S&P 500 so far has delivered moderately positive results. According to FactSet, 187 companies have reported earnings as of July 24^th, of which 76% have beaten earnings estimates, while 54% have reported sales above expectations. The factors driving these numbers is what makes them intriguing, though – international weakness remaining the biggest one. International trade now accounts for nearly 2/3^rd of world GDP, up from less than half just 10 years ago, according to the World Bank. Earnings have no shelter; the impact of currency moves, fiscal policies, and overseas markets can quickly dampen the short term progress of blue chip stocks. On that global note, this week, we decided to look into the most universal asset class of them all: commodities. Here’s our take on where things may be headed for them:

Oil, gold, and precious metals have been hammered over the recent months. The primary factors to blame are pretty simple (as usual with commodities) – oversupply, and the lack of demand. The explanation stems from Chinese growth worries, low global inflation and sustained dollar strength, in our opinion, and the trend doesn’t suggest any respite moving ahead.

Let’s start with oil, for example. US WTI crude is down over 40% compared to the same quarter last year, and continues to languish near the YTD depths. The completion of Iranian negotiations was the major catalyst, as investors now factor in the slow, yet sure Iranian oil supply onto an already oversupplied global marketplace. According to the International Energy Agency, highlighted by the WSJ, on any given day, the world already produces more than 2 million barrels more than there is demand for. Meanwhile, as the shale gas revolution redefined the industry, Saudi Arabia decided to bet on the long haul by keeping output steady, if not higher, in recent months. The supply has kept prices low, in a bid to stave off the increasing interest in renewable energy. The balance is delicate, but so far, they seem to have gotten it right. The US oil rig count isn’t drastically changing, and per Wall Street, it’ll take several months for US supply reduction to actually impact prices. Oil storage utilization continues to remain at near-record levels, and the cost of renting supertankers, highlighted in our June 7^th column, remains sustained – indicating firms are continuing to store oil, hoping to release it when higher prices come around. Need evidence? Check supertanker stocks such as Nordic American Tankers Limited – it’s up over 59% YTD. When the market speaks, listening can pay off pretty well.

Nevertheless, US airlines, among several other sectors, stand to benefit along with consumers if oil prices stay low. However, energy firms contribute the largest share of capex in the US – an important catalyst that we felt would inspire the next leg of growth for the economy. As a result, we’re becoming a bit cautious. Alongside, Espen Erlingsen from Rystad Energy recently stated that North America’s shale industry has seen the biggest cost declines, of nearly 25% compared to 2014 levels. Most big oil majors have limited exposure to shale, and falling costs in the shale basins have kept output high, capping oil prices – a double blow to the industry, in his opinion. Falling productivity has plagued the industry in recent years, and fundamental changes will be required to right the ship. We had earlier attempted to call the bottom around the low 40s the last time WTI oil reached those levels, and sided with analysts stating that crude would end the year higher, closer to $70/barrel. Frankly, we see no sign of that happening as of right now.

Gold: Prices for this precious metal continue to suffer in today’s market; the well-followed GLD ETF is down over 7% this year.  Despite slight signs of inflation, for reasons we noted  in our June 28^th column, gold continues to languish near its multi-year lows. Other precious metals that held steady until mid-July have now decided to join the downhill trend as well. A remarkable report from Morgan Stanley recently highlighted the major factors extremely appropriately – ‘the passing of deflation risk, the anticipation of the US Fed’s first rate hike, another debt resolution for Greece, and the collapse in China’s equity markets – which prompted loss-covering asset sales’, have all hit prices, according to the firm. The bottomline? Despite massive Greek turmoil, Chinese market shocks, increasing inflation expectations and potential volatility due to rate hikes, the value of gold as insurance just doesn’t seem to exist as it did in the past. Anthony Grisanti, a trader, coined it well on CNBC last week by pointing out that physical demand for gold in China is down 9%, while worldwide, demand for gold coins and bars is down 17% YTD. The buyers aren’t stepping in even though prices are going lower. That’s a very bad sign, in our opinion – and yet another reason to be careful with the deceptively shiny attractiveness of this commodity.

And finally, we look east, to China. The nation’s real estate boom defined the commodity cycle and led the global economy over the past decade, with iron ore, copper, and other imports in massive demand. Today though, we find a shaken market, overladen corporate debt levels, and a real-estate market where each price is being carefully scrutinized by overseas investors for signs of a bubble. We’re closely watching the multinationals that have exposure there this earnings season, and are uneasy with what we’re seeing. Whirlpool report a 3% decline in demand last week. Otis (part of UTX) – the inventors of the genius appliance called the elevator, reported that orders were down over 10% compared last year. Now, the question is if construction is down, so be it – but are existing real estate prices at least holding up? We hope they do. If not, it’s an even larger bubble than previously thought, and the impact would be far greater, further affecting nations such as Thailand, Vietnam, Australia, and other major trading partners. The cool-down of the commodity churn is impacting the world in more ways than just prices. With data from the WSJ, we see that the US Labor Department reported that the overall price of imports to the US from China was down 1.2% from a year ago. This is likely another contributor to inflation being low – and a consequent barrier for Fed interest rate hikes – which in turn will define asset flows to emerging markets and currencies in the coming months. It’s not a coincidence that the Dow Jones Industrials Average – note, ‘industrials’ – composed of the 30 US titans deriving revenues globally, is far underperforming the more diverse S&P 500 or Nasdaq.

What it means for you: Commodity prices don’t have much reason to go higher. As a result,  our recommendation is to stay invested with the broader market, and avoid doubling down on metals, mining, large industrials or energy firms at the moment. Selectivity is important – and in a market where global growth remains sluggish, the full extent of Chinese weakness remains to be understood, and a binary philosophy regarding Fed rate hikes dominates, investors should avoid trying to time the markets. The trouble with commodities is they themselves don’t lead innovation or productivity; its all about supply and demand for these universal products. Rather than betting on the bottom, a more sure way is to choose firms that have shown innovation and trend-setting capabilities – whichever sector they’re in. Stay in sync with economic data and keep an eye on earnings as such companies define the direction on Wall Street in the coming week’s reports.

Last week brought good news to Wall Street. Greece’s bailout terms were approved, China’s government measures stopped their market slide (for now), and US earnings kicked off with a medium-volume bang. Meanwhile, Barron’s cover on Saturday highlighted significant upside for Japanese blue chips, Angela Merkel hinted at much-needed debt relief for Greece, and oil pricing became slightly easier with the completion of Iran’s negotiations.

Stock markets don’t necessarily need good news – it’s certainty that matters more, in our opinion – so investors can price assets appropriately. When both get combined, we get rallies – and that’s what drove markets worldwide, including Europe, Japan, South Korea, India, and the US last week with the factors above. Countries dependent on commodities including precious metals, of course, are sitting out at the moment, but that’s a story we’ll be covering next weekend. The focus right now turns to fundamentals; we’re talking about quarterly earnings from the S&P 500.  Last week, the titans of the world – Facebook, Google, and Netflix, blew through the roof on the backs of news and results far beyond investors’ expectations. Apple, Coke, IBM, and several dozens of firms are on tap this week to announce earnings. The S&P 500 finds itself up 4.4% YTD, while the Nasdaq is up over a massive 10%. We’re noticing a new-found laggard, though – a sector which needs some support considering the role it plays in the US economy: the small caps, up only 4.1%. Here’s why we think it’s a good time to invest in this sector if you haven’t already:

– Small caps are significantly sheltered from currency headwinds, considering they derive over 80% of their revenues domestically, compared to less than 60% for large caps, according to the Bank of America last year. With the Euro reaching YTD lows last week, the Yen also continuing downwards, a rising rate environment in the US and quantitative easing abroad not going anywhere, there’s really little reason why the dollar should reduce in strength, if not go higher. Small caps won’t be as affected, and a reallocation from the large caps to this sector may occur soon by the market. We think it’s wise to be ahead of it.

– Small businesses employ over 90% of the US population. Consumption’s the bread and butter of the US economy (at 68.5%, above recent historical levels, according to JP Morgan), and we’re fine with utilizing small caps as a proxy for this.  Factor in that unemployment per the basic U3 definition should be reaching near-full levels around 5% if the hiring trend continues, inflation is slowly trending upwards, and wage growth should occur in the coming months as the real GDP and potential GDP gap narrows. All in all, if the domestic consumer benefits, we think small businesses and small caps will benefit – and vice versa. A strengthening economy helps everyone – including stocks.

– US small caps are incredibly diversified, with the largest sector consisting of financials – at over 20% of its total market cap, compared to the S&P 500’s technology sector, which derives much of its revenue overseas, and is a bit expensive in the short term given recent run ups in the mega caps. Financials, meanwhile, are expected to be the largest beneficiaries of interest rate hikes. As a result, the small caps’ index composition – say, the S&P 600 – is in favor of the rising rate environment in the US.

– Small caps may seem a bit bit expensive, at nearly 110% of their 20 year P/E average of 17.4, per JP Morgan data. However, the premium that small caps have had over the large caps in terms of P/E has decreased significantly, at only about 20%, compared to the historical average of 45%. The S&P 500 is above average as is, at nearly 17x forward P/E compared to the mid-15 historical average. However, as we’ve mentioned before, we need to factor in the fact that 10-year Treasury yields today are around 2.3% compared to the past’s 4%+ average, and as a result, what was ‘expensive’ in the past may not be applicable today.

– At the same time, leverage matters – especially in a rising rate environment. High quality firms are often chosen based on their return on equity. However, this metric can be manipulated by loading up on debt; if you combine the two, it’s a better approach. The MSCI Quality Index, for example, consists of three fundamental factors in choosing stocks – high return on equity (ROE), stable year-over-year earnings growth and low financial leverage. It outperformed the S&P 500 over the past 15 years, and while the index itself focuses on large and mid cap stocks, there’s no reason for the same philosophy to not be applied to small caps too, if you’re more into stock picking.

What it means for you: Since the lows of March 2009, small caps have outperformed the large caps, up approximately 300% compared to the S&P 500’s 248%, as of June 30^th (JP Morgan data). Media coverage today, due to macro events, continues to revolve around large caps, and investors are racing to the winners – seen by last week’s quarterly results. Barron’s Randall Forsyth called it interestingly this weekend by highlighting an expert quote stating that ‘narrowing leadership is typical of the late stages of a lengthy bull market’. The debate continues on what stage today’s market is at among analysts and experts, but we’re pretty optimistic on the state of small caps. Unlike other economic recoveries, the US consumer has significantly lagged in realizing the benefits of this expansion post-2009. We think the conditions are in their favor today, and it makes sense to stay aligned with them by keeping some exposure to small caps as Wall Street and Main Street merge together in the coming months.

As Greece continues to make headlines, global markets have shown remarkable resilience throughout the roller coaster ride. US indexes have ended up recovering after each fall, and although the S&P 500 remains up only 1.9% YTD, Greece’s actual neighbors have done pretty well. Overall, the European Stoxx 600 index is up 13.5% YTD, and even Spain and Portugal have delivered 7.3% and 22.5% respectively, with government yield spreads staying relatively calm. Investors seem to have factored in the inevitability of a bailout, amicable negotiations, and the potential restructuring of Greece’s debt – currently at an unsustainable 180% of GDP.

As European leaders figure out the next steps this week, the focus of the financial world is shifting eastward, to China. Here, the skyrocketing market that doubled in value over the past year lost nearly 30% in a month, finally finding support last week. Such a slide is not easy to digest, considering nearly $3 trillion in market capitalization got vaporized in the downturn. Granted, as much research has pointed out, barely 10% of China’s population engages in stocks, and according to UBS, equities only account for 20% of China’s household wealth, against 54% in bank deposits. So, the losses may not be as widespread as feared. However, we feel that the same population that suffered is part of the spending group – the middle class – and therefore, the potential for consumption to reduce there is much higher. China’s market drop was inevitable, and shouldn’t come as a major surprise. However, how the global economy deals with the after-math from such a critical economy needs to remain in focus. More on this in the coming weeks.

At the moment, we’re also watching the US earnings season, which kicked off last week. We don’t have high hopes for results. In our opinion, large caps will have inevitably suffered due to choppy overseas markets (where over half of the S&P 500’s revenue comes from), sustained currency headwinds, an emerging market slowdown, and weak oil prices. As always, analyst estimates will likely be cautious and the bar for companies will be low, so expect weak outperformance, but nothing extraordinary. We prefer looking ahead, as the rest of 2015 points to a much more fundamentally-driven market. Here are the data points we’re keeping in mind for the 2^nd half:

– The S&P 500 found itself at a 16.4x forward P/E multiple at the end of June – more expensive than its 25-year average of 15.7x (JP Morgan data). However, note that treasury yields were far higher in the past, above 4% on average, compared to today’s meager 2.3%. As a result, fixed income asset classes yield far lower these days – making stocks a more attractive choice for investors and the ‘expensiveness’ of the P/E ratio less relevant.

– Employment is getting fuller (at 5.3% in June), inflation is slowly rising, and wages are showing an upward trend, at 1.9% YoY as of June. In a tightening labor market, we’re thinking that Main Street stands to benefit in the coming months. Oil prices don’t seem to be going higher anytime soon, and that’s another catalyst for consumption to prosper.

– S&P 500 operating margins find themselves continuing to hover around record levels, at 9.4% earlier this year. So, margin expansion has a limited runway left. The priority for companies will turn to growth and productivity, which we believe should provide the next leg up (via capex). As is, the US capital stock needs serious replacement. Fundstrat’s Thomas Lee has been stressing this point for months. According to his data a few months ago, ‘the average age of consumer durable goods and business capital equipment [was] at the 99th percentile’. So, the need exists. When  companies will pull the spending trigger is the only question.

– The US treasury yield curve is showing a pretty resounding upward slope – signaling confidence in the economy via higher rates ahead. A downward curve has been a remarkable leading indicator of recessions in the past. Recessions, therefore, theoretically should not be a worry for the next 18 months or so.

– Debt to equity ratios have historically averaged around 160%, but find themselves at 100% today for large cap US companies. Firms have significantly deleveraged since the crisis, and are showing cleaner balance sheets. Corporate cash, meanwhile, is nearly 30% of assets, at the highest level since 2000. So, the money to invest is around, waiting to be deployed.

– Small cap growth stocks have returned 8.7% YTD, compared to the S&P 500’s 1.9%. A steady Main Street resurgence, shelter from currency headwinds, and an improving business environment have all caused this. Growth, meanwhile, has also outperformed value stocks. We think this is an extremely positive sign from investors, signaling confidence in the economy.

Meanwhile, some watchouts to keep in mind:

– Margin borrowing as a percentage of market capitalization is higher than during the 1990s stock market bubble, according to the IMF and WSJ.

– Employment is improving, but labor participation reached a 25-year low of 62.6% in June. Also, in our opinion, no one is able to correctly measure productivity – which seems to be declining per reports, but doesn’t add up given the advances in technology over the past 2 decades.

– Per Schiller’s CAPE ratio, the market is definitely overheated, at 27.2x, compared to the 25.5x 25-year average.

– $2.15 trillion in M&A deals occurred halfway through the year – a pace which might surpass 2007’s record of $4.3 trillion, according to the WSJ and Dealogic data. Slow organic growth and cheap cash is fueling this trend. Knowing the deal sizes from 2007, it’s worth recollecting what happened in 2008 (the downturn).

– The US homeownership rate is at the lowest level in 25 years, with details highlighted in our June 21st column. The drivers of the US economy are changing – and change sometimes isn’t easy to handle. Also, private valuations in technology remain high, and several recent IPOs have shown a below-par performance in the market.

What it means for you: Markets worldwide have shown remarkable resilience this year in the face of macro events and sluggish growth.  The fundamentals, by themselves, remain strong for the US economy in 2015’s 2^nd half. Stock downturns, especially due to overseas concerns, should be viewed as buying opportunities for longer-term investors. China’s uncertainty and Greece’s negotiations will define the near term, while the rising rate environment will define everything after. As a result, we’re sticking with our calls on small cap outperformance, a preference for growth over value, and financials, consumer discretionary and a bit of tech to outperform – all ideas noted in the beginning of the year. All in all, we’re focused on staying steady while tuning out the noise as Wall Street navigates the 2^nd half of 2015.

One thing’s for sure – the market’s Greek to Wall Street.

Greece just stunned the world on July 5^th with a resounding vote to reject the Eurozone’s austerity measures. Investors had not priced that decision in – most polls had projected a ‘yes’ edge leading up to it – and the shock’s pretty obvious given that futures are pointing significantly lower while safe havens including US treasuries, the dollar and the yen are in demand. The 1^st half of the year may be over, but the light at the end of the tunnel regarding a Greek resolution in time for the 2^nd half just flickered out. Here’s our attempt to distill the situation.

The EU’s austerity measures, if imposed, would have brought significant pressure on an already distressed Greek economy. A ‘yes’ vote would have meant that voters accepted the creditors’ demands, and the Tsipras government, while having failed to live up to their promise of ending austerity, would have been able to bow out gracefully given that the people had spoken and they’d done pretty much all they could.

A ‘no’ vote, on the other hand, would provide Greece significant bargaining chips to bring the EU leaders back to the table. An ensuing compromise between the creditors and Greece would then be the logical solution given that if the creditors and the EU pulled the plug, a Greek exit from the monetary union would prove catastrophic for the region, with the potential reversion to the Drachma leading to rapid inflation and expenses way beyond what the Greeks could afford. The outcome would range from a potential humanitarian crisis, a possible entry for new creditors such as Russia and China (leading to geopolitical complications), and a failure to live up to the unified European project and currency. Other countries would line up to exit, market confidence would without a doubt plummet due to the uncertainty, and powerhouses including Germany would certainly not be spared from economic turmoil.

As a result, with the ‘no’ vote in – resoundingly, we should add – Tsipras has now placed the ball in his European counterparts’ court. We hope logic prevails – likely a haircut to the debt while Greece stays in the Eurozone. While the negotiations play out, we only know one thing for certain – investors should brace themselves for unending volatility while either of the two endgames occur: the creditors compromise and markets breathe easy, or Greece exits and pandemonium ensues. In our opinion, it’s a binary outcome – a noted feature of stock markets this year. Given that we’re 6 months into 2015, the tight trading range for the S&P 500 so far defines it all – macro events have overshadowed fundamentals as US (and other worldwide) markets move up and down at any news arising from mainland Europe. The S&P 500 itself was up just 0.2% in the first half – the smallest 1^st half gain since 1928, according to CNBC. And even with the negligible move, it’s worth noting that the index is trading at 17.9x the past 12 months earnings, up from 17.1 at the start of the year – and significantly above the 15.7x average for the last 10 years, according to the WSJ. From a forward P/E perspective, it finds itself at 16.4 compared to the past 25 year’s average of 15.7x (data from JP Morgan). Median P/Es find themselves at even more expensive levels. Small caps are providing some solace, as stocks have benefited from the economy’s increasing Main Street strength and lack of currency headwinds; the Russell 2000 index has gained 4.9% compared to the S&P 500’s 0.2%. Nevertheless, all eyes are watching Europe this week. China, to a smaller extent, is taking up the rest of the headlines as investors attempt to dissect the market’s reflection of the underlying economy. As Chinese stocks doubled last year, policy makers let them ride. However, with the correction over the past few weeks, its all hands on deck as regulators figure out how to stop the downturn. We’re definitely bullish on China in the long term, but think it’s best to let this market sort out its rules for now. After all, buying and holding in cruise control – or investing, as we prefer to call it – is difficult if the speed limit keeps changing.

What it means for you: We’ve been talking about a much-needed market cleansing for certain sectors; Greece’s negotiations this week may help catalyze this. Any cash handy will be pretty valuable to buy sectors on the cheap, because fundamentally, we do believe that the US and several parts of the world (including Europe) are worthy of investment. Next week, we’ll be outlining our playbook for the 2^nd half. Meanwhile, our hope is that the Eurozone finds a solution to the Greek situation – not only because of the obvious clarity it will bring to markets, but also because until then, the pending Fed interest rate hike remains off the table, and a much-needed normalization in asset prices remains in the distance for weary investors. In effect, our recommendation is to keep an eye on the news and hold steady with your investments as European policy makers define the next turn on Wall Street this week.

The weekend was hardly a relaxing one on Wall Street. With an imminent default ahead due to a fallout in negotiations between Greece and its creditors over the weekend, the drama continues; one has to wonder how far the Greek government is willing to take game theory risks. With Greek banks shut on Monday, the game’s almost over – and along with that, a major, major wrench in the European recovery may be falling in place.

Meanwhile, US economic data – as well as much of the rest of the world’s – continues to moderately impress, albeit in a lukewarm, nonchalant way – sort of warm enough to satisfy the hunger, but not really hot enough to be delicious. The US showed a revised Q1 GDP that contracted less than expected, the Personal Consumption Expenditure index (the Fed’s preferred inflation gauge) nudged higher over the past 2 months, and companies continued to hire while operating at record margins. Overseas, we’re seeing signs of inflation in Japan, US rate hike discussions continuing to weigh on emerging markets, and frontier markets including Cambodia, Pakistan, and others getting more attention as the focus shifts away from China’s manufacturing engine towards less expensive economies. Also worth noting is that the disconnect of China’s markets with its economy seems to be slowly disappearing – Shanghai stocks dropped over 8% last week, complementing a major plunge in the previous week as well. Overall, with Greece’s drama reaching the final frontier and US rate hikes pending, investor seem to be resilient as markets really haven’t given up too much in value. We felt that JP Morgan’s chief US economist, David Kelly, summed it up nicely – according to him, none of the four triggers that cause a bear market – those being a recession, a spike in commodity prices, aggressive monetary tightening by central banks or extreme valuations, are in place. So, at a time when turbulence via rate hikes, inflation, and potential panic  due to a Greek exit remain on the radar, an interesting debate this week prompted us to elaborate on gold. Here’s what we’re thinking:

Gold: If there’s one symbol the whole world recognizes in unison, it’s this unique metal. Used for centuries as a currency around the world, the commodity lost much of its monetary relevance in the 1970s, when the gold standard was abolished and national currencies started getting priority for trade. Nevertheless, the emotional and addictive connect – with what is essentially a rock – continues to drive investment decisions, impact jobs and economies, and provide instant insurance under the pillow (or bank locker) for millions – if not more – of households across all income levels, demographics, and regions in the world. Turning to the markets, gold peaked around $1900/oz (in COMEX spot prices) in 2011. The commodity had a massive bull run from the early 2000s, when it was around $300/oz, providing a phenomenal return for those that owned it during the span. Since 2011, however, investors have gotten burned, as it finds itself around $1170/oz today (COMEX spot prices) – down 35% since the peak. Traditionally, gold has provide a good return with inflation – something that has been sorely missed during the economic recovery post-2008. So, given that inflation seems to be slowly returning, is now a time to get back in the game? We think not, for numerous reasons:

Gold, like various other commodities, is priced in US dollars. So, as the dollar strengthens – a trend likely to continue given the US’s imminent interest rate hikes – gold becomes theoretically ‘cheaper’ to buy, and therefore, currency trends should provide resistance for a major upward price. At the same time, a Greek default in the coming days could cause panic, aiding fear assets, with gold near the top of the list for investors seeking protection. As investors, we’re therefore looking at stark outcomes that are hard to quantify, and with diametrically opposite pulls – not to mention that gold – by itself – doesn’t provide cash flows or dividends, making the valuation much more complex.

Over to the consumption side: China and India, which together provide over 50% of the world’s gold consumption, have both been looking elsewhere with their money recently – in China’s case, towards the stock markets or real estate, or in India’s  case, elsewhere due to government-imposed controls aimed at reducing gold imports (a decision made by RBI governor Raghuram Rajan, considering gold’s massive impact on the Indian current account deficit over the decades). With investment options increasing as markets become freer, we feel that consumption from these regions shouldn’t be a major driver for prices.

From a supply perspective, South African gold mines, meanwhile, remain turbulent due to union rivalries as highlighted by Barron’s this week – another factor which is well beyond investors’ hands.  Although supply constraints seem imminent, the GLD ETF or gold spot prices haven’t really moved much, which makes us feel that worldwide sentiment remains neutral towards this asset. Gold is, in our opinion, not like copper, platinum, or silver, which have far higher industrial usage in appliances and manufacturing, and therefore can be valued more appropriately. Will Rhind, the CEO of the World Gold Trust, stated last week that ‘the GLD ETF hit a high of $2 billion in inflows year-to-date, but as of the 24^th of June, there have actually been net redemptions over the course of the year’.

Our point? Despite the 35% drop from its peak in 2011, the outlook for inflation and a potential Greece-induced panic, investors don’t seem to be attracted towards gold, considering futures contracts have barely moved in recent weeks. We feel the same way. Essentially, gold is a fear asset – one for which the returns are contingent on the next buyer paying more than the seller originally did. It doesn’t reward holders by paying dividends – and importantly, it doesn’t add value, the way companies do (investing in gold didn’t create an iPhone, a jet engine, or a water purification system, for example). In effect, it benefits the buyers, but not too many others – and the returns are highly dependent on factors well beyond the holder’s control. The current market definitely calls for diversification, but we believe it’s easier to achieve with stocks and ETFs focused on companies and regions that are not commodity-driven – especially in the case of this specific metal.

What it means for you: We recommend staying away from gold, as rather than cash flows, dividends, or value-addition, sentiment gets far more say in deciding the supply and demand pricing for this commodity than what we look for in an investment. On a broader note, watch the news from Greece this week. We’re concerned that the referendum declared by the Greek government leaves the outcome of the situation in the hands of voters that, while well intentioned, may not have the appropriate incentives to make the right call for the long term. If things do go downhill (the way futures are indicating at the moment), one thing’s for sure – significant bargains will show up in the markets. Picking up the precious jewelry – in the form of companies that investors throw out during panic situations – has the potential to look really good in the long term. The key point, in our opinion, is that domestic fundamentals in major regions are looking pretty good. Keep some cash handy as Wall Street looks for direction from Europe this week.

Wednesday’s Fed press conference was the highlight of last week – a week in which the S&P 500 finished up 0.8%, led by a comeback in defensive sectors including consumer goods, utilities and telecommunications. Janet Yellen’s carefully crafted address was undoubtedly the catalyst as she set the stage for interest rate hikes later this year, but at a more gradual, accommodative pace than the market had factored in. With US economic data continuing to show solid strengthening, Europe on the mend, and a rising interest rate theme ahead, all eyes over the weekend have been on Greece, where the last straws seem to be getting clutched to avoid running out of funds. Monday’s European markets will undoutably take center stage and set the tone for Wall Street next week as a result of the ongoing EU leadership meetings. All we, as investors, can do is wait and watch. With that backdrop, here are the two regions worth highlighting this week.

Europe: European markets find themselves at an interesting juncture. With a strong economic healing under way, the Stoxx 600 index is up over 12.5% YTD – far outperforming the S&P 500’s 2.5% gain so far – proving wrong much of the consensus forecast that expected the US to pull ahead this year. The weak euro, cheap oil, quantitative easing as well as local reforms have all aided recovery efforts; even Spain and Portugal’s markets are YTD by 6.5% and over 17% respectively. Even Italy – possibly the most tuned-in observer of Greece’s debt negotiations due to its own debt obligation, is on the mend – for example, according to the WSJ, Italy’s ‘recovery has so far been driven by investment rather than consumption, reflecting business confidence’. Local labor statistics show decreasing unemployment, and PM Renzi has promised several reforms in insolvency rules, infrastructure, and administration that have been needed for years, but haven’t been delivered. Our point is that at such a critical recovery juncture for the entire region, it’s hard to think that European leaders would willingly throw a wrench into the whole process by cutting off Greece. More importantly, our interactions with business owners in Germany last week highlighted a significant geopolitical aspect to the Greek negotiations – that being Russia’s involvement.  Russian support to Greece would have far reaching consequences for NATO as well as the EU – well described by political analysts including Eurasia Group’s Ian Bremmer earlier this year – and, needless to say, ones that western leaders would want to avoid at all cost. Therefore, the calculations involved in keeping Greece go far beyond finance and economics – geopolitics is set to play a major role. Keeping a close eye on the outcome is all investors can do – as in case any bets are placed, the payoffs would be quite binary, as described in our May 31st column.

The United States: Main Street can breathe a sigh of relief – economic data shows wages slowly growing, inflation rising, labor markets tightening, and gas prices holding steady. The past 6 years’ economic recovery has been a polarizing one – one in which the top 10 percent of the United States (coincidentally owning 80% of the stock market) effectively saw their market wealth more than double, while the middle and lower class got sorely left behind due to their limited exposure to assets such as stocks. Recent data shows that we’ve finally reached a point where most of America should start reaping the recovery benefits as well; with consumption driving the US economy, things are looking promising. As stated by the Bank Of America’s Capital Market Outlook last week, ‘the US economy is moving confidently into the middle of what should be its longest expansion ever’.  This, of course, doesn’t mean that a good cleansing for overvalued stocks isn’t due later this year (when rates rise, in our opinion) – it just means that with economic fundamentals looking solid, pullbacks should be viewed as buying opportunities for investors. Car sales reached their highest levels in a decade in May, gas prices continue to stay relatively low, small business optimism is increasing, and the S&P 500 consumer discretionary sector is seeing the benefits – it’s the 2^nd highest performer in the market, up 7.5% YTD (behind healthcare, at 10.5%).  However, there are a couple of themes we believe the market is overlooking. Student loans are at more than $1.2 trillion – steadily increasing from around $0.3 trillion back in the early 2000s, according to data from the New York Fed. With 40 million borrowers having an average balance of $29,000 (according to CNBC), we’re looking at a changed landscape for the US economic engine. The homeownership rate, at 63.7%, is at the lowest in 25 years, and is projected to continue declining, according to Bloomberg. In our opinion, the reason is that millennials have a new idea of the American dream. It involves smaller, compact – potentially multifamily homes, downtowns, craft beers, and a more entrepreneurial spirit – which means they’re busy investing in ideas rather than single family homes. Multifamily houses and – more importantly – renting – seems to be much more in vogue in the generation that’s having kids now. Housing has led the US economy for decades now – it may be time to rethink this philosophy. Companies smartly combining consumer services and technology – such as Netflix, Google (via Nest), Apple, and other new age firms such as iRobot catch our attention – and while we’re not saying go buy them all immediately, these are the type of companies that should do well as the US consumer paves a new lifestyle.

What it means for you: Economic drivers change with time, and finding the themes early can pay off in the long run. The US housing model has changed post-2008, and is one that we’ll be paying careful attention to. Meanwhile, in the short term, the global economy finds itself in a waiting game in which Eurozone leaders and the Federal Reserve hold the cards to the market’s next moves. Timing your buys and sells, as we’ve mentioned before, is a risky game. Stay invested with the rising interest rate theme and a US economic recovery, remain diversified, and keep looking into the details on Wall Street as Greece’s outcome defines the markets next week.

Interest rate hikes and Greece got some much-needed company in the headlines last week, as the financial sector joined the two on Wall Street’s most-talked-about subject lists. While the S&P 500 ended the week pretty much flat and quiet, the financial sector ended higher by over 1%. Investors are taking note of the sector’s status as possibly the biggest beneficiary of higher interest rates. Decent data from the Job Openings and Labor Turnover (JOLT) report, a higher-than-expected rise in consumer spending from the Retail Sales report last week, increasing signs of inflation, wage growth, labor market tightening and solid job gains last month are all pointing to an economy that should soon satisfy the Fed’s requirements for higher interest rates in the coming future.

In our opinion, a highlight worth noting is that while staring at the upcoming disappearance of easy money, investor sentiment seems to have remained orderly and without turmoil so far – with the exception of some treasury yield spikes during recent news releases. Market sectors are reacting as expected, with utilities down, consumer-oriented stocks up, and companies continue to utilize debt to issue buybacks, conduct M&A activity and consolidate. Wall Street’s gurus, meanwhile, are, in general, promoting active management during volatility, advising selectivity, and have been pretty vocal in their projections of an upcoming correction. We agree with all of the above – but importantly, not because of weak fundamentals, but instead, merely the need to cleanse what has been an extremely unusual, polarizing, long-running bull market for the past 6 years in a sluggish global growth environment.

The pullbacks in emerging markets including India (off 10% since its recent highs), Indonesia, Mexico, and certain currencies even though there have been no fundamental changes there is basically evidence of the reallocation of money back to the US due to the attraction of higher rates, in our opinion. Europe and Japan are on the mend as well, and other than Greece, the picture looks not-too-bad – including investor sentiment towards the regions. In the US, consumer discretionary stocks, information technology stocks, and financials are looking good; Ari Wald, Oppenheimer’s head of technical analysis, recently stated on CNBC  that ‘[these sectors] are the right leadership’, and that ‘it is a sign that investors are embracing risk’. So, one may feel pretty good reading all this. The prudent thing to do next would be to highlight the risks – and here are the two we felt were worthy of attention this week:

Greece: With debt negotiations appearing to have collapsed over the weekend, the country finds itself at a major crossroad. As we mentioned in our May 31st column, a binary approach would provide opposite outcomes for stocks. Ripping the bandaid off is probably the right approach, as dragging the drama on by kicking the can down the road is just not working; note that Germany has corrected over 10% in the past month – primarily on Greek fears. A conversation earlier this week highlighted a potential solution – let Greece go back to the Drachma, rebuild the economy on their own terms over the next, say, 5 years, and provide light at the end of the tunnel by allowing it to re-enter the monetary reunion at the end, with certain conditions. Sure, you can find some flaws with this approach – but at this point, no direction is perfect. The situation is affecting the entire globe, and the unstable footing was undoubtedly one of the reasons the IMF and the World Bank both warned the Fed against raising rates in 2015 recently. It’ll be interesting to see whether the Fed decides to heed their warnings – effectively transforming it into the World Fed, or whether it sticks to its guns and moves ahead with raising interest rates (doing exactly  what the market is looking for it to do).

China: We highlighted our concern in our May 4th column initially, and felt it was worth revisiting. Stocks here have zoomed up way too quickly here. If the world’s 2^nd largest economy’s market effectively doubles in a year while GDP growth slows down, something’s disconnected. And then, looking into the details – retail money, rather than institutional, is driving the trend, and with behavior similar to the dot com bubble sentiment stateside (investing on momentum rather than fundamentals), it’s a bit concerning. Some of Wall Street is joining us on the sidelines – according to Credit Suisse, ‘margins, profitability and value creation continue declining as productivity growth lags real wage growth and product selling prices are eroded’. The company’s model calls for a 23% overbought state (15% in US$ terms), as highlighted by CNBC. What makes this situation interesting, though, is the government’s backing of the rally. ‘Don’t fight the Fed’ is a given statement in the US. Fighting the Peoples’ Bank of China, in that case, is an absolute no-go, and given Chinese inflation data remains weak (consumer prices rose 1.2% YoY in May, and producer prices fell 4.6%) – there’s plenty of room for further easing, as the WSJ noted recently. If there’s one thing we can bet based upon everywhere else, it’s that easing helps the markets. So, it’s worth keeping an eye on this market to see how the international region reacts to China’s market boom.

What it means for you: The world’s markets find themselves in a pretty fascinating situation. Fundamentals are improving, policies are changing, and the interconnected nature of the global economy will play a major role in asset and regional returns in the coming months. For a tactical play, rotating into financials, technology, and select sectors that may benefit with rising rates and an improving domestic economy may work. If you want to protect your gains, a neutral strategy like buying the sectors above while shorting the S&P 500 is an option. You could, of course, just buy the broad market index funds such as SPY and VXUS, and sit back for the long term, as Wall Street has shown to reward its loyalists over time. In any case, it’s good to stay alert. Next week, we’ll have a special report from Germany on the state of the EU. Until then, keep looking into the details to stay on top of your investments on Wall Street.

Friday’s stellar jobs report was the icing on the cake for what was a pretty intense, yet satisfying week on Wall Street – one where US Treasury bonds took the dive investors were preparing for, Greece officially missed the first IMF payment in recent history but stated it would make the next one, and the ECB kept interest rates and the focus on quantitative easing unchanged. At this point, it’s extremely difficult to argue against the employment momentum the US is showing – it added 280,000 jobs in May, revised April upwards, and also showed a greater-than-expected wage growth of 0.3%. As expected, the S&P 500 remained mixed on Friday following the report, with investors digesting the fact that the good economic news would pave the way for interest rate hikes. CME’s FedWatch is now indicating a 50% probability of a rate hike in the October 28^th Fed meeting, and the current state points to a fascinating few weeks ahead – one where fundamentals collide with behavioral economics, and rational markets along with monetary policy. Predictions of when and what the returns will be is a tough, tough game, but this situation is too interesting to not outline. Here’s what’s on our mind as we check out Wall Street:

– Historical Rate Hike Returns: The major worry we have had regarding the bond market came true this week, with US Treasury yields jumping nearly 30 basis points to end the week at 2.4% (a massive upturn, for those not as familiar with bonds). The Dow Jones US Utilities sector also ended down 4%; with the sector acting as a a proxy for bonds due to their dividends and safety, it’s clear that investors are preparing for higher rates. A rising interest rate, as is, indicates a stronger economy, and in our opinion, the (extremely accomodative) Fed wouldn’t go for it unless they really believed the economy was ready. A look at 10 year T-bond yields as an indicator of GDP growth also aids the theory that rising rates might be a positive sign for the US economy. Now, combine this with stock returns – according to data starting from 1983 from Nuveen Asset Management’s Bob Doll in Barron’s this week, the average performance of the S&P 500 in the past 6 rate hike cycles was +14% from 250 days before (one trading year) the first hike, only +2.6% one trading year after, and +14.4% 500 days (two trading years) after. So, historically, stocks have actually done fairly well – although with higher volatility. Another key point, according to him, is that “during the previous six rate hike cycles, the Fed Funds rate started at an average of about 5%”, and the “10 year T-bond yield was around 7% on average”. That’s a far, far cry away from today’s near-zero Fed Funds rate, and 2.4% T-bond yield. We’re starting on a very low baseline, and this should definitely help keep investors somewhat calm.

– The Return Of The Consumer: At the same time, risky assets – such as stocks – have been massively driven up by investors since 2009, seeking yield in a slow-growth global environment. Today, the S&P 500 finds itself at 17.1x forward earnings, according to Yardeni Research. In our opinion, it’s inevitable that investors will take some profits when interest rates start hiking – likely in Q2 or Q3. However, the economic fundamentals remain sound, and a bounceback in Q4 is what we’re looking forward to due to pent-up consumers. This is because personal savings rate has reached 5.6% (a multi-year high), and people have been busy paying off debt so far, instead of spending. We certainly don’t think oil prices are going to skyrocket anywhere soon, given that supply (based on OPEC’s meeting last week) remains unchanged, supertankers continue to get paid massive surcharges to transport oil – which means the supply gut continues, according to a fascinating report by Bloomberg, and therefore, the savings derived from gas prices will remain around. This should help consumption in the coming months as the labor market tightens, inflation grows, and the US dollar continues to remain strong (helping small businesses – which employ over 90% of the US population, according to the Census Bureau, and derive most of their revenue domestically). So, consumption should drive growth later in the year.

– Earnings Revisions: In Q1, given the downturn of oil, the massively conservative earnings estimates by Wall Street led to an S&P 500 earnings outlook much lower than it deserved, in our opinion. Looking at FactSet’s Earnings Insights last week, we noted that ‘companies in the energy (+28.8%) and Healthcare (+10.7%) sectors are reporting the largest upside aggregate differences between actual earnings and estimated earnings’. We feel that analysts continue to be cautious in increasing estimates for the remainder of the year – even though oil has bounced back and is holding steady at around $58 (WTI crude, July contract). Our point? Earnings estimates stand a very high chance of revisions upwards as the year goes on – and therefore, our concern of limited multiple expansion from the current 17.1x forward earnings for the S&P 500 is pretty low – it would be higher earnings driving returns instead.

What it means for you: The US economy is looking pretty good. Sound fundamentals provide no reason to penalize a market that is currently being aided by immense liquidity – so if it falls when that crutch is removed via interest rate hikes, give it a hand back up by buying sectors on the cheap. Wall Street can appear intimidating in the short term, but it has definitely proven to be a faithful companion in the long term, rewarding loyal investors that stick with it during the ups and downs of life in the markets. Keep looking into the details and fundamentals at the forefront of your investment decisions as monetary policy starts engulfing the news in the coming weeks on Wall Street.

As May comes to a close, Wall Street’s traffic is looking pretty confused. Economic fundamentals look like they’re moving in the right direction – US unemployment is reducing, inflation is slowly increasing, and markets are showing positive returns across key global indexes. However, the ‘Sell in May and go away’ adage remains in the news, correction calls continue to get more pronounced by the day, and the consumer-driven sectors – highly expected to lead spring and summer’s market returns due to low oil prices – haven’t delivered yet, based on recent earnings and guidance by major companies. In our opinion, Wall Street’s sideways action is impacted by two major decisions that – unlike most things – it’s unable to influence – and both have binary outcomes: Either the US raises interest rates in September, or it doesn’t. And either Greece defaults, or it doesn’t.

Let’s look into the details. If US data continues to show improvement (unemployment gets closer to the 5% mark, inflation creeps up to 2%, more people enter the labor force, consumption increases, etc.), the Fed would raise rates. According to data from S&P Capital IQ, the US has not seen a correction – meaning a downturn of 10% or more – in 44 months, compared to the historical average of 18 months. A rate hike would trigger a major market cleansing, in our opinion, hitting overinflated asset classes including risky stocks, private companies, and the bond markets – especially the high yield sector. Abroad, countries with major current account deficits, and those dependent on imports of dollar-denominated goods such as oil, would suffer significantly. The dollar would strengthen, hurting multinational US corporations, which would likely delay capital expenditures even further. So, it wouldn’t be a rosy picture for stocks.

On the other hand, if the Fed delays the rate hike (due to poorer data than what the Fed is looking for), the exact same sectors noted above would instead do extremely well. Bad news for the economy, then, becomes good news for the markets…atleast in the short term. The outcomes would be, in effect, in opposite directions – all based on the Fed’s movements.

Now, add Greece – in parallel – to the rate hike scenario. If Greece defaults, the European Union would face a possible collapse, with Spain and other nations also looking for debt relief. This would trigger a market downturn – and with investors having already flocked to Europe this year expecting growth (The Stoxx 600 is up 16.7% YTD), that’s really not something the world needs right now. As is, we’re in a slower growth environment – a ‘new normal’, as several noted names have coined it – the last thing we need is the current growth engine to stall before it gets on the highway. Again, not a good situation for stocks.

Say, on the other hand, the euro remains intact (even though Greece defaults) and the union does not break up – which is what policy makers will strive to do, in our opinion. The Euro might get stronger, hurting Germany – the powerhouse of the region – and therefore, everyone else.

If Greece doesn’t default, of course, and its debt obligations change after reform acceptances, the markets continue to move ahead, all hunky dory. So again, we see the potential of diametrically opposite stock returns based on the Greek decision.

Add a dose of activism, buybacks, and capex decisions by US corporations (all based on the interest rate hike timing), and we’re looking at an incredibly complicated summer ahead. This week, S&P Capital IQ data analysis by the WSJ showed that companies in the S&P 500 index increased their dividends and buybacks to a median 36% of operating cash flow in 2013, from 18% in 2003. Over the same decade, those companies cut spending on plants and equipment to 29% of operating cash flow, from 33% in 2003. Factor in another expert – Byron Wien, who states in Barron’s that ‘the US industrial stock is at 22 years old – an all time high’. So, even though capex seems necessary, companies aren’t going for it, and instead, seem more keen on returning cash back to shareholders. Buybacks and M&A activity have massively contributed to earnings and revenue growth this year; according to Strategas Research, the current level of the two is less than 10% off the pre-crisis high. The interest rate hike will also impact this, because once cheap financing disappears, companies will need to make far tougher decisions on pursuing organic growth and reinvestment than they’re currently used to.

What it means for you: We’re living in a pretty binary world, with two possible outcomes for each factor. The number of factors, of course, makes the situation complex. Our recommendation is to stay diversified, think long term, and don’t jump the gun by selling or buying on the news regarding Greece and the Fed – because a factor moving may change that equation completely. Stick with the theme; as we’ve recommended earlier, the financial sector, tech and biotech stocks, small caps, and growth companies are our picks for a rising interest rate environment – so invest early, and don’t bother trying to time it. One of the finest minds on Wall Street, Burton Malkiel, has provided ample data on how market timing can prove disastrous for investors – according to him, it is ‘investors’ most serious mistake’. Make your investments based on the fundamentals and themes – everything else will fall in place sooner or later. While the complexities show both directions possible in the short term, remember that Wall Street itself is a one way road – and in the long run, investing early and staying focused means you’ll get to your destination absolutely fine.

‘Lukewarm’ is the best way to describe the stock market’s behavior in the past few days. With a lack of conviction, neither buyers nor sellers are stepping up to the plate, and as treading water remains in fashion, the long weekend in the United States is (hopefully) providing traders a good time to think and absorb Asian and European news – all of which is likely to heavily influence US trading in the coming weeks. The Broadway-worthy Greek drama is renewing headlines this weekend, with the Interior Ministry confirming on local television that it will not be able to make June’s debt payments. With a default and potential exit from the Eurozone looking more and more likely, the situation may open the doors for other debt-laden nations to take a similar stage left. A corresponding strengthening of the Euro, or a monetary union breakup, would hurt Germany’s export-driven economy significantly – driving the regional recovery back into the dust. Given Europe and Japan’s leadership in the global markets this year, we worry that any backtracking would put a serious wrench in the world’s growth. Meanwhile, Japan slid back into trade deficit territory in April. The weak yen and exports have played massive roles in its recovery, but ‘uncertainty lies ahead over whether exports will continue to be fueled by the health of overseas economies, particularly the United States and China’, according to local economists covered by the WSJ. And while China’s red-hot stock market continues to amaze, the remarkable episode of local companies such as Hanergy losing over half of their value in a matter of minutes – only to find that the chairman was shorting his own company’s stock before that – makes us wonder how representative the stock market is of the underlying economic fundamentals. To put simply, we’re more worried about the world in the short term than we’d like to be – and therefore, decided to stay stateside this week and put our thinking caps on regarding the world’s largest, most influential economy.  Here’s what we’re thinking:

The United States: Wall Street’s had a pretty amazing run, up nearly 210% from the March’09 recession depths. While the stock markets have flourished, however, growth has been tepid, the labor force has been shrinking, and near-zero interest rates have caused massive polarization among the finest minds in the game on whether the markets are reflecting economic fundamentals – or just Fed stimulus adrenaline. Corporate cash as a percentage of total assets is at its highest levels in years – but companies continue to hoard it rather than deploy it on R&D and capex. Gas prices have plummeted, but the US personal savings rate just reached 2-year highs – meaning (the much needed) consumption spending isn’t picking up. And with 9 years of near-zero interest rates having to end sometime, the bond markets, high yield markets, and private valuations are high on our radar as potentially overvalued asset classes.  All in all, while the fundamentals of the US economy are pretty solid, we believe that rates will rise sooner than later, and Yellen’s speech on Friday (along with the near-daily regional Fed speeches these days) – should serve as a notice for Wall Street that it’s time to get real. The stock market’s not a game, and when uninformed people started betting on tech stocks in the dot-com bubble, the eventual bust burnt everyone who was playing, but not thinking.  Goldman Sachs, in a note last week, basically said that the S&P 500’s not going anywhere this year – and highlighted that ‘dividends and buybacks will be responsible for supporting a market where the median stock in the S&P 500 index is trading at 18.2 times earnings, putting it in the 99^th percentile of historical valuation’. Major indexes barely moved when Janet Yellen spoke in Rhode Island on Friday – another sign, in our opinion, that complacency is heavy in the air. Meanwhile, the Dow Theory – suggesting that the Industrials and Transport indexes should move in sync if an economy is healthy – is also showing significant divergence over the past few months. Granted that oil price rebounds and significant airline returns over the past few years have skewed this a bit, but it’s still worth noting that the Dow Jones Transportation Average is down 7% YTD, compared to a 2.3% upside for the Dow Jones Industrials Average. Consumer staples, as well as the healthcare sector – both defensive plays – have performed phenomenally well in the recent years, and are richly valued, at 19.4x and 17.2x forward P/E, with data from Yardeni Research. Takeover premiums and break-up valuations are undoubtedly impacting the staples sector, in our opinion, while the healthcare sector remains a structural growth story of investment and scientific advances in the face of an ageing population and a friendly regulatory environment. The resonating opinion from analysts is that tech, financials, and healthcare are solid sectors to be in in the coming months. We agree, and in our opinion, financials lead the way. The expected earnings growth rate of the financial sector is the 3^rd highest out of the 10 S&P 500 sectors, according to S&P Capital IQ’s Erin Gibbs – highlighted by CNBC. IAT is an interesting regional financials ETF, and in a rising rate environment, this, along with XLF, would be solid plays, for reasons outlined in our February 8th column. Meanwhile, according to JP Morgan Asset Management, ‘cyclical and small cap stocks are generally favored in a rising interest rate environment’. This is another one we agree with – for reasons stated in our April 13th column. All in all, the US remains a solid place to be, but expect sectors to diverge as innovation, productivity, rate hikes, and macro events play a major role in market returns in the coming months.

What it means for you: Investing for the long term, via a diversified exposure to the broad global markets, works – and staying patient is the key. For a shorter, 1-2 year horizon, keep an eye on the factors stated above. In our opinion, riding structural or thematic waves is fair game in a market which at times is not rational – and we believe that investors at the moment are getting a bit complacent, simply doing before thinking. Take advantage of the shortened trading week in the US markets to step back, think, and prepare for what promises to be an extremely interesting drive ahead on Wall Street in the coming weeks.

As the S&P 500 continues to scale record highs, investors worldwide are faced with a US business cycle situation that continues to defy logic and expectations. In the post-2008 business cycle, 6 years of near-zero interest rates have led to an average annual GDP growth of around 2%, and inflation far below expectations. Consequently, we remain stuck in an expansion – but an incredibly slow one, and the ‘are we ready to raise rates, and if yes, when’ question continues to haunt Wall Street’s finest minds. Alongside, while the US has done its fair share of contributing to global growth, international markets haven’t exactly taken the baton and run. Europe remains stunted due to internal functioning and prolonged austerity (now ending), China’s red-hot markets continue to overlook the underlying debt and real estate concerns (noted in our May 4^th column), and several emerging nations are underperforming due to factors far beyond fundamentals, including Brazil and Russia.  Given low bond yields and fairly valued stock markets, investors continue to search for any returns possible. On this note, this week we’re focusing on South Africa as a gateway to the sub-Saharan African economy – a region with untapped potential and vast resources, but not yet on the forefront of investors’ horizons. Being ahead of the curve on Wall Street is usually extremely difficult, but this is why we think South Africa may be around the corner before other investors join the safari:

South Africa: Recent worries about South Africa’s current account deficit, regional instability, labor disputes and the prolonged dependence on commodities have overshadowed the country’s underlying economic potential, based on our research on the ground last week. Following the zoning philosophy, South Africa remains the major gateway to the Southern African region, along with Nigeria to the west and Kenya in the East – but the economy is far more developed, with a well-trenched multinational presence, a solid logistics network connecting the metro regions, and a robust banking structure already in place. While Nigeria’s GDP growth rate surpassed South Africa’s last year, at around $60 billion in market capitalization, the Nigerian stock market represents less than 15% of GDP, according to the World Bank. Meanwhile, South Africa’s market capitalization, at over $600 billion, instead stands at over 150% of GDP – significantly higher than its emerging market peers and more in line with the US’s 100%+ ratio, suggesting a relatively developed capital market and higher access to liquidity for South African entrepreneurs and corporations. Now, this comes with a domestic economy under significant strain, with nearly 25% unemployment in 2014 (according to the CIA Factbook), a declining political approval sentiment (Jacob Zuma’s government had a 34% approval rating in September, according to research firm Metro OmniCheck, compared to over 60% 5 years ago), and a continued under-performance of state-owned firms, including Eksom, who’s erratic load shedding schedules continue to hurt manufacturing and mining operations.

Despite this, the Johannesburg Stock Exchange continues to hover near all-time highs, and South Africa’s primary ETF, EZA, is up nearly 9% this year, far outperforming its emerging and developed market peers (the S&P 500 is up only 3.9% YTD). This resonates with our opinion that a stabilization in commodity prices due to the world coming to terms with China’s slowing growth, gold’s price floor given the low inflation in the developed markets post-recession, and renewed privatization efforts will lead to earnings growth and are propping up the market. While Zimbabwe’s economic woes continue to get attention, lesser-followed neighbors, such as Namibia, Botswana, Mozambique and Zambia are actually showing quite robust economies and internal demographics, and we believe investors are undervaluing South Africa’s benefits derived from them. Goldman Sach’s MD, Colin Coleman, noted in December that ‘while foreign corporate acquisitions of South Africa counterparts have all but evaporated, the capital markets have maintained faith in the earnings power of South Africa corporates. Balance sheets are solid, earnings strong and recent deal making suggests corporates ability and potential to expand abroad’. Meanwhile, Renaissance Capital, at the same conference, displayed confidence in Sub-Saharan African growth in the long term due to the ‘excellent demographics and best-educated labor force the continent has ever seen’.

As of April 30^th, the MSCI South Africa index indicated a forward P/E ratio of 17.0, well above the emerging market index’s 12.1 ratio. However, South Africa has provided an annualized 5-year return of 6.7%, outperforming the emerging market index’s 3% return. According to Wayne McCurrie, a portfolio manager at Momentum Wealth Management in Johannesburg and profiled by Finweek, ‘a market can be expensive as long as the future outlook supports the evaluation’, and that ‘the earnings outlook for the South African market is reasonable, especially in rand terms’. We’re on board, and our opinion is that South Africa’s role as a gateway into sub-Saharan Africa remains unparalleled. With the inevitable development of infrastructure, communication, banking and increasing consumption in this region, South Africa stands to be a tremendous beneficiary given its existing infrastructure and relatively robust capital markets system.  US interest rate hikes coming soon are likely to hit the market in the short term (as with most other markets with notable current account deficits), and it’s worth taking the opportunity to invest then.

What it means for you: Staying diversified helps. At a time when global market returns are significantly impacted by policy decisions, it’s worth benefiting by being exposed to the world’s progress. South Africa provides this exposure to sub-Saharan Africa. ETFs such as EZA, (which represents the South African index), are worth considering for buying and holding. Keep in mind, though, that while emerging and frontier regions can be great long-term plays, they’re subject to significant short term volatility and political and currency risks, among other factors. It’s best to play it slow and steady by investing over time in South Africa for the long haul, rather than going all in and expecting a full house on the next hand.

Friday’s US jobs report provided significant respite going into the weekend, as investors worldwide breathed a sigh of relief seeing America’s continued employment progress. With 233,000 jobs added in April, expectations were somewhat met, but definitely not blown away, helping keep Fed interest rate hikes temporarily at bay, and the easy money flowing. However, it’s not worth banking on for too much longer, in our opinion, given continued signs of labor market tightening and inflation rising. Across the Atlantic, European growth data is continuing to impress as well, although Greek negotiations remain an anchor on the markets. Overall, we’re seeing that the developed world is muddling along in the right direction, and believe investors will slowly begin to rotate asset classes, diversify, and turn on the heat in developing regions as interest rate hikes become imminent. Next week, we’ll have a report from South Africa, covering the economic prospects and investment ideas in the sub-Saharan African region. In the meantime, here are two subjects we’re highlighting this week:

The Danger With Bonds: Wall Street has decided to raise the alarm on the bond market over the past few days, with a number of high profile investors stating that a correction is coming. We tend to agree with the herd on this call, since even though the statements are resonating all over the place, unlike normal, the move hasn’t actually occurred yet. Granted, 10-year treasury yields have jumped from 1.67% to 2.2% since February – a massive move in a short amount of time. Yields rise when bonds fall in value, and this change is important to note – especially considering the unnerving volatility last week in sync with the German bond market – another region with unsustainable yields. The 2.2% yield is still far below the pre-recession era of 4% or higher. Add to that CNN Money’s fact yesterday stating that ‘the value of the worldwide bond market plunged more than $430 billion since yields began to soar last week’. These are significant numbers, especially when we consider that bond investors as a group aren’t really the thrill-seeking type. They usually prefer stability and safety – and this same bunch has moved into high yielding bonds over the past few years, given that that asset class has been one of the few sources of measurable return in fixed income. When safer horizons come calling with interest rate hikes, there will be a lot more ship-jumping than what is currently factored into bond prices, in our opinion. Forbes’ William Baldwin goes as far as to call the possible correction ‘a disaster waiting to happen’. We highlighted our concern on high yield bonds in our May 4th column, and believe the entire bond asset class is worth treading extremely carefully in the coming weeks.

The Power Of Data: We switch gears here, from asset classes to structural trends. With terms like ‘Big Data’ and ‘the Internet of Things’ being thrown around left and right during conference calls and visionary talk, we decided to chime in this week on the subject. In fact, let’s make it simple. While Wall Street continues to value Facebook, Google, and other tech companies around their advertising cash flows, we prefer to think of them as data gold mines. Why? Because Netflix knows more about your viewing habits than you probably do yourself, while Facebook can probably tell what you like, what you don’t, and what you’re thinking before you probably do. Be it shopping, eating, spending, or saving habits, we believe that the companies thriving on consumer emotion will start giving the traditional ratings and research agencies, such as Nielson, a run for their money. Other major, undervalued data hubs? In our opinion, it’s the credit card industry. Who better to dissect your spending than companies such as American Express, MasterCard, or Visa? The latter handled transactions over $6.8 trillion last year, according to The Nilson Report – to put it in perspective, that’s nearly 10% of the world’s GDP (from the CIA Factbook). Granted,the companies mentioned above have had phenomenal stock runs over the past few years. The structural theme, however, isn’t going anywhere. As ETFs of all types crop up for investors – passive, active, smart beta, geographic, etc., we look forward to a ‘data-centric’ ETF, which compiles companies that thrive off of the information from consumers. Take the example – Fitbit filed for an IPO last week to raise over $100 million. In a few years, it knows that the data from counting steps will be a lot more valuable than simply winning walkathons or corporate step challenges. That thought process is definitely a track worth walking on.

What it means for you: Outsmarting Wall Street isn’t easy. Many try, and judging by average individual historical returns, most fail (to beat the market). Noting the hints from the smart money, however, is much simpler. As every corner of the world continues to deliver market-moving news daily, right from US interest rate hike projections, European growth data, Chinese market volatility, and Arabian oil ministry comments, it’s important to maintain focus, stay alert regarding your assets, and invest in the structural themes. Short-term news, in our opinion, is like turbulence. It can hurt the aimless wanderers chasing returns down the aisles, but if you chill out and wear a seatbelt, the only effort needed is holding your wine glass steady for a few seconds. In a few minutes, it’ll be as if nothing happened, and given the impeccable safety record of planes during turbulence, you’ll reach your destination absolutely fine. The stock market, in the long term, isn’t all that different.

April saw significant volatility across global markets, as lackluster Q1 US GDP reports unnerved investors, and recent leaders on Wall Street, including transportation and biotechnology stocks, decided to take a pit stop. On the bright side, US wages finally moved upwards, indicating possible labor market tightening – and consequently inflation – ahead. This week, the US jobs report will be the center of attraction as investors continue to figure out the timing of interest rate hikes and the impact of international easing measures on the US economy. Meanwhile, as earnings season rolls on, the effects of oil prices and currency moves on earnings and revenues keeps Wall Street busy. In line with our belief that several stocks were priced to perfection leading up to the recent weeks, Twitter, Yelp, and LinkedIn fell over 20% in a single day after weak earnings reports.  Meanwhile, Carl Icahn, over the weekend, reminded Wall Street that the high yield junk bond market was in a bubble – voicing our concerns, given that the asset class is the 2^nd best performer (after emerging markets dollar debt), returning 7.7% annually over the past 15 years. Risky assets have been major beneficiaries of low interest rates. Our opinion remains that the market will continue to be sensitive to policy statements and jittery trading – as while everyone wants to ride the wave higher, it’s going to be an every-trader-for-him/herself situation when the plug gets pulled. Being cautious and selective is the key to taking 1-2 year positions, and it’s best to leave aside policy projections and focus on finding the underlying strengths in the world’s markets while choosing investments. Here are the two subjects we’re highlighting this week:

M&A Activity: Corporations continue to stash cash at record levels as a percentage of their total assets, and cost-cutting measures have proven pretty successful, considering profit margins are at multi-year highs. With global growth projections still looking weak, we reiterate our opinion that M&A activity will remain high on the radar for both activists as well as companies. According to Wells Fargo’s Gina Martin Adams, ‘the average company in the S&P 500 index involved in a transaction has outperformed the benchmark during the month after the announcement in each of the past 3 years’, showing that investors have rewarded the fact that this may be among the few ways to achieve growth at the moment. Also, according to Credit Suisse’s Andrew Garthwaite, ‘the stock market doesn’t peak until about eight months after a merger boom crests’ – and we don’t think we’re anywhere close to that stage yet. While finding undervalued targets is a way to benefit from the activity, the financial industry should continue to reap the rewards from such transactions – and although the sector hasn’t really done much this year, we reiterate our opinion from our February 8th column that the bargain prices continue on banks.

China: The Chinese stock market remains among the most watched indexes this year, as investors attempt to dissect the impact of structural economic growth and recent policy decisions. Chinese stocks have more than doubled over the past year, aided by policy changes involving the encouragement of retail investing, a broader currency trading range, and market liberalization measures aimed at enhancing foreign investment. According to Barron’s Kopin Tan, ‘Shanghai stocks fetch 22 times trailing earnings, versus 49 times in 2007’, and many analysts believe this is just the beginning of a massive bull run as China adjusts to a slower, but more solid domestic-driven economy. While the enthusiasm is pretty high on Wall Street, our concerns, however, linger around the ability of local companies to furnish their high yielding debt obligations in the coming months, the possible implosion of overvalued real estate, and the pace of the economy in transitioning into a consumption-driven one. Charles Schwab’s Jeffrey Kleintop recently highlighted  how the demographic changes mirror those of Japan in the 1970s and 80s, and therefore, the working age population ‘is peaking and set to decline in the years ahead’. China’s capital markets find themselves at a very interesting juncture for these reasons, and while the market remains high on our radar, we prefer to understand how the concerns above are mitigated in the coming months before going all-in. At the same time, there’s no doubt that the transition into a consumption and service-driven economy will occur, and therefore, adding exposure to consumer-driven stocks provides a good risk-reward scenario.

What it means for you: The coming weeks are set up for some serious short-term action, with the jobs report on Friday, along with the much-discussed summer under-performance that has occurred historically…occasionally. We aren’t paying attention to this stuff, and prefer to bet on the structural trends in the global economy. A broad exposure to the world’s equity markets via ETF combinations such as SPY and VXUS, is the simplest foundation upon seeing the historical trend of markets to deliver in the long term, given global population growth, productivity improvement, and increasing utilization of comparative advantages through cross-border trade. As for structural sector changes, it’s worth listening when the visionaries speak. In a 2013 McKinsey interview, Google’s Eric Schmidt stated that digital biology would be among the biggest trends to watch in the future. In recent years, the immense interest in fitness apps, healthier food, tracking features of the Apple Watch, objectives of companies such as Under Armour, and surging biotechnology venture capital all attest to this being a structural trend. The quest for a better – and longer – life, isn’t going anywhere, and this is a change worth being invested in. Sit back and move ahead with the world while Wall Street attempts to figure out the direction in the coming weeks.

As earnings continue to hit the newswires this week, Wall Street is looking for some shelter from rough weather by attempting to differentiate between what is noise, and what isn’t. So far, according to Yahoo Finance, three quarters of the companies that reported have topped earnings expectations, while less than half  have reported revenues above consensus estimates (below the historical average of 58%). With slower growth than projected, this week’s US GDP report should provide significant clarity on when the Fed may raise interest rates.  At this stage, caution, in our opinion, is the price required to pay for perfection; while the upside for the markets this year remains plenty, we think the ability of investors to weather through thick and thin has seriously worn out. The S&P 500 is up more than 210% since the 2009 bottom, and continues to hit record highs, along with the Japanese Nikkei. The Nasdaq has now regained its 2000 peak, and Europe has returned over 20% this year. At the same time, growth has been far slower than expected, monetary policies worldwide have played a much bigger role in increasing risky asset prices than during previous bull runs, and income divergence has dramatically increased – picture this – there are now 14,600 families with at least $100 million in assets globally, up 42% since 2008, according to Bloomberg Markets. Meanwhile, US wages haven’t really moved since the recession. So, people that are rich enough to participate in the markets have prospered, while the rest, not nearly as much. Meanwhile, valuations for large private companies, a subject we highlighted in our March 8th column, have gone up 68% in just six months, according to the WSJ’s Billion Dollar Club data. Investors are scraping for yield wherever it’s available. The combination of all these factors is uncharted territory for the bulls – and it only takes a few to start a stampede backwards. The Shiller CAPE ratio is indicating that the S&P 500 is at 27, well above the median of 16. However, the rest of the developed world is at 17, below the median of 22.5, highlighted by Barron’s. Consequently, as all of Wall Street boards overbooked capital flights to Europe and Japan, it’s worth keeping an eye on discounts elsewhere, especially considering the major risk that lies in the hands of Greek politicians – which frankly we have zero control over. Staying invested is the right approach, but taking short-term positions at the moment is – we keep reiterating our broken record – more akin to betting on people rather than on company fundamentals. With this overview in mind, here are two subjects worth highlighting this week:

ETFs: The popularity of ETFs – a phenomenal product, worries us a bit – even though we use it plenty ourselves. The reason? All the stocks, as single baskets, go up and down at the click of a key. Consequently, given a continued rise in the assets in this product, mispricing might occur more frequently among companies that don’t deserve to be yanked up or down with their entire sector or geography. Also, due to the user-friendly liquidity of ETFs, market downturns (or even upturns) can be dramatically exaggerated due to automated buying or selling of entire sectors en masse. ETFs account for 25% of total market turnover, according to Goldman Sachs, 10% higher than 10 years ago. As this is projected to increase with time, it’s worth keeping an eye for some diamonds in the coal mines as investors move the passive route and start differentiating less between the quality of individual companies.

Macro: This week, conversations on the ground with German export-oriented business owners re-emphasized our continued confidence in the German stock market. The cheap Euro continues to help exports, multinationals are steadily investing in capex, and the country continues to benefit for these, as well as other reasons described in our January 14th column. We reiterate buying the HEWG ETF, especially if the Greek story goes downhill this week – as our focus is on the structural strength, and not the impact of policies. We also believe the Greek outcome will be an important factor in Germany’s decision (amid continuing US pressure) to start lowering its current account surplus to aid global economic growth. Meanwhile, we highlighted Mexico in our January 25th column, and reiterate a strong buying opportunity here. The country’s current account deficit is less than 2%, its got among the most diversified GDP sector contributions in emerging markets, and while the forward P/E indicates a slightly expensive 18.6 compared to the 10-year average of 14.8 (at the end of Q1, according to JP Morgan), we think there’s plenty of room to run as the Peso continues to hold its ground. The Global Competitiveness Report by the World Economic Forum indicates that ‘Mexico (61st) has adopted important structural reforms in the past year’. With elections around the corner, this statement is key, and the country remains among our favorites, along with India. Meanwhile, China remains in the headlines, but the demographic trends there worry us a bit. We’ll be elaborating on this next week.

What it means for you: Staying invested works. The worst 20-calendar year stretch in two decades through 1948 still resulted in a 3.1% annual gain, according to Morningstar, highlighted by the WSJ. As we keep reiterating, global markets at the moment are heavily impacted by monetary and fiscal policies, and corresponding investor actions have led to riskier assets getting priced to serious perfection. While this doesn’t cap the remaining year’s upside, we believe it’s wiser to invest in structural stories and themes, rather than betting, essentially, on what direction policy makers will take. Stay in cruise control on Wall Street as earnings play out, the US GDP report reveals the first quarter’s progress, and watch for whether Greece is able to pay the bills this week.

You may want to turn some lights on, because it’s looking pretty bleak on Wall Street right now.

With markets caught in the hands of policy makers and speculators, we’re finding a significant lack of direction in the short term ahead. The start of earnings season was a breath of fresh air this week; with Alcoa and other financial heavyweights reporting, the outlooks didn’t just sound good, but were also a relief from the daily press-conference drama that Wall Street has gotten addicted to these days. This week, we decided to take a step back and summarize the complexity – if such a thing is even possible – of the world’s capital markets.  Here are some points worth keeping in mind as we attempt to steer through the chaos:

– Chinese stocks skyrocketed for some weeks, and then slammed the breaks on Friday when regulators decided to curb margin trading, in order to reduce bubble risk. Combining this with the ongoing GDP growth slowdown, read that sentence again – it’s a bit scarier than it sounds. Bubble risks being curbed by regulators, via margin trading? At what point did fundamentals and stock prices decouple? We’re waiting to find out. China has tremendous market potential, but as we mentioned in January, this is a rally we’re comfortable sitting on the sidelines for until markets become a bit more transparent. Continued downturns could catalyze an emerging sector pullback, and we’ll be keeping an eye on news from this region moving ahead.

– Meanwhile, the Eurozone’s chugging faster by the week – with QE being declared as a success by Draghi (hey, we have no complaints!), GDP growth rates are increasing, confidence indexes are higher, and the weak Euro continues to aid exports. Then comes a newswire stating Greece’s payment is due next week, and the markets collapse.

When will this drama end?

Steve Forbes’ commentary this month summed it all up – ‘such a move [by Greece to exit] the Eurozone would, perversely, be welcome by European governments’, as it would be an object lesson for Greek voters. As Wall Street’s banks work behind the scenes to restructure debt and policy makers grind it out, we reemphasize staying invested in the Eurozone’s structural change story, and to avoid panicking  if short term turmoil hits due to a Greek exit. We’re hoping for a conclusion soon, preferably by ripping the band-aid off – whatever the decision – so markets get some clarity.

– Meanwhile, in the US, with unemployment rates reaching Fed target levels and inflation showing some signs of increasing (core prices have climbed 1.8% over the past year, according to the WSJ), the impending rate increase remains front and center on Wall Street’s minds. It’s worth remembering that the writers at Barron’s, this week, pointed out the horror stories from Japan, where continued low rates – that were meant to stimulate economic growth – led people to save more than spend (the opposite of the desired effect), and consequently rendered monetary policy pretty much useless. The polarization seen between the finest minds in economics on the current monetary policy is just unbelievable, as is the complicated nature of predicting the outcomes. As a result, we reemphasize focusing on sectors decoupled from this – and those include both small caps, as well as growth stocks, for reasons noted in our 4/13 column.

What it means for you: The world’s markets continue to be driven by press conferences and policies more than corporate performance and economic growth. The Bank of America’s Capital Market Outlook this week states that ‘stocks look attractive in relative terms‘. The word ‘relative’ is key in our opinion – where else would you get any yield? Per Fidelity’s Business Cycle Approach, the energy sector outperforms during a late business cycle phase. However, if we start seeing an oil price increase and a consequent energy sector outperformance, is there a reason to be worried? We think not. Our approach is for the long term, and due to the conditions described above, we’re looking at practically the most unconventional market in recent history, in our opinion – and therefore, conventional theory in tackling it gets thrown out the window. Trying to time the market and outcomes today means essentially betting on people, rather than stock fundamentals or structural themes. That’s not our style. Also, at this point, we really can’t say Wall Street didn’t warn us of short term turmoil when interest rates do move up. Per our posts on 2/8 and 2/1, we emphasize financials and consumer discretionary stocks respectively, along with the energy sector, as 1-2 year plays. Alongside, our opinion is that Germany will play a much bigger role than expected in the coming months in driving world economic growth; we’ll be elaborating on this point in detail next week. Importantly, the critical role of capital markets in shaping society keeps us optimistic. All roads end up in the same direction if you stay invested – and we believe there’s significant light ahead. In our opinion, financial markets are too smart for short-term policies or people to distract them from their long run objectives. Therefore, we’re going to keep focus on the ongoing earnings season, while drowning out any chaos. Our recommendation? Watch the details as companies report earnings to dissect their underlying business strength, and keep cool while policy makers and speculators battle it out on Wall Street in the coming weeks. 

After weeks of headlines driven by currency moves, geopolitics and commodity prices, it’s time to get back to basics as we enter earnings season. Analysts and companies alike been clamoring over each other to lower expectations on growth, net income, and guidance. In our opinion, the next few weeks will present some excellent bargains due to short-term selling by nervous investors. According to Bank of America’s Savita Subramanian, highlighted by Marketwatch, ‘S&P 500 bottom-up EPS [projection] has come down 8% over the last three months to $27.04—a bigger cut than in any other quarter in recent history’.  The actual numbers in the next few weeks, in our opinion, are of limited importance due to the impact of macro factors. Blaming a company that has sales overseas purely because the dollar got stronger isn’t our style. If it has great products and is not a financial firm, we’d much rather focus on how the quality and volumes  are looking for their core business rather than how well it’s hedging currencies. Thinking long-term will be the key, and we recommend having some liquidity on hand swoop in on undervalued sectors if the bears start stampeding on Wall Street. With that background, here are some details worth thinking about this week:

Valuations: The 6-year old, seemingly unstoppable bull market continues to keep investors guessing on when it’s going to end. As of last week, according to Yardeni Research, the forward P/E ratio for the S&P 500 stood at 16.6 – higher than the 15.2x P/E at the peak in October 2007, but lower than the 25.6x seen during the dot com bubble in March 2000 (with data from JP Morgan). However, it’s also worth noting that the 10-year treasury yield was at 4.7% and 6.2% during those earlier peaks, compared to below 2% at the moment – meaning investors have had few places to go for yield other than stocks in recent times. Using Blackrock’s data, we see that large cap value stocks have delivered average annual returns of 10.5% over the past 20 years, outperforming small caps and growth stocks. The valuations reflect this, with JP Morgan’s data showing the asset class is now trading above a 16x forward P/E, far higher compared to their 20 year average around 14.3. Meanwhile, when we consider growth stocks, the small, mid, as well as large cap classes are under their 20-year average P/Es. Our opinion remains that with interest rates projected to go up in the coming months, value stocks – averaging a higher dividend than growth stocks, will underperform their peers in the near term. This, now, gets combined with the fact that S&P 500 operating profit margins are looking extremely solid, and cash as a percent of total assets is hovering around 30% – at the highest levels since 2000. Therefore, our belief is that cost cutting is in good shape – the focus will now shift on growing revenues in a slow global growth environment. GE’s sale of its non-core business last week, and the consequently sky-rocketing stock is, we believe, an indicator of the trend ahead. Companies will need to acclimatize to the new era of lean, smaller, fast moving machines, and as a result, spin-offs, M&A activity and segment changes will reward stockholders well. Therefore, even though valuations are looking slightly stretched, we remain cautiously optimistic in the short term, and bullish (as usual) for the long term. With this foundation, our main focus will be on the guidance of companies regarding their individual business units as earnings season unfolds.

Macro: Meanwhile, world markets find themselves at an interesting juncture. Europe continues to trounce the US in returns this year; China, Hong Kong, and Japan’s markets are hotter than ever, and Russia’s currency has shown the best return among its emerging peers year to date – something not too many investors expected. Overall,  global markets (via the MSCI ACWI) are at a forward P/E of 16, compared to their 10-year average of 13.1,  – showing some possible overheating. While we absolutely do not recommend selling your international holdings, keep your seatbelts on in case of pullbacks. For new positions, selectivity is key. Germany and India’s leaders (two of our favorite regions, for reasons described in our 1/14 and 1/11 columns) are meeting this week, while Mexico’s consumption and investment scene keeps it an attractive investment. Several neglected markets, including Spain, Italy and France, are also on our radar, and for the long term, we recommend exposure to Nigeria. Our reasons are simple – it’s the fastest growing economy on the continent, will have a larger population than the US by 2050 (per UN’s data), and is one of the best entry points for international investors to sub-Saharan Africa. Infrastructure, technology and telecommunication growth will lead the way based on our research, and we believe the growth remains heavily discounted due to near-term politics, regional instability and its dependence on commodities – which will give way to services and consumption-driven growth in the long term.

What it means for you: A diversified portfolio of investments, especially in the span of rising volatility and interest rate, makes sense. Maintain exposure to the US and international markets (via ETFs such as SPY and VXUS), avoid looking at the quarter’s data in isolation of the macro context and freaking out, and enter a solid sector or company if investors start selling on short term news. Importantly, stay invested in your current holdings – and remember the words of one of our favorite columnists, Jason Zweig, from the WSJ – ‘Let the rest of the world grow ever more myopic. In the long run, he who trades the least will end up with the most’.  We’re being gifted the best seats in the house to watch the drama; sit back while staying sharp as the bulls and bears figure out which direction to run in on Wall Street.

2015’s first quarter delivered action packed headlines for the stock markets, and volatility to levels not seen in several months. Policy makers were the key drivers of the market moves, primarily through central bank actions. As we mentioned last week, the concept of measuring an asset purely on economic fundamentals, such as supply and demand, seems  as outdated as the Jurassic Era – monetary policies and geopolitics are just as critical for valuing markets at the moment.

Nevertheless, if Jurassic Park can make a comeback (yeah, it’s releasing this summer), so can the markets – and we’ll see if they get back to basics as the year goes on. In our opinion, one can initiate tactical, short-term trades by projecting policies, dissecting investor sentiment, and through timing. For sustainable returns in the long term, however, we believe that any investment needs a solid fundamental thesis. So, our approach is to find investment ideas that are undervalued due to short term mispricing, and then invest in them for the long term. With that background, here’s a recap of where we find ourselves at the end of the first quarter of 2015:

Macro: Our favorites outlined in January, including India (+2.8%), Germany (+22%), Indonesia (+4.4%), the Philippines (+10.5%), Mexico (+2.5%), and South Korea (+6.8%), have delivered solid returns in Q1. Albeit in local currencies, again, we feel strong fundamentals are on each country’s side for the long term, with favorable demographics and domestic growth potential – and therefore, our attempt is to disassociate from currency risk – as in the long term, the comparative advantages from each economy will balance  out. For Q2, we’re adding France, Spain, and Greece to our watchlist, along with Nigeria – which we’ll be writing more about next week. We had also projected  that WTI crude oil would bottom in the low $40s – we think this support level will hold, but at this point, it is of limited importance, as the stocks and sectors affected are already at bargain levels. The dollar will continue to remain strong in light of central bank actions worldwide, and we believe companies less impacted by international revenues will remain sheltered, and outperform those that look beyond the borders.

The United States Economy: In January, we outlined our two compelling questions for the year: Would wages grow, and would capex increase?

Following the cues from America’s largest employers – including Walmart and McDonald’s,  we think the answer to the 1st question is yes, given solid data as well from small business sentiment, commercial lending, and increasing [voluntary] quit rates; for example, the ‘hard to fill [positions]’ rate is at approximately 30% – nearly the highest in a decade, according to Bloomberg Businessweek. Regarding capex, we’re not yet seeing a clear direction, although we reiterate that companies are capable of spending due to the strength of their balance sheets, but are just waiting to pull the trigger – again, due to uncertainty in policies ahead. It’s also worth highlighting that the personal savings rate in the US hit multi-year highs at 5.8% in January, per CNBC – meaning the savings from low gas prices are not translating into spending – yet. It’s a question of when, and we reiterate investing in our favorite sector for the year – Consumer Discretionary – via XLY, which, up 5% so far, is still undervalued in our opinion.

It’s also worth noting a structural change that we believe is flying under the radar. The baby boomer workforce is transitioning to the millennials – and consequently, the hierarchy, stability, and long-term relationships that drove employee loyalty and defined the S&P 500 titans over the past 3 decades will give way to the entrepreneurial, disruptive, non-binding mentality that millennials bring. Consequently, companies will need to adapt, and we think reducing their size and tailoring their business segments will be high on their priority list. Spin-offs, M&A activity, and greater employee ownership will occur during this transition, and the financial sector (via XLF), will reap the benefits, among other reasons outlined in our column on February 8th. So far, this sector is underperforming the S&P 500 and is down 2% this year – the bargain continues, and we reiterate buying this with a 1-2 year horizon.

Stock Market Activity: In January, we outlined increasing activism and volatility as among the important themes to watch for this year. So far, the two remain on track – activist funds continued to thrive in first quarter, as saturated markets, low bond yields and sluggish global growth kept investors scouring for returns. Meanwhile, as we projected in January, the heightened volatility has led to actively managed funds returning 2.8% in Q1, according to Lipper, significantly outperforming the S&P 500’s 0.9% return. Also, seeing how passive ETFs continue to grow in popularity, there’s a case to be made for the market getting dumber – indicating more asset mispricing as investors buy and sell in bulk. Our projection is that active management’s outperformance, along with volatility, will increase as the year goes on in light of potential interest rate hikes in the 2nd half of the year.

What it means for you: The first quarter delivered some serious news, but little change in the US markets, with the S&P 500 returning 0.9%. The MSCI World Index was up over 2%, indicating opportunities continue to exist globally. We’ve set ourselves up for an extremely interesting span ahead, with monetary policy decisions and consequent investor over-reactions defining the landscape. The key, in our opinion, will be to keep our cool while others don’t. Being part of the smart money is sometimes alot simpler than you may think. Stay invested, think long term, and get ready to pounce with us on the pieces of fine art that get thrown out with the kitchen sink as the bulls and bears enter the rink on Wall Street in the coming weeks.

The past 7 days’ financial news was enough to keep market connoisseurs continuously occupied, and pretty happy. Among emerging markets, India’s budget release showed a balanced approach to deficit reduction and spending, and China lowered its interest rates to join the rest of the international central bank herd. Meanwhile towards the west, Warren Buffett’s annual letter got dissected, European data showed positive signs, the Dow announced it was adding Apple to the menu, and the US jobs report blew through expectations. Alongside, NASDAQ’s conquering of the tech-bubble mark on Monday was fun to note, but pretty insignificant – considering adjusted for inflation, it’s still nearly 40% off the 2000 peak.  All in all, we’re pretty content with where the global economy stands from a long term perspective, but note some temporary caution required. Here are 4 subjects on Wall Street to keep an eye on:

– The onset of rising interest rates: Since 2008, investors have fled to stocks for yield. Friday’s jobs report continues to show stellar growth in employment. We do recognize that  wages didn’t grow significantly – but we believe that it’s only a matter of time – and among several data points, BMO Private Bank’s Jack Ablin summarized a key observation very well: ‘strikes at oil refineries, west coast ports, and pay increases at Walmart and TJX are showing that bargaining rights for workers are increasing’. The labor market is tightening, and the Fed’s aims are well on track to being met, in our opinion. All these factors point to a rate hike sooner than later – likely in the summer. As the required return on assets will increase when this happens, future cash flows from companies (used to determine stock prices) will get discounted more, and stocks should, theoretically, come down. A healthy pullback is much needed, and we think the time has come to lower expectations from the S&P 500 for some weeks.

– Private valuations: The frothiness in the private sector continues to worry us. Company valuations, along with young, fast money and real estate price growth in the Bay area, as well as the cyclical nature of the technology industry is leading us to believe that any minor company busts will lead to VCs tightening their belts, and also catalyze consequent pullbacks in the biotech and tech sector. Consider that IBB, the iShares Nasdaq Biotech ETF, is up 12% YTD and has a P/E of 33 (according to iShares). That’s pretty unsustainable, in our opinion, in the short term. While not a major risk, we think this subject is worth keeping an eye on (even more than oil volatility – a subject that keeps dominating headlines).

– Apple’s impact: This magical, life-changing company has enough cash on its balance sheet to make a material reduction in Greece’s debt. As if we don’t love the company enough, how epic would it be for Tim Cook to swoop in and literally save the Eurozone? Anyway, back to the point. With its inclusion in the Dow index starting March 18^th, Apple will represent approximately 4% of the Dow and S&P 500 index, and nearly 10% of NASDAQ’s market weight. There’s no hiding from this giant anymore. Historically, the stock hasn’t done much (in the few weeks) after big product launches, and with the iWatch event this week, a pullback for the stock (due to any product disappointment or simply as a breather from its colossal run-up in the past 3 months) could lead the markets down too.

– The Eurozone ahead: We reiterate buying (currency hedged) European stock ETFs; even with the run up this year, the region remains undervalued. The MSCI Europe Index shows a forward P/E of 15.9, compared to 16.8 for the MSCI World Index and 17.6 for the MSCI USA Index. Eastern European PMI data and German manufacturing is showing significant improvement, and inflation expectations are increasing for later this year – countering the threat of deflation. Meanwhile, rising corporate profits from the weak euro and low oil prices should help multinationals in the coming quarters. Bank of America’s Capital Markets Outlook last week noted that ‘the austerity that held back global growth after 2010 is slowly fading, especially in Europe’. Importantly, we note that quantitative easing begins there this week. Bespoke Investment Group had an interesting observation that we can extrapolate to the region: During the multiple initiatives in the US in recent years, the S&P 500 rallied 36.4% during the 1st round of quantitative easing, 24.1% after the announcement of the 2nd round of easing until the end, and during the 3rd round, according to the WSJ, over 25%. Whether QE is good for growth remains a polarizing question among economists, but it has certainly shown to be good for stocks – and we can expect something similar from Europe ahead.

What it means for you:  The yellow traffic light is a confusing one – neither red or green; in different countries it either means slow down, or get set to go. But one thing’s for sure – we can think of it as depicting temporary caution – and that’s what we’re taking away right now from the data. In the short term, we see a breather in the S&P 500 – mainly due to the 1^st point above. But structurally, the US economy is showing solid strength, making a case for buying on the dips if you want to capitalize on the rebounds.  Other than the passive ETFs (such as SPY and VXUS) that we recommend for the long term with the bulk of your assets, we reiterate investing in the consumer discretionary sector, the transportation sector, and Europe for possible outperformance over the market in the coming year. In the meantime, stay invested and in sync with the details on Wall Street.