On Investing in Bunny Markets; US versus Europe; Dietary Fats and the Human Brain!

From: aditya rana
Date: Sat, Apr 2, 2016 at 1:33 PM
Subject: On Investing in Bunny Markets; US versus Europe; Dietary Fats and the Human Brain!


Markets continued their recovery in March from their January lows with the MSCI world index close to erasing the 6% loss. The best performing markets this year (in US$) have been the laggards of last year – Brazil (+28% and +55% from its January low), Turkey , Russia and Argentina while developed markets have largely faltered with only the US managing to squeeze in a gain of 1%, while both Europe (-5%) and Japan (-11%)are down. So what can one expect going forward? Veteran market analyst Jim Paulsen, Chief Strategist at Wells Capital Management, wrote an interesting piece on the likelihood of the US having entered a market best describes as a “bunny” market. To summarise:

-Unlike an enthusiastic bull or a scary bear market, a bunny market is best characterised as hopping around but not really going anywhere – and historically they have often occurred at the late stages of economic recoveries.

-As the chart below (US stock market since WWII with recessions shown by grey bars) illustrates, the two recent expansions of the 1990s and 2000s experienced strong bull markets which only ended with recessions. The current market rally (despite some volatility in 2011) has exhibited similar characteristics which has led investors to either expect a renewal of the bull market or an end to the expansion – and few expect a bunny market which hasn’t occurred since the mid-1990s.

-The above chart also highlights that bunny markets can either be rather volatile (i.e. latter halves of the 1960s and the 1980s) or be quite tame (i.e. the late 1940s, mid-1950s and the mid-1990s). In all these cases the stock market was flat or made only minor gains against the backdrop of an economic recovery.

-Bunny markets usually occur during late expansions, as cost-push pressures, inflation and higher interest rates weigh on markets. Cost-push pressures and inflation were features during the late 1940s, mid-1950s, last half of the 1960s, most of the 1970s and late 1980s, while Fed driven interest rate hikes caused the bunny markets in the early 1980s and the mid-1990s. All bunny markets have faced either a Fed embarking on a tightening cycle or an economic expansion in its late stages – this one is facing both these constraints simultaneously.

-Buy-and-hold (bull market) and sell-and-avoid (bear market) strategies don’t work well during bunny markets while trading strategies tend to do well. Alternatively investors can pursue other strategies like stock picking, sector-weighting, alternative investments or increased allocation to other trending asset classes (e.g., bonds, commodities, currencies or international stocks).

-The main reason why we have likely entered a bunny market is that the risk of a recession remains low in the US as economic policies are still stimulative – the interest rate curve is positively sloped, rates are low, money supply continues to increase at a steady pace and the fiscal stimulus is positive.

-In addition, there are few signs of excesses in the economy which typically precede a recession – consumer spending remains subdued, household debt service ratios are at near record lows while net worth is at a record high, capital spending and capacity utilization remain low, the housing sector is recovering but not booming, corporate debt to profits is no higher than it was in the early 1970s and the banking sector is well capitalized.

-Finally, confidence amongst consumers, investors, businesses and policy officials is not at a level to worry about the likelihood of a correcting recession – i.e. excessive borrowing, companies overstaffing or overbuilding, consumers overbuying, investors overexposed to stocks and the Fed over-tightening.

-On the other hand, a continuance of the bull market is also unlikely – with profit margins at record highs and labour costs as a percentage of sales at a record low thereby increasing the likelihood of weak earnings growth going forward and a stock market which is not cheap with a P/E of 18.5 to allow for further multiple expansion against the backdrop of rising interest rates.

-Investors can expect annualized returns to be in the 6% to 7% range based on earnings growth keeping pace with nominal GDP growth of 4% to 5% . Some ways to enhance returns during this bunny market:

1) Some degree of market timing could be beneficial – adding to equity exposure on significant weakness and trimming exposure after solid runs.

2) Capitalising on individual stock picking opportunities as well as sector allocations which outperform during late economic cycles like industrials, materials and capital goods rather than consumer sectors, as well as small, mid cap and value versus growth sectors.

3) Increase exposure to other developed and emerging markets where recovery cycles are at an initial stage and valuations are relatively more attractive given their underperformance over the last several years.

4) Amongst other asset classes, bonds and cash are likely to underperform in a rising rate environment, while commodities and other real assets could outperform.

5) Lastly, hedge funds may finally start outperforming after being unable to keep up with the index since the start of the bull market in early 2009.

-A well argued and persuasive piece which reiterates the strategy of maintain a well diversified global portfolio between stocks (ex-US developed markets and emerging markets with less US), bonds (high yield credit – EM, Europe and US) and reasonable cash to allow one to increase exposure on significant downturns. Trimming exposure on sharp rallies and adding on downturns continues to be the best way to optimize returns going forward.

-On the theme of the US versus Europe, Ben Carlson of “Wealth of Common Sense” provides a helpful analysis:

-“Europe seems to fit the bill here in terms of bad news. Economic growth is slow-to-non-existent. The demographic profile isn’t pretty. And the European Union looks to be something of a failed experiment as a fiscal union with no easy way out. All of this adds up to a relatively attractive valuation profile for European stocks when compared to U.S. shares. This chart from AMP Capital shows the CAPE ratios for both U.S. and Eurozone stocks:”

-“Valuations in Europe are nearly back to the 2011-12 crisis lows and are even flirting with 2008-09 levels. Another way of looking at lower valuations in the Eurozone and higher valuations in the U.S. is the fact that U.S. stocks have crushed European stocks this cycle. Look at the 5 year annual returns through the end of last week:

Vanguard S&P 500 Fund (VFIAX): +11.43%

Vanguard European Index Fund (VEURX): +1.92%

-“U.S. stocks have outperformed European stocks by 9.51% per year for five years running this level of relative outperformance is unprecedented. Comparing the 5 year rolling annual returns on these two funds you can see that the current relative outperformance by U.S. stocks is as high as it’s ever been. For comparison purposes, in late 2007/early 2008, there was a five year period where European stocks were outperforming by over 11% per year, so these points in the cycle can go the other way too.

Lastly, given the extreme levels of market volatility we have experienced in January and last August/September, I would like to provide an apt quotation from the legendary market observer Richard Russell who wrote the “Dow Theory Letter” almost daily from 1958 until a week before his passing last year:

-“The markets (any market) are seldom surprised by shocking events. But during those rare instances when the market is caught by a surprise a panic may result. My own definition of a panic is this: A panic is a collapse (triggered by fear and unforeseen circumstances) which causes the price of the item to fall precipitously within a short span of time. That’s a loose definition but it will do.

-We’ve had a few panics declines in the markets over the last few years. Panics are particularly interesting for one reason. The reason is this: The surest action in the markets is the recovery following a panic. It is almost a rule (if anything in the markets can be called a rule) following a panic, there will be an advance that will recover roughly one-half of the price lost during the panic. This applies to individual stocks, to commodities, to indices, and to the averages.

-People forget that what prolongs a bull market, any kind of bull market, is the phenomenon known as the correction. A rocket-rise type of bull market, one with little or no corrective action, always ends up as a short bull market. Thus, seasoned investors tend to welcome corrective action during bull markets. They know that the more corrections and the longer and more often a bull market is held back, the bigger that bull market will be – and ultimately the higher that bull market is fated to climb. Of course, the same thing is true (in reverse) during bear markets.”

Dietary Fat and the Human Brain:

-An important piece from Dr. David Katz, Director of the Yale University Prevention Research centre, on the importance of intake certain types of dietary fats to maintain a healthy brain function – for kids as well as adults:

HuffPost, Sept , 2015:

-“That what we eat, in general, affects brain function should come as no surprise to anyone. Food is the fuel that runs the human machine in all of its remarkable capacities, and that pertains as fully above the neck as below. This is crucial throughout our lifespan, as we are continuously burning through, and replacing, the parts of our parts. Enzymes and neurotransmitters are depleted and replaced in countless numbers daily. Hormones and other chemical messengers are, in essence, Kamikazes — fulfilling their physiologic mission only at the cost of their own molecular suicide. These, too, must be replaced daily. There is as well a daily turnover of hundreds of millions of our cells. We are, to some extent, a bit like rivers — renewed by the flow and flux of ourselves, and never entirely the same.

-Compelling as all that may be, it pales in comparison to the reliance on food as a basic construction material in the first place — for in childhood, it is exactly that. The adult human body is being renewed, but is no longer being manufactured from scratch. The embryonic and then infant version of us is subject to just that phenomenon. But, of course, matter cannot be constructed from nothing; it must come from the conversion of energy, or from other matter. The growth of human children is a product of both, with food supplying both the energy and the construction material. I have noted before that once we acknowledge food as the one and only source of construction material for the bodies of children we love, “junk food” rather loses its sheen of harmless fun. There is nothing harmless in the construction of something we hope to thrive through decades out of junk.

-In all matters of human construction, and refurbishment, the distribution of materials on hand is obviously germane. Just as the construction of a well-made house depends on the right materials in the right proportions, so too the manufacture and maintenance of the human body, and brain.

-One very well characterized illustration of this is the relationship between omega-6 and omega-3 fats. These are both families of polyunsaturated fats, and both described as “essential fatty acids,” because our bodies need them and cannot manufacture them without dietary intake. These fats have opposing effects, which may be simplistically described as “pro” and “anti” inflammatory. They enter into the same biochemical pathways, but then travel down different branch points. As a result, they can compete with one another both in their effects, and in their use of the available assembly lines. Too much dietary omega-6 fat, for instance, relative to omega-3 fat, will co-opt the machinery required to make long-chain omega-3s, and use it to crank out long-chain omega-6 fats instead, notably arachidonic acid.

-The right way to think of all this is not in terms of good and bad, but rather in terms of balance. Omega-6 and omega-3 fats are Yin and Yang to our metabolism. We need them both, and we need them in proportion, to achieve the right balance between the pro-inflammatory molecules that help us fight off microbes and cancer cells; and the anti-inflammatory molecules that defend us against allergy, autoimmune disease, and chronic degenerative diseases as well.

-In addition to this role, essential fatty acids are of structural importance to our cells, contributing to the composition of cell membranes. This proves to be of singular importance to brain development, and function. The human brain is, apart from adipose tissue itself, the fattiest organ in the body, and it preferentially soaks up an acid (DHA), a long-chain omega-3 fat. Numerous studies suggest functional, developmental, and cognitive liabilities from a deficiency of this crucial, structurally important molecule. Humans get this nutrient from one of two sources. We can consume it, from breast milk as infants — which is among the reasons for the many established benefits of breast milk over all alternatives — and later from foods such as fatty fish. Or, we can make it from a precursor, a shorter-chain omega-3 called alpha linolenic acid (ALA), found in a variety of plant foods, notably walnuts, flaxseeds, algae, hemp and chia seeds.

-This is where the riveting, and directly relevant dialogue with colleagues last week picks up. My friend and colleague, Dr. Tom Brenna, a nutritional biochemist at Cornell, described research showing that when malnourished children are given a therapeutic food with a relative excess of omega-6 fat (particularly, linoleic acid), they wind up with a relative deficiency of DHA in their blood — and thus, their brains. This is because the surplus omega-6 fat blocks the pathway that would allow the body to make DHA from ALA. The concerning implication of this, then, is that supplemental ALA would not fix the problem, and the research findings indicate exactly that.

-Dr. Brenna discussed the evidence that in the presence of excessive omega-6 fat, supplemental ALA will boost levels of one long-chain omega-3 called EPA, but not DHA. These findings pertain directly to a massive, population-level dietary trend. Over recent decades, more and more of the oil in the typical American diet has come first from corn, and then from soybeans. In both cases, that oil is an unusually concentrated source of omega-6, linoleic acid. The direct metabolic implication of this is immediately clear: the production of DHA is being inhibited at an enormous scale. The public health ramifications are less clear, but clearly worrisome. Is widespread interference with the production, and brain uptake of DHA, a contributing factor to trends in autism, ADD, and other disorders of behavior and cognition? Proof of causality is an elusive standard, but the proposition is every bit as plausible as it is disturbing.

-This story is, above all, a reminder about the importance of balance – it is about the necessary balance among construction materials, for the human brain and body as for a building. Excessive omega-6 represents an imbalance in inventory, and it leads to imbalance in the manufacturing process. When the structure in question is the human brain, this is a matter of obviously grave concern.

-For now, we are also well advised to feed ourselves, and our children, with our brains in mind. Newborns are best fed breast milk whenever possible. After that, we can all avoid an excess of omega-6 fats by minimizing our intake of highly processed and fast, fried foods — and getting our fats from nuts, seeds, olives, and avocado; olive and canola oil. For those so inclined, we can also get DHA directly from fish such as salmon, or from supplements (I take one).

-It is important to reflect on the human brain doing what it does uniquely well in all the known animal kingdom: learn. At the very foundation of that remarkable Homo sapien aptitude lies the structural integrity of the brain itself, which proves to be highly dependent on a native, salutary balance of dietary fats. I trust we will agree that this gives “food for thought” a whole new, surprisingly literal meaning. My advice is merely the obvious: chew and swallow accordingly.”

Here’s to maintaining a balance between the Omega-6 and Omega-3 fatty acids by cutting down on fried and fast food, reducing the vegetable oils used for daily cooking (i.e. replacing with more olive oil) and increasing the consumption of Omega-3 acids (ALA and DHA) and consider supplementation (there are vegan supplements now available for DHA derived from algae).




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