In the beginning of Act II of Hamilton, Thomas Jefferson returns in the Fall of 1789 from his five years abroad in France as our Minister in Paris and finds himself decidedly out of touch with Post-War America as he prepares to join Washington’s first cabinet as Secretary of State and square off with Secretary of the Treasury Hamilton.
We took a Summer hiatus from writing for the WCM blog but kept our noses close to our screens and made multiple adjustments to the portfolios in August. This blog post was written as a bit of a thought experiment. If we had stepped away entirely at the beginning of July and came back for the Fall like Mr. Jefferson and also asked “What’d I miss?”, what would our reaction be?
The Jefferson character sings “There is no more status quo”. He is referring to France following us to revolution, but looking around in September 2017 in these United States, the same could easily be said here and now. What’d I miss? North Korea is rattling its nuclear sabre, hurricanes batter the Caribbean and South, Nazis and the Klan are marching in Charlottesville, healthcare reform legislation imploded, the previously unassailable bro culture in Silicon Valley is finally being taken to task, the Dollar fell and the Euro was ascendant, and long term rates are closer to 2% than 3%. With Stanley Fischer’s announcement, the Federal Reserve Board is going to have more empty than filled seats. Let’s throw a total solar eclipse in for good measure.
This should be the market equivalent of leaving a formal dining room full of 4-year olds unattended with spaghetti and red sauce, crayons, and matches. And yet, the S&P 500 closed today at 2,500. Somehow, the absence of a status quo in international relations, government and civil society has not penetrated the equity markets. One of our favorite questions to ask in our investment committee meetings is “What could take this market out?” The 4-year olds did a great job of hitting some of the big ones, including civil unrest, terrorism, nuclear confrontation, rates, natural disasters, and legislative failure.
Is the market immune to the world in which it operates? Perhaps, but this is cold comfort. We have spent a great deal of time since the financial crisis considering, and discussing with some of the most respected and revered market observers and participants, the other, more intimidating question – Will the next crisis originate from within the markets themselves? The last debacle was a largely self-inflicted wound, from poor underwriting and securitization to overconfidence in diversification benefit and program trading. The brief but chilling moments since then, including reactions to fat-fingered trades and systems failures that left securities unpriced suggest that the risks are still internal. Is it structural? Will it be a liquidity crunch? A technology failure? Out-of-control algorithmic trading? Some attribute of ETFs and passive index investing that could drive markets down as persistently as they have supported steady low-volatility growth for 8 years?
We will have more to say in the coming weeks about our outlook on currencies, countries, coupons and companies. For now, the economy grows sluggishly, markets continue to grind higher, and little seems able to persistently disrupt that trajectory. We are now invested for expansion with a home bias. But, we are watching the technicals and examining the risks from within as much as from without.
“Hey, and if ya don’t know, now ya know” – Hamilton, An American Musical, Act II, “Cabinet Battle #2”