US Equity And Economic Review: Where's The Next Big Trade Idea?

The market started the year with quite a bang, selling off to a degree not predicted by any event that occurred at the end of 2015. The ensuing sell-off has not only caused a fair amount of stress among investors, but also analysts who are struggling to explain what exactly is happening. To that end, I will argue we are seeing two events: an unwinding of the major post-recession trades followed by the markets attempting to find “the new trade.”Most importantly, current turmoil is the result of the inability to find new investment thesis.

The following two trades dominated the post-recession investment environment:

Low rates in the US forced investors to seek higher yielding returns.This led to money flowing into both developed and emerging equity markets.

Additionally, the Chinese government greatly increased fiscal stimulus to prevent a recession.This continued their massive consumption of raw materials, which in turn continued the large investment in raw material extraction in the southern hemisphere.

A fair number of people have criticized the Fed for QE, arguing the program created a bubble. This argument makes little sense for two reason. First, there would have been a huge backlash had the Fed done nothing. Second, subsequent research demonstrated the natural rate of interest is very low, indicating the Fed made the right decision. But regardless of whether or not you agree with the Fed’s decision, there is absolutely no reason to “fight the Fed;” when they cut rates, you go long equities. And, just as important as the Fed’s rate cut is the growth in corporate earnings, which naturally support higher stock prices. As for China, their massive stimulus simply continued their trend of infrastructure investment started a long time ago. And with the Fed lowering interest rates, money flowed to more profitable projects, such as those involving raw material extraction in emerging economies.