1. Corrections are normal — watch the fundamentals. The pullback over the past week and half was prompted by a number of fears — mostly related to the effects of oil’s sharp decline on U.S. and global credit markets. We believe those fears are overdone. We do not see global systemic risk from oil-rich governments liquidating holdings from their sovereign wealth funds; we think fears of Russia’s collapse are exaggerated; we think fears of systemic stress derived from energy-related high-yield debt in the U.S. are overdone. The bullish fundamentals that we identified in last week’s 2015 outlook are still in place.
2. Data encryption goes mainstream. Responding to consumers’ desires for privacy and security (privacy from state surveillance, and security from hackers), more and more consumer-facing and internet infrastructure companies are implementing default encryption. Apple’s Tim Cook boasts that Apple couldn’t hand over iMessage data even if they received a subpoena. We view this trend as positive. Intelligence agencies will still be able to crack the communications they really need to read, and consumers will be more secure from hackers. After a few years of prominent stories about security breaches, the defenders of privacy are visibly pushing back.
Source: International Monetary Fund
Secondly, the Russian people’s stoicism in the face of economic adversity should not be under-estimated. For ordinary Russians, patient endurance of economic turmoil is written too deeply in their cultural DNA to have been weakened by the last ten years of prosperity. We believe that even in the face of recession, internal Russian opposition to Vladimir Putin’s rule will be more subdued and peripheral than many foreign analysts fear it will be.
Don’t mistake our calm for a lack of concern about Russia’s long-term problems, and the long-term problems Europe will face as a result of Russia’s intransigence. We are simply arguing that market fear of a contagious Russian meltdown is overblown.
3. Fear that bank debt tied to oil will collapse bringing the world or U.S. banking system down. In our view, fear of this risk is not reasonable. The proportion of oil-related lending is much too small in terms of total loans outstanding. The highest-risk energy-related high-yield bonds represent less than 0.3 percent of the total U.S. corporate bond market. Doubtless, more high-yield energy-related debt will be downgraded as the effects of oil’s fall are evaluated. Even so, this is a matter of some investors taking a hit — not the kind of spark that would be needed to ignite a systemic credit event.
Data Source: Securities Industry and Financial Markets Association, Bloomberg
4. Fear of sale of securities by the sovereign wealth funds of countries whose wealth is generated by the sales of petroleum. This will happen, but will not be a major negative. It will create some overhead supply for the stocks of the big-capitalization companies that are held by the major sovereign wealth funds.
Our research suggests that distressed selling of assets from oil-related sovereign wealth funds will not be a significant issue for the global financial system. The largest oil-related sovereign wealth funds — those worth $100 billion or more — have total assets of about $4.3 trillion. Even if we assumed that all were distressed (which they aren’t) and would sell a significant portion of their equity holdings (which they won’t), those sales would amount to a very small portion of the total market capitalization of developed-world stocks, and would be spread out over a considerable period as they made sales to meet fiscal needs.
We’re bullish on world economic growth in 2015, and we’re bullish on U.S. economic growth in 2015. We are not panicked by the normal stock market correction which is currently taking place. As we often say, the U.S. market can correct 5 to 10 percent at any time, for a variety of transitory reasons. This is one such correction.
Investment implications: Our bullish thesis for our favored markets in 2015 has not been derailed by the current correction, which we regard as a normal and healthy event in an ongoing bull market where stocks are, on the whole, fairly valued. We think that the credit risk posed by oil’s fall to distressed sovereigns or distressed oil producers is not the systemic threat some observers are anxious about.
Encryption Goes Mainstream
In spite of the past few years’ news stream about government surveillance, hacking, and data breaches, consumers’ data is getting more secure than ever — at least when it comes to web browsing, social media, messaging, and email communications. Consumer-facing companies like Facebook (NASDAQ: FB), Apple (NASDAQ: AAPL), and Google (NASDAQ: GOOG), as well as IT infrastructure companies like Cisco (NASDAQ: CSCO) and Akamai (NASDAQ: AKAM), are leading a trend to encrypt communications by default.
While encryption of web activity used to be the domain of geeks, encryption by default, with simple configuration, is becoming the norm. Apple’s Tim Cook told Charlie Rose in September: “Our view is, when we design a new service, we try not to collect data. So we’re not reading your email. We’re not reading your iMessage. If the government laid a subpoena to get iMessages, we can’t provide it. It’s encrypted and we don’t have a key.”
More Communication Is Now Encrypted By Default
Investment implications: Despite the increasingly robust default encryption of consumers’ communications. We think that intelligence agencies will still be able to get the data they need, albeit with more difficulty; and we think it is one more step towards consumers being safe from hackers. All the high-profile hacks of the past two years are beginning to bear fruit in a new security orientation of consumers and businesses. Technology companies will continue to innovate and invest in new security and privacy solutions.
This week’s letter is shorter than usual. We are keeping a close eye on the markets. As markets head into the final trading days of the year, we are watching current volatility closely. We encourage our readers to call or email with questions or concerns, and wish you a joyful holiday season.