Navigating Rough Seas with Plenty of Cross-Currents and Limited Visibility

To Our Clients:

The summer months delivered a long, wild and often painful ride in the financial markets. The nice summer weather may now be in the history books, but unfortunately, the financial storm appears only to have worsened in September. How much of this tumult is real and justified based on true economic and corporate developments, and how much is sentiment compounded by outright fear, the herd instinct and weaknesses in market structure? We will only know the answer in coming weeks and months.

We would like to share with you 10 forces we see at work in the world today:

1. China appears to be in a period of major transition and we believe this could last quite a while. This transition and how it is managed will have a major impact on everything from global GDP growth, commodities to currencies. We truly are one world and it is in all of our collective best interests to manage this transition in as transparent, straightforward and balanced way as possible.
2. Europe’s recovery is still going very slowly. While enjoying the benefits of continued monetary easing, the continent is still early in the long-term process of balancing and coalescing the interests of all the Euro members. Rates will need to stay low on the continent for quite some time, as the recovery is still too young and fragile to be left on its own.
3. Russia, which was not that long ago seen to be embracing capitalism, is ensconced in the massive pain that comes from being economically dependent on a narrow export commodities base−oil and gas. (By the way, the capitalism concept really never took hold in Russia because the only way sustainable open markets work is through transparency, a culture of integrity and a legitimate legal system.)
4. Other emerging markets across the globe have either had major corrections or have been all but obliterated. This seems to happen every bunch of years, and our guess is that, while markets are strained today, now is probably a good time to begin to get more involved in EM.
5. The shining light in the world today is the U.S., as we have cleaned up our financial services industry, and have a culture of entrepreneurism, creativity, innovation, resilience and hard work. Yet the U.S. risks social and political fracture, as evidenced by the recent resignation of Speaker of the House John Boehner and by the goings-on of the two political parties’ selection processes for presidential candidates. (By the way, despite all the flaws in the U.S. political process, nobody has yet to invent a better one.)
6. We believe the Federal Reserve soon will begin to wean the U.S. economy and markets off an unprecedented amount of monetary intervention. This stimulus has given U.S. markets an almost straight up trajectory for seven years. While we are most bullish on the U.S. economy, we believe this will be a very gradual return to normal rates, which is probably the right strategy.
7. The world is struggling to find sustainable growth anywhere (see Caterpillar sales warning) and, when we do, it appears there is a euphoria that develops that strikes us as potentially very dangerous (see the “unicorns” of Silicon Valley and beyond). Many of these latter companies are very real and incredibly valuable. We worry about some of the others when the eventual “down round” occurs and changes the momentum, or worse yet, diminishes “the dream.”
8. Volkswagen, a national champion and aspirant to world leadership in one of the most significant industries ever, admitted to years of “manipulation of emissions data of diesel engines,” and announced a new CEO and Interim Chairman. This black swan news rocked markets everywhere and broadly. If there was ever a doubt, this should confirm that it is virtually impossible to “see the next one coming.”
9. Focusing on what may be the greatest threat to world commerce, U.S. and Chinese leadership announced an agreement on broad principles armed at stopping the theft of corporate trade secrets and prosecuting cybercriminals. To our way of thinking, this is long overdue and essential to a workable global recovery, but the devil will be in the details and enforcement. Achieving a true treaty or governance structure will take time and an incredible level of commitment, accountability and enforceability.
10. The energy and commodity complex is being shaken to its very core. The cause is a combination of geopolitics, supply and demand imbalances, technological advances and leverage. Having energy prices down materially are rarely systemically bad, as they make every other industry operate more profitably and supports the consumer. That said, a further collapse in energy prices could bring an increase in geopolitical risk, and clearly the most leveraged players will need to quickly address their capital structures or succumb to the marketplace, which can be both swift and unforgiving.

Given all these cross currents, it is understandable why every CEO or Investor’s head may be twisting and turning as we all do our best to navigate this exceptionally volatile world. The sad reality is that it may stay this way for a while. Rather than fall into any despair, we will leave you with four thoughts that guide us as we navigate periods like this.

1. All that matters is the long-term, so long as you are secure in the short-term.
2. Culture matters and the companies that best capitalize on periods like these are the ones that have everyone pulling in the same direction.
3. These are periods where you cannot communicate too much to all constituencies.
4. Capital structure matters and these are periods that can create or lose a lot of long-term value and upside. Honest assessments and good investment banking advice is invaluable.

We can’t predict what today and the future hold for valuations or markets, but we can commit to all of you, our clients, that everyone at Jefferies will be in the trenches every day to serve you with our best ideas, senior level attention, and the best execution possible.

Sincerely,

Rich and Brian