Lordy, I hope there are tapes…

James Comey’s testimony yesterday before the Senate Intelligence Committee made for riveting theater as the nation was glued to their televisions, monitors and phones. It was likely the first time that many people had ever witnessed the inner workings of a Senate Committee hearing. Regardless of which side of the aisle you may fall, it’s fair to say that the event lived up to the weeks of anticipation.

While the hearing and Mr. Comey’s responses may have significant repercussions on Pennsylvania Avenue, we think that Wall Street continues to be focused on other issues. We’ve discussed previously in this space that we believe much of the market’s rally since the election was predicated on expectations that this administration would usher in significant corporate tax reform. Large caps have paced this rally, closing the gap with small cap performance over the past six months. It appears, however, that any post-election momentum for meaningful reform in the tax code has stalled, and more recent trading suggests that the rotation out of large caps into small caps has already begun.

JP Morgan is calling for a summer top followed by a correction, while, further out, Pimco sees a 70% chance of recession over the next five years. The comments from JP Morgan are from its lead technical analyst, while Pimco has significant macro concerns: “All three key risks that we saw on the horizon — elevated and rising debt levels, monetary policy exhaustion and the ascent of populism — have either materialized or become more real.”

Pimco’s monetary policy spotlight is perhaps most interesting. Richard Clarida of Pimco said, “People need to remember that in 2001, the Fed cut interest rates by five percentage points. In the next recession, the Fed is not going to have room to cut the interest rate by five percentage points.”

Another concern we have is that there has been unusually high correlation across diverse assets in recent weeks. The bond market, precious metals, Bitcoin and other cryptocurrencies have all been rallying together with stocks. History tells us is this level of correlation often presages corrections of varying duration.

The current secular bull market can be traced back to early 2009, as the market began to emerge from the financial crisis of the previous year. Eight years is a long run for any bull market, and we think Pimco is likely correct about the chances of this rally hitting a wall over the next five years. Even in a correction or recession, there are companies that will always outperform, and we remain focused on those at the microcap end of the spectrum that are undervalued, are relatively immune to whatever reforms may or may not happen in Washington and represent a long dated option on our innovation economy.

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