June 26, 2015
By Steve Blumenthal
“People are habitually guided by the rear-view mirror and, for the most part, by the vistas immediately behind them.”
– Warren Buffett
I was the keynote speaker last night at a large advisor client event in suburban DC. The title of my presentation was “Buffett Burgers.” With five boys in the house, we find ourselves often grilling Bubba Burgers; thus the incredible inspiration for my presentation. I know, cliché – but I think it went well.
So I began with one of my favorite Buffett quotes, “This is the one thing I can never understand. To refer to a personal taste of mine, I’m going to buy hamburgers the rest of my life. When hamburgers go down in price, we sing the “Hallelujah Chorus” in the Buffett household. When hamburgers go up, we weep. For most people, it’s the same way with everything in life they will be buying–except stocks. When stocks go down and you can get more for your money, people don’t like them anymore.”
Right now it is time to weep, the “burgers” are expensive. Stocks are expensive by all measures including Buffett’s favorite, Stock Market Capitalization to GDP (cited as his favorite measure in a December 2001 Fortune article. If you have some extra time, it is well worth the read). I shared with the event participants the valuation charts I put in a Forbes piece I wrote (published yesterday) titled, Are Stocks Really Cheap Relative to Bonds? Buffett suggested that stocks would “likely do well for you” when Stock Market Capitalization is around 70% to 80% of Gross Domestic Product (GDP). Unfortunately, we are at 140% today with only March of 2000 showing a higher reading.
To put this into layman’s terms, think of the total Stock Market Capitalization as the value of all U.S. publicly traded businesses combined. GDP is the total amount of production a country creates. Currently the GDP number is above $17.66 trillion. The growth rate for the country’s businesses has historically grown at approximately 3.24% per year (1948 until 2015). We know that GDP has grown at closer to 2% per year over the last 15 years (debt is a drag). So what is the collective value of U.S. public companies worth? Let’s just say the burgers are richly priced.
This whole valuation discussion is important from the perspective of risk. If the Buffett Burgers were cheap, we’d all join in and sing the “Hallelujah Chorus”. It is not yet time to sing. Let’s make sure we are in a happy mood (principal preserved) when it is time.
Last week I showed a simple three-way asset model along with how to use a 50/200 day Moving Average cross to identify trend. The point is to show that there are simple tactical trend based processes you can put in place that help you stay in uptrends and avoid major downtrends. They work for individual assets and on strategies as well. Of course, no process is perfect – there will be a few whipsaw trades. It took 15 years for investors to overcome the tech wreck (2000 to 2015). We must avoid -30% to -75% losses.
I favor mixing various non-correlating tactical strategies together to further control portfolio downside risk. You can change your weightings (overweight equities and bonds) when the burgers go back on sale. Make sure you are in a position to fire up your grill.
Next week brings deadlines for Greece and Iran. Brace yourself. Both are potential snowflakes that could trigger other systemic risks. I include some brief comments on Greece and share some thoughts on the incredible size of the derivatives market in comparison to stocks, bonds, real estate, gold and cash. Perhaps, like me, you’ll find it astonishing (concerning).
Included in this week’s On My Radar:
- Greece – It’s Not About Greece (It’s About a Larger Sovereign Debt Crisis) – It’s About The Banks – It’s About Counterparty Risk
- All the World’s Investable Assets – Derivative Exposure Exposed
- Trade Signals – Trend is Up but Aged and Tired – Zweig Bond Model Remains a Sell – 06-24-2015
Greece – It’s Not About Greece (It’s About a Larger Sovereign Debt Crisis) – It’s About The Banks – It’s About Counterparty Risk
I was asked at the conference about my thoughts on Greece. The question referenced that Greece is about the size of West Virginia. Small on a geographic basis but I think the issues are much bigger. Greece is not the only EU member out over its skis in debt and dealing with pension promises (lack of funding) that can’t be met.
My answer is that they will and have to default. I added that I believe the systematic risk is that they will soon be followed by other member countries – France is a mess, as are most of the other southern EU members. I worry about the pile on effect. The economies are being choked. Default is coming. The banks own the bonds. The hidden risk may exist in the intricate web of derivative related counterparty risk. Bank to bank. One may have properly hedged its Greek debt holdings yet that means nothing if your counterparty defaults and can’t pay you your gain. A rolling Lehman-like moment across the EU and the rest of the globe. Our banks do a great deal of business with EU banks. Recall the structured mortgage junk we sold to them prior to the last crisis. As my daughter says, “karma’s a bitch.”
Overall, I believe the key will be interest rates. As they rise, the deficits will rise, the need for taxes will spiral even higher, and that is when a large bank or two gets caught offsides. That is when we’ll find out just what kind of counterparty risk exists (see next section on All the World’s Investable Assets to get an idea of the pure size of notional derivative exposure).
This is from Goldman Sachs’ President and COO, Gary Cohn, on Bloomberg Radio this week:
- Years of discussing when and how the Federal Reserve will raise interest rates probably isn’t going to prevent market participants from being caught off guard, Goldman Sachs Group Inc. President Gary Cohn said.
- “We’re probably less ready than people think,” Cohn said on a podcast posted Wednesday on the firm’s website. “It won’t at all be surprising to me if there are some interesting market reactions based on official change in rate policy by the Fed.”
- Economists estimate the U.S. central bank will begin raising its benchmark target in September after more than six years of near-zero rates. Cohn cited quantitative easing in the U.S. and Europe as examples of macroeconomic events that were long expected and still caused market swings when announced.
- “When it does happen, it’s usually not the first-derivative event that people are caught off guard by,” Cohn said. “They’re caught off guard by the second-, third- and fourth-derivative events. It’s ‘Oh yeah, when interest rates go up, that happens.’”
You can read more about Greece.
All the World’s Investable Assets – Derivative Exposure Exposed
$682 Trillion in over-the-counter Derivatives Notional Amount (2014 per BIS)
$182 Trillion in Global Real Estate (2014 per Savillis)
$161 Trillion in Global Debt, Securities and other types of Debt (2014 per BIS)
- $94 Trillion of which is Global Debt
- $64 Trillion in Global Equities (per World Equity Exchange)
$24 Trillion in Global M1 Money Supply (Year-end 2013, per the World Bank)
$6.8 Trillion in Gold (per Thomson Reuters GFMS 2013 Gold Survey)
To add perspective to the $682 trillion of derivative leverage in the system today, total notional derivative exposure was $72 trillion in 1998. Courtesy of Elliot Paul Singer via Zero Hedge.
I simply say, “yikes!” Put a plan in place that manages your personal risk exposure and remember that it never feels risky when markets are up and it always feels risky when markets are in crisis. We want to get aggressive when the burgers are cheap and risk adverse when the burgers are overpriced.
I share ideas on risk management every Wednesday in Trade Signals. Next is a link to this past Wednesday’s post.
Trade Signals – Trend is Up but Aged and Tired – Zweig Bond Model Remains a Sell (06-24-2015)
Trend remains favorable but aged and it frankly feels tired. Sentiment is now neutral and both the CMG HY and the Zweig Bond Model remain in sell signals.
Click here to view all of the most recent Trade Signals.
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A special thank you to Mike and Todd at Legacy Capital Planners. They hosted the client event and I really enjoyed meeting with and connecting with their clients. I have watched them go from a few million to managing over $62 million in just a few short years. While I’m well aware of their investment process, I learned from them last night a great deal about their seminar efforts and how it has helped their growth. It was really nice to see how wonderful they are with their clients.
Travel ramps up again in July. I’m in NYC on July 8 & 9 for business and several media meetings and then I’m jumping on a train to meet Susan in Newport, Rhode Island. She found a place on the water so we are sneaking away for a long weekend. I hope to be writing from the room while the waves crash in the background. Chicago follows on July 15-19 for several meetings including a presentation at Brookstone Capital Management’s Annual Advisor Conference.
The USA Woman’s National Team is in the quarter-final tonight at 7:30pm (EST). Maybe some Bubba Burgers on the grill, a cold IPA (sodas for the boys) and a big win, I hope, are in my immediate future.
Wishing you the very best!
With kind regards,
Stephen B. Blumenthal
Chairman & CEO
CMG Capital Management Group, Inc.
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