April 14, 2020
Senior Vice President, Private Wealth Group, CMG Capital Management Group
- Segment 1 (03:48): Interview with John Mauldin, Chief Economist & Co-Portfolio Manager, CMG Capital Management Group
- Segment 2 (17:00): Interview with CMG Mauldin Smart Core ETF Strategist, Steve Cucchiaro (President and Chief Investment Officer, 3EDGE Asset Management)
Brian Schreiner: Hello. Welcome to the quarterly conference call for the CMG Mauldin Smart Core Investment Strategy. My name is Brian Schreiner. I am Vice President of the Private Wealth Group here at CMG.
The Mauldin Smart Core investment strategy is the culmination of over 30 years of economic thinking by one of the world’s leading economic writers.
John Mauldin is the Chief Economist and Co-Portfolio Manager of the CMG Mauldin Smart Core investment strategy. John believes that the end of the debt supercycle is one of the most profound trends that will impact your portfolio over the next several years – and he believes the period ahead will require you to think and invest differently to get through the “Great Reset.”
Instead of diversifying asset classes, Mauldin Smart Core diversifies among trading strategies. The strategies seek growth, have the ability to respond to the global economy on a daily basis and do so with a disciplined investment processes that seeks to minimize downside risk.
Think of Smart Core as four strategies in one managed account portfolio. The strategists utilize ETFs that enable them to trade across asset classes, countries, sectors, commodities and cash-like securities for safety. <Long Pause>
Today’s call will be split into two segments. First we will hear from Co-Portfolio Manager John Mauldin on what he sees in today’s investment environment and the economic landscape.
In the second segment, we will hear from one of the portfolio’s four asset managers: Steve Cucchiaro, President and Chief Investment Officer at 3EDGE Asset Management. Steve will give us his take on the current market environment and provide insights into one of the individual trading strategies within Mauldin Smart Core.
As you are listening to the call today, if you have any questions or if you’d like to learn more about our investment management services, please contact us by phone or email. Our phone number is 800-891-9092 and our email address is firstname.lastname@example.org
Federal securities laws require us to make the following disclosure: Investing involves risk. Past performance is no guarantee of future results. Different types of investments involve varying degrees of risk. Therefore, it should not be assumed that future performance of any specific investment or investment strategy (including CMG Mauldin Smart Core) will be profitable, be suitable for your portfolio or individual situation, or prove successful. No portion of this call should be construed as an offer or solicitation for the purchase or sale of any security. There are additional important disclosures in our Form ADV, which is available on our website.
It’s always an honor to introduce my friend and colleague, John Mauldin. In addition to serving as Chief Economist at CMG, John is a noted financial expert, a New York Times best-selling author, a pioneering online commentator and the publisher of the weekly letter, Thoughts from the Frontline. Together with Mauldin Economics, John hosts the Strategic Investment Conference every year, which brings together some of the world’s most respected economists, analysts and investment managers. John has written many books – several have appeared on the New York Times best-seller list, including Endgame,… Code Red,… Just One Thing,… and Bull’s Eye Investing. Welcome John. Thanks for joining us today.
Mauldin Smart Core is an opportunistic, multi-asset, multi-manager investment strategy that combines several investment strategies into one portfolio. The objective is to seek global growth opportunities while maintaining a level of protection in down markets.
Mauldin Smart Core is outperforming its Morningstar Category both year-to-date through March 31 and over the last 12 months. The Morningstar Category for US Fund Tactical Allocation was down 13.4 percent year-to-date while the Mauldin Smart Core managed account strategy was down 7.9 percent over the same period. Over the last 12 months, The Morningstar Category was down 5.1 percent while Mauldin Smart Core was down 3.3 percent.
John Mauldin: I’m actually very pleased for a reason that is not obvious to maybe to the average person. But as I frequently talk about in my letters is I understand the limitations of models, and this time, owning it to this rapidity of the drawdown, we lost more given the 30% drop that we would have lost at any past 30% drop because just how fast it happened, and the parameters around some of the systems saying they’re going to react at certain times into the day, end of the week, you know, just their own particular models. And I was concerned as I’m watching it drop so fast because I knew about the limitations of those models.
And the fact that we went down as little as we did on a 30% drop that happened so fast, really made me feel good. It did better than I thought it would have done under a similar circumstance given that a similar circumstance had never happened in history.
And so, we had a result that, in fact, when something really different happened, turned out a lot better that I would have expected. So, when I say I’m pleased that we had an 8 or 9 or 10% drawdown in the middle of the 30 plus percent market drawdown. I’m pleased because it happened so fast. It wasn’t designed for that because nobody had seen that for a hundred years. It wasn’t in anybody’s realm of programming, if you will, but it worked. And so, I was happy. And to me it demonstrates the robustness of what we are doing.
Brian Schreiner: As asset managers, especially the managers in Mauldin Smart Core. We focus on technical indicators primarily and the way that we design our investment models is using historical market data and historical market time periods. And so, we build the models to deal with markets as we know them. But what markets routinely do is they behave in ways that we’ve never seen. And this is really what you were saying, the speed of that decline was entirely unprecedented, faster than the 1929 crash, faster than the 1987 crash. And the fact that the combined strategies of the four managers were able to survive and to limit loss as to what they did is really a testament. I think to you when the foresight to be able to put the managers together and to work together because it really, that style diversification I think was probably the main reason for that diversification across trading strategies.
John Mauldin: Well that’s true and one of the things that was a blessing if you will, was that there’s one particular manager, he’s in there because they’re going to outperform or the upside – they are the most volatile manager we have, and their system had them in treasuries and shorting – actually shorting some – and in a reasonably for them short order. That blending really did work out, to me one of my principles is we’re not diversifying asset classes because all asset classes go to one. We’re diversifying trading strategies, and I believe it works this time.
Brian Schreiner: I want to shift gears and talk about your recent thoughts from the frontline letter. After I read it this past weekend, it just raised so many questions and like you said, it could have been two times as long. It could have been four or five times as long. Right. You could have definitely could’ve written more on all that stuff.
John Mauldin: It really could have been.
Brian Schreiner: And after I read it, I felt myself say, man, I’d really like to ask him some questions and then it hit me. Oh well in a few days I get to do that. So, go ahead.
John Mauldin: Then head on with it.
Brian Schreiner: I guess first the title, “Bending the Inflation Curve” What did you mean by that?
John Mauldin: If I said “Bending the Deflation Curve,” the average person wouldn’t get that because they don’t understand deflation, but that’s really what we’re talking about here. We are a world, but as a nation are facing a depletion or depression – it’s a certainty. That’s what we’re dealing with. And the Federal Reserve said (Jerome Powell came in) and basically said, “Not on my watch.”
Both Steve; your boss Blumenthal and I for two to three years have been highlighting the dangers and the corporate leverage loan market, the collateralized loan obligations high yield debt, especially the covenant light and even no covenant high, high yield junk bonds. I mean it’s just been massive. And to me it was going to be a source of the next crisis. And it’s as if the Fed said, Oh, John and Steve and everybody else. I mean we’re not the only people that noticed this. They came in and said they’re right, but we’re not going to let it happen. And so, they’ve gone to the market and they’ve just bought, and they bought in size.
I understand their motives. Are they screwing around with the free market? Yes. Have they destroyed price discovery? Absolutely. Are we going to have to have that day of reckoning at some point? Yes, but they’re saying we’ll take that pain in the future. I mean against the certainty of a deflationary depression, and they said, we’re going to take the deflation off the table. Now we’re going to take that bad bond rate off the table. I think they’re going to come in with more. I think the government will do more. I fully expect an infrastructure bill before the election. Of one in size too, I mean minimum of a trillion, probably closer to 2 trillion because not all the jobs are going to come back. We’re going to have an unemployment problem and so that’s why I think an infrastructure bill that could create jobs that actually give us something. I mean the money they’re giving to people and job, that’s not stimulus, that’s just replacement money. It’s not stimulating buying that’s replacing lost income and not dollar-for-dollar. I mean you’re getting a portion of the dollars you were getting, so it’s a problem.
Brian Schreiner: I want to go back to the question of inflation or deflation. You mentioned that you think the idea that this unprecedented amount of federal reserve intervention, the idea that that’s going to cause inflation or hyperinflation is wrong-headed. You mentioned kind of an alternative understanding of Milton Friedman and Anna Schwartz’s work.
John Mauldin: It gets very technical. That’s what I was trying to say. In this period where they did their work and the correlation between the supply and inflation was pretty much evident.
Brian Schreiner: Was high, yeah.
John Mauldin: Well there was high correlation, but the velocity of money was steady. What we’re now watching, starting with the Bush administration, I mean this has been going down for some time. The latter part of the Bush administration, we’re watching the velocity of money drop. We’re now at rates we haven’t seen since the great depression, and it’s still dropping, it’s not falling out of bed. It’s just dropping and doing it. It’s doing it like I said, for 10, 12 years. You can increase the money supply. I mean its mathematical, I don’t want to try to get into it, but you can increase the money supply and do the things the Fed is doing and get away with it more than you might think simply because the velocity of money is dropping. Does it make me happy they’re doing that? No, it doesn’t make me happy, but they didn’t ask my opinion.
Brian Schreiner: I worry about the “velocity of money” in the markets. And what I mean by that is I worry about how much of the printed money finds its way into markets. And…
John Mauldin: Well, a lot of it will, I mean we are going to see a lot of repricing of real estate. We’re going to see a lot of re-pricing of venture capital money. We’re going to see a lot of repricing on many things. And it’s all going to be deflationary
Brian Schreiner: With so many moving parts. How would you begin to think about this as an individual investor? You know, who maybe is in retirement and thinking about their investment portfolio.
John Mauldin: Especially if they’re in retirement. They need to be thinking more about income and certainty and taking less risks and not more. I’m not trying to be too counter-intuitive here, but we really don’t want to be taking more risk than we need to at this point. So, I would urge caution to the extent that an investor can.
Brian Schreiner: One of the things I’ve been preaching to clients at this time is reliance on disciplined investment strategies. We can’t expect to sit on our couch and watch CNBC and decide when to enter and exit positions. That’s just not going to work.
We have to have a game plan to begin with. And to me, and I’ve said this for many, many years – and I’ve been wrong so far – but I do believe that we will be entering an era where active management matters. It hasn’t mattered for so long. Buy-and-hold has worked, but active management, I believe, is going to matter in the years to come. Professional management, the ability to position assets in the right places at the right times, is going to start to matter with so many market forces at play. And buying and holding and making ad hoc investment decisions flying by the seat of your pants isn’t going to work. I think investors need to have and investment plan and I think it needs to be, as you’re saying, risk managed and disciplined. That’s a written plan and I think most investors don’t have the sophistication level to do it. And I think they’re going to need to find managers… And that’s why we are here.
John Mauldin: And would that maybe it’s a good time to wrap up.
Brian Schreiner: Absolutely. Thank you for your time today. Really appreciate it and look forward to your letters and SIC conference. Anything to announce yet?
John Mauldin: Oh yes, we’re going to do a virtual SIC. I’m actually going right from here into my backyard and then down to the ocean. I’m doing the announcement video, if you will, from my phone. As you know, everybody has a studio in their own home these days.
It will be from May 11th through the 21st we’ll pick five days. We’ll do like four sessions a day. It’ll be live streamed; people be able to ask questions. I’ve been able to get people from around the world that I could never bring together in one physical place, just logistics, time, expense, whatever. It’s going to be a really special strategic investment conference at a really special time when we all have a lot of questions.
Brian Schreiner: Wow, that sounds like fun. I’m looking forward to it.
John Mauldin: I am too. You’re going to want to be there.
Brian Schreiner: I will be. Thanks again for being on the call today and look forward to talking again soon.
John Mauldin: Thank you. Bye, bye.
Brian Schreiner: Sure. Bye, bye.
Brian Schreiner: Okay, we’re back for the second segment of the Mauldin Smart Core Quarterly Conference call for the first quarter of 2020 as a reminder, if you have any questions or you’d like to learn more about our investment management services, please contact us by phone at (800) 8919092 or by email at email@example.com.
I’m very glad to be here with Steve Cucchiaro, president and chief investment officer at 3EDGE Asset Management. Steve oversees the 3EDGE total return strategy, which accounts for 25% of Mauldin Smart Core.
He has over 35 years of experience studying the global capital markets and managing investment portfolios. Steve was the founder and served as president and chief investment officer of Winward Investment Management, which managed over $20 billion in client assets and was acquired by Charles Schwab in November of 2010. In 2016 Steve founded 3EDGE. Steve appears frequently in the media. You may have seen him on television, on CNBC or quoted on the wall street journal. He also has a degree in mathematics from MIT and an MBA in finance from the Wharton school. Steve, welcome to the call.
Steve Cucchiaro: Well, thank you Brian.
Brian Schreiner: Steve, I wanted to get your thoughts on the investment environment and your investment strategy, but before I do, I wanted to ask about your business operations. I know they’ve been impacted by the Corona virus. Your office is located in one of the tallest buildings in Boston. I assume you’re all working remotely now. How are your people coping with the change?
Steve Cucchiaro: Well, it’s actually been going very smoothly as part of our annual compliance program. We have practiced in the past working remotely to make sure that the software is smooth and seamless, and so now that we’re working remotely again in an extended way, I can report that it’s been very seamless. We have meetings, not just audio but video. We share documents, it’s really gone surprisingly well.
Brian Schreiner: Well that’s the same here at CMG. I think for the particular business that we’re in, it’s very conducive to working remotely. I know that even when we’re in the office, in person, we’re still working in a cloud environment and it’s not much different being home for us either.
Shifting to the markets and the economy, I know one of the fundamental beliefs that you hold is that markets tend to be micro-efficient and macro-inefficient. How important is this concept in light of the unprecedented environment that we’re in today?
Steve Cucchiaro: Well, Brian, to be honest, I would say that it’s more important than ever. If we look back at 2019 and early 2020, we had investors who are very much focused on the micro markets kept going higher and higher, breaking all-time records. But if you look at the macro, as we did, you’d recognize that the U.S. stock market in particular had reached seriously overvalued levels. And so, while we were quite defensive last year and maybe not taking full advantage of the rise, we’re very well protected going into the downturn by recognizing that more macro concept.
What I would maybe point out is that on February 11th, we published a brief paper that we titled The Next Bear Market. And on February 11, the market was still going up, making new all-time highs in the bear market, to many seem quite distant. But we highlighted some of the most important macro factors that we thought were affecting valuation and were affecting the market and what some of the triggers might be to pull us back down. And that proved to be very helpful for our own investment management as well as people reading that. And that’s available on our website, www.3edgeam.com.
Brian Schreiner: Great. Now, the methods you use for analysis, they include valuation metrics, measures of investor psychology and behavior as well as multiplayer game theory to better understand how policy actions by different market actors could influence the direction of the capital markets. What factors are most at play right now and what role are they playing in your asset allocation framework?
Steve Cucchiaro: That’s a great question because this is truly a time when all factors are playing a major role. I discussed what we see as the overvaluation of the U S markets going into this downturn. Also, if you think about multiplayer game theory, we have a situation where the government has had this massive intervention as the market was plunging. And so, I see it as a tug-of-war between this massive economic shutdown pulling the market down, and equally massive government intervention trying to prop the market up, in this fund folded in a sequence where first we have the steepest decline in history – even steeper than the famous stock market crash in 1929, and even steeper than the famous stock market crash of 1987.
That was followed by one of the steepest bear market rallies that we’ve ever seen, all initiated from the government stimulus and the government intervention.
When we think about bear markets, we’ve analysed every bear market going back to the late 1800s, and while they’re all unique, there are patterns, there are attributes that are similar and that goes back to investor psychology. In a bear market you have these three phases, phase one, phase two, phase three.
Phase one it’s typically very sharp market decline. We had that from February 19th to March 23rd and then that’s typically followed by a relief rally, and there’s government intervention coming to save the day to rescue the situation and you begin to get hope and you start climbing hope. And we certainly have had that very strong relief rally. Then phase three you might call a reality check, and if it looks like the downturn is going to be very short in duration, or if like in 1987 the recession never materialized, then phase three is just a more gradual volatile period with an upward bias. In most cases the reality check is, well we’ve had a lot of hope the government came in to intervene, but there’s still a lot of unresolved issues and then you go into a new down leg, not nearly as sharp as phase one, but it’s possible to test or even breach the new lows.
Brian Schreiner: That’s the question I think investors are asking themselves right now is to talk to the clients. It’s there’s a range of opinions and thoughts, but I think many market participants are expecting some more downward pressure. Maybe that’s why it hasn’t really come yet.
I was looking at the April 7th edition of your “View From the Edge” investment letter. That’s also available on your website and I think it’s great you guys look at a variety of factors, but in this one I noticed that you did reduce your equity exposure to only about 30% by the end of February, and then reduce it further in March. What caused you to reduce your exposure and what exposures look like now?
Steve Cucchiaro: Well, it began to reduce our exposure back in late January and we pointed out a few factors. One was the overvaluation was getting even more extreme, especially in the U.S. market. Number two, despite the hope of a trade truce, global manufacturing was beginning to decline. And three, we highlighted in our letter in late January the possible threat of this thing called the Corona virus. So, we began quite early to get defensive and then as the markets evolved and developed, as time went on, we actually get below 30% we actually get all the way down to 20% and this is why we had such a small drawdown during the worst of the market times, when you look at peak-to-trough market fell over 33% from February 19th to March 23rd and our fall was just, you know, a very small fraction of that and that was because we were defensively positioned.
Since then, and very early April, April 2nd our models indicated the chance, the probability of phase two of the market bouts coinciding with the government intervention. And so now we’re back up to about 40% equity allocation, which is still in the grand scheme of things defensive. We still have plenty of dry powder should we get that phase three anytime soon. But we were able to take advantage of some of this climb since early April.
Brian Schreiner: It seems to me at least on an anecdotal level that investor sentiment is decidedly negative or at least kind of wait-and-see, which I think translates probably to negative, and that’s why in reading that letter I was almost shocked to hear that you guys do see some opportunities for investors. What are some of the opportunities that you’re seeing now or that you’re seeing that are starting to develop?
Steve Cucchiaro: Well, if you look outside the stock market, there are markets that never really participated in the rally of the last decade and then on evaluation basis are a lot more attractive. And we don’t think it’s prudent to go full bore and load up your entire portfolio with equities right now, not by any stretch. But if there are places to look at where the valuation might be compelling, then we do look overseas.
Germany is one area where German stocks fell even more sharply than U S stocks. And at the bottom they were at levels once seen 23 years ago. And yet the size of the German economy is almost twice what it was 23 years ago. So, that’s certainly an interesting area to look at. Now, Germany has a whole host of challenges and issues coming up, but you can say that the stock price reflects a lot of that bad news, so that’s one area.
Emerging markets have been relatively undervalued and certainly underperformed ever since the financial crisis of 2008. They still have lots of challenges ahead of them, and some of them haven’t yet been hit the way they will by the coronavirus. Having said that, prices reflect bad news, so there are places to look at for bargains there.
And finally, longer term, Japan is a market that again is still far below its peak of 1989, in score as well in certain valuation measures, but we’d say it’d be good to wait for a catalyst before that market goes from undervaluation to valuation. Obviously as the Fed keeps printing more money, we keep liking gold more and more and we’ve had a strong position in gold throughout this period, and that’s done very well for us.
Brian Schreiner: Steve I know you’ve been a careful observer of the Fed for a long time. In the last 30 days we’ve seen the Fed announce that they will inject more than $6 trillion into the economy. They cut interest rates on March 3rd and again on March 15th. They announced a bond buying program on March 17 and efforts to support money markets on March 18. On March 19 they imposed a brand new operation in the currency swap market and on March 20 they said they would be buying municipal bonds. On March 23 they expanded their original asset purchase program (which was supposed to max out at $700 billion) saying the program is now unlimited in scope and has already expanded the Fed’s balance sheet by more than $2 trillion dollars. On March 23 the Fed announced a $300 billion dollar program that would extend credit to businesses and consumers. On April 6th they announced a program to provide support to the U.S. Treasury. On April 8th they lifted a regulation on Wells Fargo to allow them to participate in the business lending programs. And most recently, at the end of last week they announced a massive $2.3 trillion dollar lending program to extend credit to banks and to buy distressed corporate debt and more bonds from state and municipal governments. What are the implications of these massive interventions for investors in the near-term and long-term?
Steve Cucchiaro: Well, what the Fed has done is truly unprecedented. In fact, that’s probably understating the degree to which they’ve gone way beyond any past practice and introduced new policies that weren’t even contemplated years ago. But it all goes back to the Treasury and the government wanting to backstop the second ionic decline. And if they had been building government surpluses during the good years, then they’d be going into those surpluses to fund all these rescue programs. But before this all started, the government was $21 trillion in debt and that was increasing at the rate of a trillion dollars a year, even in good time. So, now the government doesn’t have the money to put together all these programs. So, they need to borrow in a major way. And the most convenient borrower is the Fed.
So, the Fed is literally printing trillions of dollars out of thin air to fund all these government programs. And the Fed and the Treasury now acting in unison. And what we’re doing is we keep piling up more and more debt on top of more and more debt. To quote a good friend of mine, John Mauldin, he’s been worried about this for years. And he’s used the phrase that “we’re kicking the can down the road.”
And so, I think you have to ask yourself right now, are we now down that road? Have we piled on so much debt on top of debt that the marginal usefulness of the debt, or the actual increase in the debt is going to cause more problems than the solution that’s trying to produce?
So, if you think about the great increase in the supply of Treasuries, eventually that’s going to overwhelm the demand. And that usually leads to higher interest rates and that’s bad for the markets. However, we might have a situation where the government and the Fed don’t want that to happen. So, the fed will continue to print money to buy those treasuries. And you might think of that as a form of financial repression. Last time we had such strong financial repression was right after World War II, and they wanted to make sure government could refinance itself after the big debt it incurred in World War II, at low interest rates to make it easier. And they actually pass regulations, capping interest rates. And that was financial oppression, bad for the bond holders and good for the borrowers.
So, now we might have a different form of financial oppression, which is the Fed continuing print money to fund increasing supply of Treasuries, which of course will be bad for bond holders and savers and lenders and good for the borrowers.
Now furthermore, who owes all this debt? Well, it’s really the U S taxpayer. So, depending on the political environment, we might see higher taxes, which again could constrain economic growth in the markets. And then finally, studies have shown over many years that when you keep increasing debt, you’re apt to have slower and slower growth. You don’t have enough growth to pay off the debt and you get into a vicious circle. And so, if we have slower growth, and what we saw back in at the end of World War II, and we had financial repression, eventually inflation did come back even we least expect it.
We could be looking at a period longer down the road of stagflation, and that would not be good for the stock and bond markets, but it would be good for gold, it would be good for safe cash, and it’d be good for tips to Treasury Inflation Protected securities (TIPS).
So, now do we need to go down this dire path? Is it preordained? And I think that the key question that a lot of people are asking is are we going to get through this and recover quite quickly or are we going down this long slow path of decline?
And the answer to that is tied to the idea. What is the length of this recession? Right now, we all know we’re in a sharp recession right now. What we don’t know is how long it’ll last. And the optimist hope that it’s like a blizzard that goes through and that at the end of the blizzard everything goes right back to normal. And there’s certainly talk of the Coronavirus. The deaths per day in the U.S. now is peaked and it’s starting to come down, same with some parts of the world.
And so, there’s a prospect that the economy gets going as early as the end of April, early may and everything gets revved up and off we go. And the Fed has created a bridge to that timeframe. So, it could happen. On the other hand, if the Coronavirus mutates, or if deaths per day don’t slow like we hope. If the idea of an economic recovery and everyone getting back to where it goes a lot more slowly, in fits and starts with consumers remain a lot more cautious than people hope, then that bridge might be a bridge to nowhere, and we might be in a worse situation.
So, one indicator we’re watching that is a great indicator to determine this tug of war between the economic contraction, and the massive stimulus that the Fed is providing, is to look at corporate credit spreads. We saw during the plunge, credit spreads widened tremendously, and that typically happens as a leading indicator into the plunge. And we saw when credit spreads narrow when the government and the Fed came in, we saw the market take off in a rally. So, we’re watching corporate credit spreads very, very carefully as to clues whether one side or the other is winning this tug of war.
Brian Schreiner: Steve thanks so much, really appreciate your thoughts. Thank you for all the work you’re doing for clients and Mauldin Smart Core, and we certainly look forward to having you on the call again.
Steve Cucchiaro: Well, we’re very happy to be a participant and thank you Brian.
Brian Schreiner: My pleasure. Thanks for listening everyone, and please be sure to listen again next quarter. We will again host John Mauldin and asset manager, Brian Lockhart, founder and Chief Executive Officer at Peak Capital Management. Thanks again, and have a great day.
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