June 24, 2016
By Steve Blumenthal
“Italeave, Finish, Czechout, Oustria, Byegium and Departugal.”
— Wilfred Frost, CNBC, June 24, 2016
Brexit! The world markets are in shock. What’s next? You’ll find my thinking below. This is day 1. There is more to come.
I’m en route to California where I’ll be leading a panel on portfolio construction at the Global Indexing & ETFs Conference early next week. It should be a lively conversation. I have to admit I’m feeling both unsettled and calm.
Long-time readers know I’ve been in the “it is time to play defense” camp. Two percent bond yields and 2-4% 10-year forward equity returns are just not going to cut it for you, for me, for pension plans, for insurance companies nor for the 75% of the capital that will be in the hands of pre-retirees and retirees by the year 2020.
Better to wait for the next significant correction to reset the playing deck. Until then, hedge that equity exposure, raise some cash to give you future buying flexibility and overweight to liquid strategies, such as tactical and managed futures, which have the potential to perform due to the unconstrained nature of their investment processes.
Logic and common sense must step to center stage. While levered long investments still need to unwind, fear not. There will be opportunities for those who have cash and wealth preserved in the days and weeks ahead.
So here we sit. A Brexit shock. Another snowflake? Does this one trip an avalanche or does it add one more layer of highly unstable snow? We just don’t know.
What is clear is that “We, the people” are pissed. I’m sure you, like me, are getting bombarded with Brexit commentary in your inbox. Following are our views on Brexit, a quick thought about the T-juncture and a link to this week’s Trade Signals.
This week’s OMR is a quick read. I hope you find it helpful.
♦ If you are not signed up to receive my weekly On My Radar e-newsletter, you can subscribe here. ♦
Included in this week’s On My Radar:
- Italeave, Finish, Czechout, Oustria, Byegium and Departugal
- T-Junction – Think About the Following
- Trade Signals – HY Opportunity Ahead (Just Not Quite Yet)
Italeave, Finish, Czechout, Oustria, Byegium and Departugal
We sent the following to our clients today: While it would be foolhardy to predict the details of what happens after the United Kingdom voted to leave the European Union, we wanted to address the potential impact of this unprecedented and historic vote. With global valuations already stretched and growth tepid and declining, the amount of uncertainty that the vote has brought into the market can have a significant impact and knock-on effect on financial markets and global politics. Below are our insights on what may come next.
Economic and Financial
The impact on financial markets has been startling. Currency markets have exhibited volatility not seen since the financial crisis and the collapse of Lehman Brothers. The British Pound has seen its largest one day drop ever and has hit its lowest level since 1985 against the dollar. European financial markets are down across the board, the Euro has weakened, the Yen and Dollar are higher against most global currencies and the Swiss central bank has intervened to prevent further appreciation in the Swiss Franc. The safety trade is on with U.S. Treasury bonds up sharply. Below are our thoughts on what may happen next:
- The Fed and US Interest Rates: The likelihood of a rate hike in September has declined precipitously and there are now predictions of a potential rate cut. As a result of the vote and the upcoming US election, it now appears highly probable that the Fed does not raise rates at all this year and bond yields are likely to remain lower for longer as a result. We remain in the rates will remain lower for longer camp.
- Risk of Recession: The UK is likely to fall into a recession and the risk of a US and global recession has increased. The EU accounts for approximately 50% of UK exports. We don’t see how this decision helps UK growth over the next several years while the UK and EU negotiate an exit. The big questions surround the UK’s status with respect to the EU common market and how subsequent trade agreements will be negotiated as well as the free movement of people (Norway can serve as a template). Further, the EU and specifically Germany loses a liberal economic ally and will now have less support for free market initiatives in the EU. Longer term, the UK is a major player in the world economy. They will negotiate, compete and do well.
- Greater Volatility: Much like the uncertainty surrounding Grexit over the past several years, we will likely see heightened levels of volatility in ebbs and flows for some time as details regarding Brexit are negotiated.
- This event is a major stress test on unconventional central bank policy.
- The title of this section suggests what we believe. There is more to come.
- United Kingdom: Today, United Kingdom looks a lot less “united”. Prime Minister David Cameron, who just last year secured the first Tory majority in 23 years, announced he intends to resign in October, a staggering defeat. Later this year, voters will determine who will lead the transition out of the EU. No one has any idea of who that person will be. Scotland is considering another vote to leave the UK in order to stay in the EU and there has been a call in Northern Ireland to leave the UK. In fact, the majority of votes to remain in the EU came from voters in Scotland, Northern Ireland and London. A UK without Scotland and Northern Ireland is a weaker UK.
- EU: In the short term, populist, anti-EU politicians stand to gain. Spain is set to have elections on Sunday and their two party system is likely to fragment while smaller parties gain power. It is not unreasonable to expect ideologically Eurosceptic candidates to harness the Brexit vote to stir voters. Immigration and the refugee crisis were key motivating factors for voters in the UK. Greek and Italian citizens will also be watching closely to see if the UK benefits from the exit. Longer term, if the impact of Brexit is negative for the UK, the EU could actually become stronger and more motivated to integrate if other member countries see what they stand to lose. Conversely, if the UK does well, it could spur other countries to consider their options. Politicians campaigning to leave the EU have promised voters control over immigration and a stronger economy. Now they have to deliver. Easier said than done.
- NATO and Russia: A fragmented EU will make discussions within NATO more difficult. It will be essential for the US, the EU and the UK to work constructively to insure that the NATO alliance is not weakened. Anytime European institutions are weakened, Putin and Russia stand to benefit. We believe they stay united
It is always difficult to deal with uncertainty. As humans, we don’t have the mental software to process these types of risks well. While we would all like to capitalize on market dislocations of this nature, few of us have the resources, conviction and speculator guts of George Soros to position significant wealth in highly targeted singular risks. We do however have an amazing set of tools in today’s world to manage risk better through broader, more holistic portfolio management. While we cannot predict the timing of such exogenous events, we can incorporate tactical strategies that raise cash and hedge equity investments, and include unconstrained bond and other non-correlating liquid alternatives in our portfolios to lessen the impact of chaotic events. We stand ready to assist you in deploying these risk diversifiers in your own portfolio and practice and are here to help you weather the strongest storms.
T-Junction – Think About the Following
Think about the following in relation to Brexit and political stability and cooperation. Heavy lifting needs to be done to soft land this debt deleveraging mess – both in the U.S. and abroad. The plane is coming in hot and the conditions are bumpy.
Read it and ask yourself which of Mohamed El-Erian’s views (below) are most probable:
“We are at a T-junction and the outcome is wide open, though I will not make a prediction because I simply don’t know,” he said. The primacy of central banks and the notion of a global economy at a crossroads are both themes of El-Erian’s recent book, The Only Game in Town: Central Banks, Instability, and Avoiding the Next Collapse.
El-Erian talked of optimistic and pessimistic views of the outcome:
The optimistic view hinges on three positives:
- Most economies know what’s needed—massive fiscal spending on infrastructure to stimulate the economy, even though there is a lack of political leadership to implement such policies
- The private sector is cash-rich and will start spending their cash on wages or capital expenditures
- Innovation that will disrupt the world of finance and how our economies operate
The pessimists will see the negative view that is equally valid:
- Politics are becoming really messy and may hinder the recovery by implementing disastrous policies (e.g., Brexit, Trump)
- Central banks will follow the Bank of Japan in becoming ineffective or counterproductive
- Financial assets have decoupled from fundamentals and heightened volatility will mean they will overshoot on the way up and undershoot on the way down, triggering an economic recession
“It has been nearly eight years since Lehman went under. If only we could congratulate ourselves for capitalizing on that misfortune for the betterment of the next generation of financial market firefighters. Instead, we stand on the precipice of God knows what, as central bankers’ grand experiment threatens to come undone wreaking havoc of wholly unforeseeable proportions.
– Danielle DiMartino Booth
Italeave, Finish, Czechout, Oustria, Byegium and Departugal… Brexit is just the beginning I’m afraid. Too much debt. Fractured structure. Zero currency flexibility for those that need it most.
International capital may fly quickly to U.S. stocks and bonds for money will always flow to where it is treated best, but the market is richly priced by most every historical measure. I’m not so comfortable taking the foreign capital flow equity bet.
Underweight and hedge that equity exposure, diversify, stay tactical and stay extremely alert. Significant opportunity remains in front of us. Let’s not get run over on the way.
Brexit is just the start. This is going to get very interesting. I think my friend Jim Rickards said it well earlier today:
“The problems don’t end there. What happened to markets as a result of the Brexit vote is not a one-time event. It’s a reflection of the following:
- Elites are out of touch with the everyday citizens.
- Experts are using obsolete models that produce erroneous forecasts and market losses.
- Central bankers are impotent since monetary solutions don’t solve structural problems.” Source: private newsletter.
Trade Signals – HY Opportunity Ahead (Just Not Quite Yet)
Click through to find the most recent trade signals. My favorite weight of evidence indicator, The CMG NDR Large Cap Momentum Index, remains in a sell signal. Trades Signals is posted each Wednesday. Here is a link to the Trade Signals blog page.
Personal Note – California and Chicago
The 21st Annual Global Indexing & ETFs Conference is up next. I’m finishing this week’s letter from 36,000 feet somewhere over the Rocky Mountains. The wifi is slow but not too bad today. Mohamed El-Erian is the keynote speaker and I’m leading a panel on “Portfolio Construction Using ETFs.” Joining me at the conference are large institutional investors (endowments, foundations, pension funds), wealth advisors, ETF issuers, technology solutions providers and academics.
Our collective agenda, of course, is to explore opportunities for achieving superior investment performance through the utilization of an ever-expanding array of indexes and tradable index products. The growth and innovation of ETF products helps us all. I’ll share with you what I learn.
Chicago follows on July 20-22 for a large advisor client conference. August slows down. We just rented a beach house for the third week in August in Stone Harbor, New Jersey. I’ll be hitting Springers ice cream a bit too hard that week but hey… All the kids will be with us. Really looking forward to that downtime with my family.
In September, I’ll be speaking at the Morningstar ETF Conference about portfolio construction.
If you find the On My Radar weekly research letter helpful, please tell a friend … they can sign up for the free letter by clicking the “subscribe here” link that follows:
♦ If you are not signed up to receive my weekly On My Radar e-newsletter, you can subscribe here. ♦
Wishing you a wonderful weekend. I hope you too are planning to take some time off… and eat some ice cream.
With kind regards,
Stephen B. Blumenthal
Chairman & CEO
CMG Capital Management Group, Inc.
Stephen Blumenthal founded CMG Capital Management Group in 1992 and serves today as its Chairman and CEO. Steve authors a free weekly e-letter entitled, On My Radar. The letter is designed to bring clarity on the economy, interest rates, valuations and market trend and what that all means in regards to investment opportunities and portfolio positioning. Click here to receive his free weekly e-letter.
Social Media Links:
CMG is committed to setting a high standard for ETF strategists. And we’re passionate about educating advisors and investors about tactical investing. We launched CMG AdvisorCentral a year ago to share our knowledge of tactical investing and managing a successful advisory practice.
AdvisorCentral is being updated with new educational resources we look forward to sharing with you. You can always connect with CMG on Twitter at @askcmg and follow our LinkedIn Showcase page devoted to tactical investing.
A Note on Investment Process:
From an investment management perspective, I’ve followed, managed and written about trend following and investor sentiment for many years. I find that reviewing various sentiment, trend and other historically valuable rules-based indicators each week helps me to stay balanced and disciplined in allocating to the various risk sets that are included within a broadly diversified total portfolio solution.
My objective is to position in line with the equity and fixed income market’s primary trends. I believe risk management is paramount in a long-term investment process. When to hedge, when to become more aggressive, etc.
Trade Signals History:
Trade Signals started after a colleague asked me if I could share my thoughts (Trade Signals) with him. A number of years ago, I found that putting pen to paper has really helped me in my investment management process and I hope that this research is of value to you in your investment process.
Following are several links to learn more about the use of options:
For hedging, I favor a collared option approach (writing out-of-the-money covered calls and buying out-of-the-money put options) as a relatively inexpensive way to risk protect your long-term focused equity portfolio exposure. Also, consider buying deep out-of-the-money put options for risk protection.
Please note the comments at the bottom of Trade Signals discussing a collared option strategy to hedge equity exposure using investor sentiment extremes is a guide to entry and exit. Go to www.CBOE.com to learn more. Hire an experienced advisor to help you. Never write naked option positions. We do not offer options strategies at CMG.
Several other links:
IMPORTANT DISCLOSURE INFORMATION
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 the investments and/or investment strategies recommended and/or undertaken by CMG Capital Management Group, Inc. (or any of its related entities, together “CMG”) will be profitable, equal any historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. No portion of the content should be construed as an offer or solicitation for the purchase or sale of any security. References to specific securities, investment programs or funds are for illustrative purposes only and are not intended to be, and should not be interpreted as recommendations to purchase or sell such securities.
Certain portions of the content may contain a discussion of, and/or provide access to, opinions and/or recommendations of CMG (and those of other investment and non-investment professionals) as of a specific prior date. Due to various factors, including changing market conditions, such discussion may no longer be reflective of current recommendations or opinions. Derivatives and options strategies are not suitable for every investor, may involve a high degree of risk, and may be appropriate investments only for sophisticated investors who are capable of understanding and assuming the risks involved. Moreover, you should not assume that any discussion or information contained herein serves as the receipt of, or as a substitute for, personalized investment advice from CMG or the professional advisors of your choosing. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisors of his/her choosing. CMG is neither a law firm nor a certified public accounting firm and no portion of the newsletter content should be construed as legal or accounting advice.
This presentation does not discuss, directly or indirectly, the amount of the profits or losses, realized or unrealized, by any CMG client from any specific funds or securities. Please note: In the event that CMG references performance results for an actual CMG portfolio, the results are reported net of advisory fees and inclusive of dividends. The performance referenced is that as determined and/or provided directly by the referenced funds and/or publishers, have not been independently verified, and do not reflect the performance of any specific CMG client. CMG clients may have experienced materially different performance based upon various factors during the corresponding time periods. Mutual funds involve risk including possible loss of principal. An investor should consider the fund’s investment objective, risks, charges, and expenses carefully before investing. This and other information about the CMG Tactical All Asset Strategy FundTM, CMG Global Equity FundTM, CMG Tactical Bond FundTM, CMG Global Macro Strategy FundTM and the CMG Long/Short FundTM is contained in each fund’s prospectus, which can be obtained by calling 1-866-CMG-9456 (1-866-264-9456). Please read the prospectus carefully before investing. The CMG Tactical All Asset Strategy FundTM, CMG Global Equity FundTM, CMG Tactical Bond FundTM, CMG Global Macro Strategy FundTM and the CMG Long/Short FundTM are distributed by Northern Lights Distributors, LLC, Member FINRA.
NOT FDIC INSURED. MAY LOSE VALUE. NO BANK GUARANTEE.
Hypothetical Presentations: To the extent that any portion of the content reflects hypothetical results that were achieved by means of the retroactive application of a back-tested model, such results have inherent limitations, including: (1) the model results do not reflect the results of actual trading using client assets, but were achieved by means of the retroactive application of the referenced models, certain aspects of which may have been designed with the benefit of hindsight; (2) back-tested performance may not reflect the impact that any material market or economic factors might have had on the adviser’s use of the model if the model had been used during the period to actually manage client assets; and (3) CMG’s clients may have experienced investment results during the corresponding time periods that were materially different from those portrayed in the model. Please Also Note: Past performance may not be indicative of future results. Therefore, no current or prospective client should assume that future performance will be profitable, or equal to any corresponding historical index. (e.g., S&P 500® Total Return or Dow Jones Wilshire U.S. 5000 Total Market Index) is also disclosed. For example, the S&P 500® Total Return Index (the “S&P 500®”) is a market capitalization-weighted index of 500 widely held stocks often used as a proxy for the stock market. S&P Dow Jones chooses the member companies for the S&P 500® based on market size, liquidity, and industry group representation. Included are the common stocks of industrial, financial, utility, and transportation companies. The historical performance results of the S&P 500® (and those of or all indices) and the model results do not reflect the deduction of transaction and custodial charges, nor the deduction of an investment management fee, the incurrence of which would have the effect of decreasing indicated historical performance results. For example, the deduction combined annual advisory and transaction fees of 1.00% over a 10-year period would decrease a 10% gross return to an 8.9% net return. The S&P 500® is not an index into which an investor can directly invest. The historical S&P 500® performance results (and those of all other indices) are provided exclusively for comparison purposes only, so as to provide general comparative information to assist an individual in determining whether the performance of a specific portfolio or model meets, or continues to meet, his/her investment objective(s). A corresponding description of the other comparative indices, are available from CMG upon request. It should not be assumed that any CMG holdings will correspond directly to any such comparative index. The model and indices performance results do not reflect the impact of taxes. CMG portfolios may be more or less volatile than the reflective indices and/or models.
In the event that there has been a change in an individual’s investment objective or financial situation, he/she is encouraged to consult with his/her investment professional.
Written Disclosure Statement. CMG is an SEC-registered investment adviser located in King of Prussia, Pennsylvania. Stephen B. Blumenthal is CMG’s founder and CEO. Please note: The above views are those of CMG and its CEO, Stephen Blumenthal, and do not reflect those of any sub-advisor that CMG may engage to manage any CMG strategy. A copy of CMG’s current written disclosure statement discussing advisory services and fees is available upon request or via CMG’s internet web site at www.cmgwealth.com/disclosures.