June 17, 2022
By Steve Blumenthal
“The risks of a debt bubble breaking and the rest of an equity bubble breaking have simply not been understood by our Federal Reserve since Paul Volcker. They are incredibly naive. They haven’t even got a clue. They’re not even interested in the idea. Bernanke said the US housing market has never declined. That it merely reflected a strong US economy. Alan Greenspan encouraging… etc, etc. That’s the Fed right through until today.
They don’t realize that playing was such fire. My second point, high levels of debt are just far too often seriously dangerous and should be, in general, a discouraged actively that should be one of the responsibilities of top management including the Fed.”
– Jeremy Grantham, co-founder and chief investment strategist of Grantham, Mayo, & van Otterloo (GMO)
Stagflation. “In economics, stagflation or recession-inflation is a situation in which the inflation rate is high, the economic growth rate slows, and unemployment remains steadily high.” Wikipedia
You may be looking at your gas and grocery bills with an immediate thought as to where you might cut back. The cutting-back decision is going on in millions of homes. Your and my spending is someone else’s income. A quick look at household debt in the U.S. and it’s easy to see how rising interest rates impact consumers’ pocketbooks. Mortgage rates above 6.50%? You can see how the economy will slow.
I’ve been writing for months that inflation is kryptonite to Fed policy since the actions needed to lower inflation, raising interest rates, will quickly destroy economic growth. The Fed is stuck between, as my father used to say, “a rock and a hard place.” On the one side is inflation and the other is the recession, we are going to get both. The most probable period ahead, described in a word, is stagflation. But chin up, from an investment perspective, there is much you can do. We’ll consider a few ideas today.
This week’s piece is broken into several sections. I begin with an excellent interview with Ray Dalio and Jeremy Grantham and encourage you to grab your sneakers, put your earbuds in, and head out for a nice walk. They discuss the current state of the economy/markets and share a few conceptual ideas on how they are investing. It’s timely and excellent. And, you’ll then find several links to resources I hope you find helpful, (further learning) on the endowment approach to investing in another section I share several ideas. “Investing Like Harvard and Yale “is worth the read. Finally, I share a few ideas we are seeing today and conclude with a personal note about the U.S. Open in Boston.
Grab that coffee and find your favorite chair. I hope you enjoy this week’s letter. Thanks for reading.
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Ray Dalio and Jeremy Grantham
The founders of Bridgewater and GMO discuss the big risks they’re watching, including inflationary pressures, political conflict, asset bubbles, and climate change — and what investors can do to protect themselves. The conversation is moderated by Jim Haskel, editor of the Daily Observations, and Alex Shahidi, co-CIO of Evoke Advisors, and is separated into two broad sections.
In Part 1, Ray and Jeremy cover the major risks they are tracking — including strong inflationary pressures, rising political conflict, and asset bubbles.
In Part 2, they talk about how investors can adjust their portfolios to prepare for these risks. Jeremy concludes the discussion by describing the threat that climate change and the overuse of natural resources pose to humanity, and the most promising solutions he sees to these problems.
Break out those walking shoes, plug in and click on the photo to start the video:
Endowment Investment Approach
Endowments strive to meet two chief objectives: First, they attempt to generate high enough returns to cover their yearly withdrawals, without dipping into their principals. Secondly, their goal is to preserve their principal. The best-performing endowments access alternative investments, long-short equity, select private credit, private credit, and venture capital. Their network of relationships gives them greater access to many crucial investment opportunities. Find yourself a network.
Following are two papers on an approach to investing.
- Investing Like the Harvard and Yale Endowment Funds – Research Paper 11-13-17, by Azlen and Zermati Frontier Investment Management
- The-Principles-Of-Endowment-Style-Investing_April-2021 by Koda Capital
IMPORTANT DISCLOSURE INFORMATION. INFORMATION IS FOR EDUCATIONAL PURPOSES ONLY. THE OPINIONS EXPRESSED ARE THOSE OF THE AUTHORS. INVESTING INVOLVES RISK. PAST PERFORMANCE DOES NOT GUARANTEE OR INDICATE FUTURE RESULTS. ADDITIONAL DISCLOSURES
Investment Implications and Ideas
Your job and my job as the stewards of capital is to grow and defend our wealth. How and where we decide to allocate our capital is important in terms of improving our family’s financial state and, importantly, using our resources to make the world a better place. Therefore, I believe we must think about the global financial markets in terms of how complex systems works. What are the inputs: monetary and fiscal policy, tax policy, geopolitics, trade, valuations, interest rates, currencies, and what do the push-pull of these factors mean in terms of global capital flows. Where do we sit in the cycle and what does this mean in terms of positioning your wealth?
The big picture to me is we sit at the end of a long-term debt cycle in the U.S. and the rest of the developed world. Implications range from extreme deflation to inflation and the outcome I believe is most probable over the coming decade, is a period of stagflation. Slow growth and inflation. It won’t be a straight line. Inflation will ebb and flow but will remain relatively persistent. Why? There is no good way out of the debt trap we are in and the response mechanisms of leadership (central bankers and elected leaders) will likely lead to more inflation. The other risk is deep deflation (debt defaults) and depression. The Fed is trying to middle these two challenges.
The end game in my view is some form of debt monetization. Print new dollars, buy the bonds, and hold on government’s balance sheets forever. We printed ~50% of all dollars ever printed in the history of the dollar in the last two years. And with Covid helicoptered much of that money directly into the system. Will the masses vote for the responsible leader advising us to tighten our belts? Take some intermediate-term pain for long-term gain, reduce social security and pension benefits and reduce medicare? And tax us more? Or will we vote for the magic modern monetary theorists (MMT)?
Understanding how complex systems work is not so easy. The MMT’ers will sound believable and after all who doesn’t want more sugar. Does the mass population understand the implications? I just don’t think so; thus, more sugar from the government until the markets sniff this out and we reach a crisis. Inflation is bringing us nearer that to a crisis point. We are in the early-to-middle innings of the sniffing-it-out process. More sugar means more inflation. Offsetting inflation will be a recession. So many companies have been living on debt and not profits. Long-term debt cycles eventually end. Too much debt is at the core of the trap we are in. MMT’ers will tell you the exit is easy. Your recent grocery bill will tell you it isn’t.
William White, former head of the Monetary and Economic Department at the Bank of International Settlements, shared his thoughts at the 2022SIC concluding, “My real worry on the downside is that it may be that the fragilities are so great at the moment that a moderate degree of tightening will, in fact, spark a downturn of such a magnitude that even if the Fed does back off, that there’s not much that can be done about it, that will have a downward momentum… that we really won’t be able to handle.” Bill is famous for flagging the wild behavior in the debt markets before the great financial crisis that hit in 2008.
If I had to guess the timing of The Great Reset (the restructuring of the debt and entitlement challenges), it is somewhere in the 2026 to 2030 window. Mauldin’s best guess is 2028. He coined the phrase so let’s lean toward his date. But really, there remain too many unknown and yet-to-be-determined inputs. What we can see is the snow piling up, but no one can really know what will cause the avalanche to begin. Yet, as it relates to our family’s wealth, there is much we can do.
Following Are A Few Ideas
Here are a few ideas. Let’s begin with the conceptual framework first. I want to make sure you know I’m speaking in general terms and not making a recommendation to you so I’ll avoid specific names in many cases, as some investments are private and for accredited investors only.
First, have a framework in which you define your approach to wealth management. In our family office, we call our approach “80% CORE / 20% EXPLORE.” As a general rule, if we diversify 80% of our wealth to CORE investments our goal is to grow the 80% back to 100% in approximately four to five years. To do so, modest annualized returns in the mid-single digits with low drawdown are needed. Of course, all investing involves risk so no guarantees can be made.
With CORE wealth focused on modest returns in safer investments, this then enables EXPLORE wealth where we seek asymmetric risk on returns. In the Explore bucket, we are looking for aggressive risk-on investment opportunities that have the potential to significantly create wealth. In general, it looks like this:
80% CORE: The objective here is to build a portfolio that thoughtfully diversifies to a portfolio of well collateralized short-term private credit yielding in the mid-to-high single digits, select high & growing dividend stocks, hedged equity exposure, uncorrelated alternative trading strategies, diversified private equity, select real assets (real estate, farmland, infrastructure, etc.), absolute return focused investment strategies and gold.
20% EXPLORE: The objective here is an aggressive ‘risk on’ allocation to a targeted selection of approximately 10 to 30 high conviction bets. Here we are thinking about aggressive upside opportunities in companies that have an edge and can improve our way of life: Considers select venture capital, direct investments in late-stage private equity, biotechnology, agriculture, gene editing, disruptive technologies, growth equity, oil & gas, crypto, and commodities.
CORE ideas (general overview):
Short-term Private Credit – Following are examples of offerings we have participated in within our multi-family office. Certain offerings are limited to investors with a minimum net worth of $1 million. This is not an offer or recommendation to buy or sell any security. Certain offerings are made by private placement memorandum only. Review prospectuses closely.
- A pharmaceutical royalty-backed short-term lending fund. Approximately 7% yield paid semi-annually with a 9% targeted internal rate of return over a three to five years period. The royalty rights are the collateral. Loans are tied to a base lending rate plus a spread. For accredited investors only.
- A senior-secured floating-rate direct-to-business lending fund. The fund is broadly diversified by issuer and industry. An approximate 7% yield is paid quarterly with an 8% targeted internal rate of return. Banks don’t generally provide capital to this space because of regulatory/structural changes in banking. Former executives at Blackstone, Goldman Sacs, and KKR. For accredited investors only.
- A real estate debt fund. Custom financing on opportunistic and distressed opportunities which offer defensive credit characteristics and high current income. Think rescue capital to borrowers the what the fund managers believe to be strong risk-adjusted returns. The fund seeks low volatility and high current income, with a targeted 10% net distribution yield to investors. Experienced institutional firm. 10% total return since inception in 2006. Two-year minimum hold, quarterly liquidity. For accredited investors only.
- A first lean short-term construction lending fund that targets short-duration (12-18 months) loans that are senior secured, in the first lien position, and fully collateralized by high-quality income-producing properties. 6% current cash yield, paid monthly. The fund is targeting a net 10% to 12% internal rate of return to investors. There is an 8% annualized preferred return objective for investors. After which, there is a sharing in subsequent returns between investors and the fund. Three-year minimum holding period, then quarterly liquidity.
- A specialty trade finance credit fund that underwrites a particular type of short-duration (typically 3 to 6 months) credit risk that triggers only if the creditor files for Chapter 11 (bankruptcy). A manufacturer sells goods to a firm like Macy’s. Should Macy’s file Chapter 11 before they pay the vendor, the vendor, and its entire ecosystem is at risk (ie: its business, its bankers, its suppliers, and the firms it hired to transport the goods to Macy’s). A bank or a shipping company may require it to ensure the company will be paid by Macy’s. This fund enters into a guaranteed contract with the manufacturer that that should Macy’s file for Chapter 11, the manufacturer can “put” its receivable to the fund and for that, the fund earns a fee. The targeted internal rate of return is mid-to-high teens paid out to investors on a quarterly basis. For accredited investors only.
Trading Strategies – Following are a few examples of strategies we utilize or have utilized within our multi-family office.
- A multi-strategy, multi-manager hedge fund focused on global investment trading strategies. The objective is to deliver positive returns in all sorts of market environments trading in credit, event-driven, long-short equity, macro, and quantitative strategies. Investment history dates back to 2008 with low-to-mid-teen investor returns and good downside risk management as measured by low drawdown. Capital Allocation, Risk Management & Talent are the cornerstones of the funds business. For accredited investors only.
- A multi-strategy multi-manager low volatility investment approach with capital allocated to numerous underlying trading teams. Relative value fundamental equity, quantitative trading strategies, quantitative trading, equity arbitrage, and fixed income trading strategies. The investment history dates back to the mid-1990s with low-to-mid-teens annualized returns. The worst 12-month performance was better than -4%. For accredited investors only.
- A U.S. Total Market Hedged ETF. A non-cap weighted ETF with broad-based exposure to the U.S. total stock market with a process that hedges downside risk exposure with stock options. There are a number of hedged ETFs to consider. Our focus is on a select few. For all investors.
- The Greenrock Research High and Growing Dividends Stock Strategy. A liquid strategy that invests in publically traded stocks with a focus on stocks that pay a high current dividend and have a history of growing or increasing their dividends. Due to the emphasis on dividends, this portfolio produces returns that are generally less volatile than the broad equity market and seeks higher returns over a full market cycle. For all investors.
- Broadly diversified core private equity exposure in a single allocation managed by a global leader in private equity. The funds objective is to source and execute the best possible private market opportunities with exposure year-end 2021 exposure of 66% North America, 29% Europe, and 5% Asia-Pacific. Long-standing reputation with 40 years of investment experience in private markets. A staff of nearly 400 employees globally of which 115 are investment professionals. The objective is to generate low-to-mid teens annualized returns with low drawdowns. For accredited investors only.
- 3Edge Total Return Strategy. A global multi-asset investment firm seeking to minimize the volatility of an all-equity portfolio. The management team combines science with sound judgment and long-term practical experience. Rather than approach their research from a traditional finance background, the research team comes from mathematics, physics, and engineering backgrounds. A quant-based total return investment process that utilizes ETFs to express their investment views. Return objectives in the mid-to-high single digits with low drawdowns. An alternative to traditional bond investing. For all investors.
- Risk-on / risk-off trend-based trading strategies. Rules-based Trend following strategies don’t predict; they react to what price is signaling in terms of supply and demand. The long-term objective of trend-following is to participate in secular bull market gains while minimizing the losses associated with secular bear market declines. Risk managed equity, fixed income, and gold trend following trading strategies. For all investors.
EXPLORE ideas (general overview):
- A leading-edge biotech agriculture company focused on nature-identical non-GMO gene editing. Leaders in a new class of breeding techniques based on precision gene editing that helps seed companies produce seeds with better traits that help farmers tackle the challenges presented by the environment such as disease, weeds, and pests in a more sustainable way with fewer chemicals, less fuel, and less manpower. For accredited investors only.
- Private investment in a company aiming to become the first company in the world to develop a novel drug that repairs the dysfunctional gut-brain axis in patients with neurodegenerative diseases such as Parkinson’s Disease, Dementia, and Alzheimer’s. For accredited investors only.
- Venture Capital – fund investments and co-investment opportunities in early, mid, and late-stage VC. Specific focus on health care, biotech, and AI technology sourced through select relationships. For accredited investors only.
- Kingsland Transformational Growth Strategy. Transformational growth is rare in the investment world but occurs when a new product or service is materially superior to what it is replacing. It manifests itself when discovery leads to a change in human behavior and rapid adoption of a new way of doing things by using a product, technology, or service. The Kingsland Transformational Growth Strategy seeks to invest in companies with disruptive technologies that will change the way we live. High conviction stock portfolio.
- The Gould Tactical Concentrated Small Cap Growth Equity strategy is designed to capture the excess return that is typically embedded in just the top 10-20 high conviction stock holdings of a well-managed traditional small-cap growth portfolio. A tactical investment strategy that follows William O’Neil’s CANSLIM investment process seeking to invest in small-cap growth stocks using a combination of fundamental and technical analysis techniques. CANSLIM is a bullish strategy for fast markets, with the goal to invest in high-growth stocks at an early stage before they are recognized by institutional funds.
- ARK Invest Disruptive Technology Portfolio. Catherine Wood launched ARK Invest in 2012 because she believed disruptive technology was a necessary investment category that would contribute to the overall success of investor portfolios. Today, ARK comprises a head of research, ten analysts, and Wood herself, all of whom scour numerous data sources for a glimpse into how the world will look in the coming years. Their goal is to find companies whose disruptive technologies will make products and services better, faster, and cheaper. ARK Invest has identified five platforms with the potential to change everything: • Artificial Intelligence • DNA Sequencing • Robotics • Energy Storage • Blockchain Technology. (quick side note: everyone loved the story, tracked their stock picks, and herded into the same few names. Today (June 2022), Wood’s main ETF is down 75% and sentiment has switched from love to something less than love. Our view has been to be patient and seek a ‘buy when everyone else is selling moment.” If you follow OMR and Trade Signals, you are up to speed with our market view. “Buy when there is blood in the streets,” is the old saying. We are now, very much interested in this high conviction portfolio of ~ 11 stocks.
Summary: From our way of thinking, building a CORE portfolio is similar to how an endowment approaches investing. It is important to have access to a network that enables you to source ideas and a team that has the research experience to do the necessary due diligence. Broad diversification helps to further mitigate your risk. The idea here is to give you a feel for how to achieve mid-to-high single-digit returns and grow your 80% CORE back to 100% in four to five years. A 7% annualized return gets you back to even in less than four years and a 4% annualized return gets you back to even in just over five years. Once you’ve achieved a well-built and diversified CORE portfolio, we believe in going aggressively risk-on with the EXPLORE. Seek radically risk on return type investments into opportunities you believe have the ability to achieve 10x returns in ten years. Of course, no guarantees can be made. If your 20% EXPLORE bucket is made up of ten different investments with a 2% allocation to each and one turns out to be zero, you are down 2% on the overall portfolio. The EXPLORE portion of an investment game plan is about creating meaningful wealth.
Important note for small investors: One of the challenges for small investors is limited access to investments due to a number of factors. One of those factors is net worth. If you are worth less than $1 million, then you are not considered an accredited investor. Another factor is the larger minimum investments certain funds require. That limits what you can do but you aren’t entirely out of luck.
There are closed-end funds, interval funds, and ETFs that can help you build your CORE investment bucket and there are ways to build your EXPLORE bucket with select ETFs and publicly traded stocks. Everyone loved Cathie Wood and now she is about as unloved as it gets in this business. The overall idea is to get 80% CORE back to 100% and with your CORE wealth defended, it enables the EXPLORE. Of course, you may be more risk-on and go 70% CORE, 30% EXPLORE, or 50/50. Talk to your advisor and come up with a game plan that is suitable for your needs, goals, and time horizon.
If you are a small investor, here is a resource to learn more. Blackrock, one of the world’s largest ETF investment firms, believes investors can replicate an endowment model approach with ETFs. Small investors can build CORE portfolios utilizing some of the trading strategies on the CMG Mauldin Platform and/or learn more from firms such as Blackrock by clicking here.
If you are an accredited high-net-worth investor and would like to dive deeper into specific investment opportunities, you can email me at Blumenthal@cmgwealth.com.
NOT A RECOMMENDATION. FOR DISCUSSION/EDUCATIONAL PURPOSES ONLY. Please note that nothing I write is a recommendation for you to buy or sell any security. Much depends on your age, needs, and time horizon. If you are young, keep dollar-cost averaging and party on. Double up when markets dislocate as they always do during an economic recession. If you are a pre-retiree or retiree, there are certain periods when you must defend your wealth. The good news is it is not hard to do. Talk with your advisor(s), have a game plan, and stick to your plan. The information in this email and OMR post is for discussion purposes only, may not be relied upon in evaluating the merits of participating in any of the funds, and is qualified in its entirety by the information contained in each of the fund’s private placement memorandum’s and subscription agreements. All investing, including ideas referenced in this email and OMR post, involve significant risks and investors should review the “Risk Factors” specified in each fund’s private placement memorandum. The actual performance may differ materially from those reflected or contemplated in this letter.
Trade Signals: Recession Is On The Horizon
June 16, 2022
Notable this week:
Some color on the Fed from our friends at WallachBeth,
“Equity markets rallied hard after the Fed decision at 2 pm (Wednesday June 15, 2022) with the S&P closing around 1.5% higher while tech outperformed as the Nasdaq rose 2.5%, halting a five-day rout for the S&P. In the post rate announcement press conference, Fed Chair Powell said that these outsize rate hikes will be “rare” while the Fed attempts to fight inflation after the Fed raised rates by 75bps at this meeting, the biggest rate hike since 1994. Powell did say that Fed officials could move by another 75bps again next month or possibly 50bps, but he also said that he currently sees no slowdown in the broader economy while the federal funds rate is 1.5 to 1.75% with the rate projected to raise to 3.4% by the end of the year. The Fed also stated it will shrink its balance sheet by $47.5B per month and step that reduction up to $95B a month in September.”
Recession risk is rising. An inverted 2’s – 10’s yield curve has predicted the past seven recessions.
- The 1-year Treasury yield is 3.15%
- The 2-year Treasury yield is 3.35%
- The 10-year Treasury yield is at 3.44%
The Dashboard follows next. More red than green.
Click HERE to see the Dashboard of Indicators and all the updated charts in Wednesday’s Trade Signals post.
Not a recommendation for you to buy or sell any security. For information purposes only. Please talk with your advisor about needs, goals, time horizon, and risk tolerances.
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Personal Note – The U.S. Open and Happy Father’s Day
What a week. I spent Wednesday and Thursday in Boston and felt like a kid in a candy store. On Wednesday, it was 18-holes at Essex Country Club located on Boston’s North Shore, approximately 30 miles from Boston. You may have watched the movie, Manchester By the Sea. That is where Essex Country Club is located. What a beautiful area. My new favorite Boston Hotel is called the Canopy by Hilton. A short walk to some of the best Italian restaurants anywhere. We had dinner at Mamma Maria’s. The Lobster Ravioli was fantastic. And yes – red wine… an Italian Toscan Bourdeau. Grown-up candy indeed!
Donald Ross designed the eighteen-hole golf course in 1917. Pictured is Donald Ross’s house. A wow for golf enthusiasts. A perfect 71-degree clear New England day.
Steve, Chuck and Bob
18th tee box with the Essex Clubhouse in the background: Chuck, Max (our host), Steve and Bob
I woke early on Thursday to finish updating Trade Signals and enjoyed a lobster omelet prior to our Uber ride to day one of the U.S. Open at The Country Club. In Boston – more lobster! And it didn’t disappoint.
Good friend Dr. C was located just under the TV tower at hole #10. He and his son were updating the live stats for each player on what looked like an iPad. Did the player reach the green, distance from the hole, number of puts, birdie, par, bogie, or worse? Other volunteers sat along near the landing areas and recorded various data. Hat’s off to Larry and Sam. A six-hour shift that looked to require great attention. I spent some time watching the golfers from behind the green and walked the course. As I write this post, there are four leaders at -4 and Colin Morikawa is one of them. Following is a photo of the prize they are after.
Steve with the U.S. Open Trophy – I so wanted to lift up the trophy.
We walked the entire course and circled back to several favorite spots. Some of the LIV cross-over players took some heat from the fans. I’m not sure you are following the drama but more than a few are upset with players they feel are selling out for Saudi money. All of the players who signed with LIV played their round with police escorts. Of course, political tensions are high between our two countries. To me it is not a PGA vs. LIV thing, it’s more of a are we dealing with a good partner thing. I’ll duck away from touching this one anymore (ultimately my opinion adds up to a great big zero in the overall equation anyway). I do like competition and maybe this will up the pay for the many players in the PGA. Ultimately, everyone has the right to make what they feel is the best decision for themselves. It is going to be interesting to watch how this story plays out.
Back to the U.S. Open. I have a particular interest in Collin Morikawa, Cam Smith, Matt Fitzpatrick, and Will Zalatoris. A bit of a risk-managed probability-based trading strategy… Let’s just leave it at that. As I write this post, there are two leaders at -5 and Collin Morikawa is one of them through 10-holes today (day two of the tournament). Following is one last photo to share. This is a picture behind the 10th green looking back down the fairway. Notice Sergio Garcia on the left and the wild turkey walking between him and Kevin Na.
10th Green at The Country Club
I’ve got a lot of catching up to do so the plan is to work tomorrow. I’m feeling a bit of a candy hangover. Boy was it a fun two days in Boston.
Father’s Day is Sunday and I want to pre-thank my kids for the U.S. Open Belt and golf vest with the TCC squirrel logo on them. I’ll be thinking about my father with fond thoughts on Sunday as I watch the conclusion of this year’s U.S. Open. Would love to have him take a look at my short game. He was a great coach and a great father. I sure do miss him.
Best to you and your old man.
Wishing you a wonderful Father’s Day!
Stephen B. Blumenthal
Executive Chairman & CIO
CMG Capital Management Group, Inc.