June 28, 2019
By Steve Blumenthal
“You should invest more when the tickets in the bowl are in your favor.
You should invest less when they are against your favor and
what determines the mix of the tickets in the bowl largely where we stand in the cycle.”
– Howard Marks
Oaktree Capital and author of Mastering the Market Cycles
I promised you I’d conclude the Mauldin Strategic Investment Conference series this week but I simply need more time. Sharing my notes with you over the last six weeks has been fun for me, and my hope is to really stick the landing. In Part VII, I’ll summarize the important takeaways, share my thoughts and present several investment allocation ideas.
In the meantime, I want to share with you an important exchange of views between Ray Dalio and John Mauldin. Three weeks ago, Mauldin started a mini-series in the form of an open letter responding to a series of Ray Dalio’s essays. Ray is the founder of Bridgewater Associates. Bridgewater is the largest hedge fund in the world. No small thing. John’s kinda, sorta really poking the bear. And I like that because what I feel is needed on the national stage is a high level, thoughtful debate. We need to educate ourselves, our legislators and our central bankers. The train is racing down the tracks and it’s coming right at us, both here in the U.S. and in the rest of the world. It’s time. This from John:
Two weeks ago I started a mini-series in the form of an open letter responding to a series of essays by Ray Dalio, the founder of Bridgewater Associates. I wrote that he was kinda, sorta wrong in Why and How Capitalism Needs to Be Reformed, Parts 1 and 2 but really, really wrong in It’s Time to Look More Carefully at ‘Monetary Policy 3 (MP3)’ and ‘Modern Monetary Theory,’ in which he basically endorsed MMT.
If reader feedback is any indication, you are also passionate about this conversation. Last week’s letter generated many long, thoughtful reader comments. Clearly, it is not just Ray and I who are worried about the country’s future direction. I find that encouraging. A national conversation is precisely what we need in these serious times.
As noted, Ray has done us all a service by pointing out some rarely mentioned elephants in the room (some tinged with pink). We discuss various parts but seldom the entire creature. By that, I mean the rapidly growing potential for “progressive” control of both Congress and the White House. This stems from differences between haves and have-nots, between the protected and unprotected, combined with a desire to have government solve our society’s perceived ills.
Ray, in his healthy and balanced way, responded to Mauldin’s series of Ray Dalio is Kinda, Sorta, Really Wrong (Parts 1, 2 and 3) articles. It is Ray’s response that I share with you today.
What I find most helpful is the polite engagement and thoughtful discourse between Ray and John. This is the way forward… We can disagree and we can do it respectfully and through meaningful debate. We are hearing about the magical powers of MMT (Modern Monetary Theory), but magic sometimes comes with consequences.
We sit at the end of a long-term debt accumulation cycle. The last one occurred in the mid-1930s. The problem we face has happened before. We need to solve the problem and we will… we just don’t yet know how.
As Dalio said in his response, “Let’s unite behind the problem and the need to fix it.” Amen, brother Ray. Grab that coffee and find your favorite chair (hopefully a beach chair). Ray’s response is thoughtful, balanced and outstanding (a short, quick read). Click on the orange On My Radar button below and it will pop you through to the full post. I hope you enjoy this week’s post.
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Included in this week’s On My Radar:
- Ray Dalio: Clarifying What John Mauldin and I Agree and Disagree On About How Capitalism Is Working
- Trade Signals – Gold Breakout Impressive, Trend Signals Remain Green Across the Dashboard
- Personal Note
Ray Dalio: Clarifying What John Mauldin and I Agree and Disagree On About How Capitalism Is Working
Published in Forbes on June 24, 2019, by Ray Dalio.
Because I appreciate thoughtful discussions to try to get at what’s true and how best to deal with it, and because I respect John Mauldin’s thinking about economics, I am happy to explore what’s true about how well capitalism is working and what happens when interest rate cuts and quantitative easings don’t work.
John wrote his comments in response to Ray’s two articles, How and Why Capitalism Needs to Be Reformed and It’s Time to Look More Carefully at MP3 and MMT which are available at economicprinciples.org and on LinkedIn. The first piece was written in two parts and the last one in one part, so there are three parts in total that he refers to.
John summarized his view of them as follows: “I agreed with much of Part 1, with a few quibbles. Ditto for Part 2. But when I read the third piece, I found myself thinking, ‘Ray Dalio is really, really wrong.’ I am glad that we agreed on the most important thing, which is that our existing system is not producing the desired results of equal opportunities and that that’s both unfair and threatening to our well-being. To me that’s the most important thing, because if respected capitalists can agree on that, then we will be more likely to move on to explore sensible policies for dealing with that problem. Like John, I don’t want to quibble over the little thing he raises, which is about whether one defines capitalism to include or exclude the fiscal and monetary policies that are being used. While he would prefer to say that the problem is with policies, I described it as how the profit-making capitalist system is inadequately allocating resources. I’m perfectly happy to say that fiscal and monetary policies need to be reformed to allocate those resources better rather than to say that capitalism needs to be reformed. Let’s unite behind the problem and the need to fix it.
Of less importance, though still worth exploring, is our disagreement about MP3 and MMT. Before going into it I’d like to clarify something about my views about why and how capitalism needs to be reformed. Some people misconstrued my statement that “capitalism needs to be reformed” to mean that I don’t like capitalism. Lest there be any doubt, I am a capitalist who believes that both capitalism and equal opportunity are required for the American Dream to be a reality. What I’m saying is that the system is failing to deliver the desired equal opportunity piece so that we are risking the whole thing falling over unless the system is reformed. I encourage you to read my piece on this yourself to make your own assessment of the evidence and my logic rather than to listen to others’ assessments of it.
Regarding MP3 and MMT, my view is that central banks and central governments will have to coordinate fiscal and monetary policies, and central banks will have to monetize the resulting debts in ways that have similarities with MMT. That can sound like I’m in favor of MMT even though that is not true. Once again, to understand what I’m saying I urge you to read what I said in this article rather than other people’s interpretations of it.
John and I appear to disagree on what happens when the economy turns down and central banks’ are lowering interest rates and printing money to buy financial assets (i.e. quantitative easing) no longer work — i.e., when there is “pushing on a string.” As I explained in my piece, there’s nothing “modern” about Modern Monetary Theory. The “pushing on a string” dilemma has happened many times in history. Having studied these dilemmas in the past and thought a lot about the cause:effect relationships that determine how they work, it is my conclusion that central banks will have to turn to what I call Monetary Policy 3 (MP3) in the next downturn. MP3 follows Monetary Policy 1 (which is interest-rate-driven monetary policy), which continues until interest rate cuts can’t be big enough to do the trick. That’s when Monetary Policy 2 (which is central bank printing of money and buying financial assets) happens and continues until that doesn’t work anymore either. MP3 is fiscal and monetary policy working together with fiscal policy producing deficits that are monetized by the central bank. Modern Monetary Theory as it’s described is simply one version of many types of MP3. What I’m saying is that I believe that in the next downturn you will either see some form of MP3 from central banks or you will have terrible economic and social conditions.
To be clear, I’m not saying that such policies don’t have some undesirable consequences, and I don’t think that MMT is the best form of MP3. What I’m saying is that MP3 is the best of the bad alternatives and some form of it will likely happen, so one had better know how it works and how to deal with it. I welcome alternative descriptions of what will happen when both interest rates cuts and QE don’t work to stimulate the economy in the next significant downturn.
While a much more extensive discussion of MP3 and Modern Monetary Theory than can occur in this limited space is warranted, if you’re interested in my views of how the debt works and how all the big debt cycles over the last 100 years worked, you can get these things in my book Principles for Navigating Big Debt Crises which you can get free as a pdf download here or as a print book on Amazon.
[SB here: Interest rate cuts are expected next month. Odds are pointing to a 50 bps cut. The Fed is seeing that the global economy is turning down. First, we’ll get a series of cuts. My view is we are heading back to zero bound (we currently sit at 2.50%). Then we get QE3. It won’t have the desired effect. Can’t encourage over-leveraged borrowers to borrow more. Thus, no juice to the economy. I think Dalio is right… after that comes MP3.]
As Ray put it above:
MP3 is fiscal and monetary policy working together with fiscal policy producing deficits that are monetized by the central bank. Modern Monetary Theory as it’s described is simply one version of many types of MP3. What I’m saying is that I believe that in the next downturn you will either see some form of MP3 from central banks or you will have terrible economic and social conditions.
To be clear, I’m not saying that such policies don’t have some undesirable consequences, and I don’t think that MMT is the best form of MP3. What I’m saying is that MP3 is the best of the bad alternatives and some form of it will likely happen, so one had better know how it works and how to deal with it.
[By the way, if you are not reading Mauldin’s free weekly e-letter, you can sign up for it here. John is CMG’s Chief Economist and Co-portfolio Manager of the CMG Mauldin Smart Core Strategy. He is Chairman of Mauldin Economics, the publisher of “Thoughts from the Frontline.” John is a visionary thinker, a noted financial expert, a New York Times best-selling author, a pioneering online commentator and the publisher of one of the first publications to provide investors with free, unbiased information and guidance. I’m biased, of course… but he’s good. You can learn more about Mauldin here.]
Trade Signals – Gold Breakout Impressive, Trend Signals Remain Green Across the Dashboard
June 26, 2019
S&P 500 Index — 2,926
If you are a regular reader of Trade Signals, a quick “Notable This Week” summary follows immediately below.
If you are not familiar with Trade Signals, it is a dashboard summary of the overall trends in various markets: stocks, bonds, gold and we look at the state of the economy and I share with you my favorite monthly “recession probability” charts. Over the years, this weekly process has helped me steady my thinking around the major trends. For example, I have the fundamental view that the current bubble is in the debt markets (sovereign debt and corporate debt). I believe the next recession will provide you and me with an epic buying opportunity. I could be wrong, of course, but I believe the HY market may decline more than 60% in price. Yet with that view, the last two HY trend buy signals have been very rewarding. My point is “The trend is your friend” and given the late stage of the current cycle, the low yields, the low covenant quality of the debt and the record size of corporate debt, it is especially important to have a trading process to position on the right side of major trends. Also, I share a few different processes for the equity market trends, like the “Golden Cross,” which is a trend signal that triggers when the 50-day moving average trend line crosses above (buy) or below (sell) the 200-day moving average. All of the market gains since 1929 and since 1999 have come when the 50-day intermediate price trend was above the 200-day longer-term price trend. A nice way to manage against downside risk. Diversification is the key. It’s better to diversify to several different trading approaches as there are many that are quite good but none are perfect. Look for high probability processes and systems. You can find the most recent dashboard here.
Notable this week:
Catching my eye this week is the trend in “Margin Debt.” The chart below shows that current margin debt is $568.75 billion. The red arrows show select points in time when margin debt dropped below its six-month moving average trend line. Specifically, 2000, 2008 and today. The idea in terms of market impact is simple. If your brother has a $100,000 brokerage account and he leveraged up to buy more stock or borrow money from his account, that extra buying power helped to drive prices higher. Eventually, a high level of leverage is reached and when markets decline, margin calls become common and leveraged investors are forced to sell. As you see in the dashboard above, all of our trend indicators are bullish (green). Margin debt is simply an indication of investor leverage and, when the trend turns down, risk rises.
Source: Ned Davis Research, CMG
The breakout in gold is impressive (see far right in the next chart). Our short-term and intermediate-term gold indicators remain bullish.
Bonds too remain in an uptrend (prices up, yields down). HY has had a good move and remains in a buy signal. The Zweig Bond Model has again defied most analysts expectations for rising rates. It remains in a buy signal. Finally, investor sentiment is turning bullish. I suspect the rally ends when investor sentiment reaches extreme optimism.
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.
Click here for this week’s Trade Signals.
“Grit? What is it? I believe it’s driven by love. Inspired by vision and purpose.
Fueled by optimism and belief. Powered by faith and hope. Revived by resilience.
Kept alive by stubbornness. And if we are honest, it includes some fear of failure and desire to improve oneself.”
– Jon Gordon (@JonGordon11)
I’ll be in New York City on July 1 for meetings and a drink with Art Cashin, Mauldin and a few friends after the closing bell. I’m really looking forward to that. On Tuesday evening, July 2, Mauldin and I will host a dinner for accredited investors at 6:00 pm at Del Frisco’s in Rockefeller Center. We’ll be talking about John’s debate with Ray Dalio and our thoughts and ideas around investment positioning for the period we see ahead. Rory Riggs will also join us at the dinner. Rory is a biotech, pharma, healthcare and fin-tech expert. If you are an accredited investor or independent investment adviser and would like to attend, you can register here. Space is limited.
It’s hard to believe it is nearly July. I hope this note finds you taking some time off. I do enjoy the Fourth of July holiday. I’ll be home with Susan. A cookout is likely; though maybe we throw beach chairs in the car and head to the Jersey shore. I’m going to take next Thursday and Friday off so there will be no OMR post next week.
I’m making progress on pulling together my thoughts and investment ideas learned at the Mauldin conference. There was so much to digest. David Rosenberg, Howard Marks, Felix Zalauf, Dr. Lacy Hunt, Mark Yusko, Bill White, Carmen Reinhart, Louis Gave, Jim Mellon, Liz Ann Sonders and Kyle Bass. I will share my concluding thoughts with you on July 12. Do yourself a favor and put next year’s conference in the back of your mind. It truly is the best conference I attend each year.
I’m in LA on July 15 and San Francisco on July 16. Then back down to LA for more meetings. I will be flying west a day early to celebrate son Kyle’s 20th birthday.
Finally, a special shout-out to my new friend, Dr. Larry C. Larry invited me to his one-day member-guest golf outing in Brooklyn, Massachusetts. I flew up early Wednesday and the day was just perfect (except for our team score). Larry’s an avid golfer who spent years on the golf course with his son. I’ve mentioned golf with my kids from time to time over the years and how nice that time together was and continues to be. When the kids were growing up, it was sometimes hard to find that quiet downtime. Most times you talk, sometimes you just walk but you’re together. I’m grateful for the day this past week together. Larry, I really enjoyed being with you. Thank you!
With that, hope you make a new friend this weekend. Or reach out to an old friend you’ve been thinking about. Why not… Time goes by too fast. Let’s enjoy the ride.
Wishing you a great weekend and a Happy 4th of July.
Stephen B. Blumenthal
Executive Chairman & CIO
CMG Capital Management Group, Inc.
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Stephen Blumenthal founded CMG Capital Management Group in 1992 and serves today as its Executive Chairman and CIO. Steve authors a free weekly e-letter entitled, “On My Radar.” Steve shares his views on macroeconomic research, valuations, portfolio construction, asset allocation and risk management.
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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.
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