November 8, 2019
By Steve Blumenthal
“In a world where growth is meager and monetary policy less effective,
governments will have a much greater effect.”
– Joe Kalish
Chief Global Macro Strategist, Ned David Research
On my way into Philadelphia for a breakfast meeting yesterday, I listened to venture capitalist David Rubenstein interview Ray Dalio. Ray talked openly about his early years as a hedge fund manager and how he totally blew it back in in 1982. He had to let eight employees go and borrow $4,000 from his musician father in order to pay the bills and feed his family.
Though it was painful at the time, he reflects on the experience fondly. Losing made him seek out bright people who saw things differently than he did. The idea was this: together, they could rigorously debate ideas, arrive at the best answer, and ultimately improve the win rate. And win he did, in part because he recognized something crucial about investing: What matters most is avoiding the really big mistakes.
Think back to 1984—if you’re old enough to remember it, that is. Could you have imagined having the ability to access pretty much any piece of information out there—instantly—from the palm of your hand? The internet— what’s the internet?
I clicked and listened to the Ray Dalio interview while I drove to my breakfast meeting. Rubenstein asked the questions, Dalio answered. The video played on my phone and the audio streamed through my car’s speakers. It was a far cry from that same trek years ago, suburb to city. Back then, I would leverage my downtime to make a few calls, that big fat cell phone pressed to my ear. You may have had one too. Kids, imagine this thing—a communication device nearly the size of your forearm—up against your head. My manager at Merrill Lynch loved it. My friends thought I looked stupid (my friends were right).
Thanks to modern technology, traffic is less stressful and downtime is more interesting. Rubenstein/Dalio: one of the great private equity investors interviewing one of the great investment managers. You’ll find the interview plus two more below.
In short, Dalio believes we are in a different place than we were in 2007. He said that 12 years ago, the problem was easy for him to see and position for. He made a lot of money when others didn’t. This time, it looks less like a crash and more like a gradual squeeze. We have to deal with a lot of a certain type of debt. There is the problem with pension liabilities and health care liabilities. We’ve made a lot of promises, and as we struggle to keep them, we’ll feel the grip tighten gradually. He says that when monetary policy can no longer be effective (with rates reaching zero and even going negative in parts of the world), the Fed will have to do something different.
Dalio thinks we will monetize the debt: print new money, buy the debt, and let it evaporate away on the government’s books. (For more on this, see last week’s On My Radar: We Will Burn the Debt.) He also believes we will see increases in spending (government fiscal policy). This, of course, remains to be seen. How it is going to come about and what we spend the money on will be hotly debated, with extreme views on both sides. A trillion-dollar print and make America’s infrastructure great again. Aging demographics? Print and make America’s police, fire, and school pension systems great again. Social security, health care, print, print… “I Want My MTV.”
Now look at them yo-yo’s, that’s the way you do it
You play the guitar on the MTV
That ain’t workin’ that’s the way you do it
Money for nothin’ and your chicks for free
Now that ain’t workin’ that’s the way you do it
“Money For Nothing” by Dire Straits (1985)
We just don’t yet know how any of this will play out. We don’t yet know who will lead. We don’t know who will get big fat kisses, and we don’t yet know the unintended consequences of the decisions. It depends on who gets into power and their abilities to coach and guide us forward. It will take time to play out. A slow squeeze indeed.
Early Thursday morning, I attended a breakfast presentation and discussion with Joe Kalish, Ned Davis Research’s Chief Global Macro Strategist. Joining the meeting were other investment analysts and money managers—all NDR clients. Joe hit on a few points that immediately took me back to the Rubenstein/Dalio discussion, especially when Joe shared his “10 Rules of Research.” Pay particular attention to rule #10:
- Be objective
- Be disciplined
- Be flexible (and humble)
- Be risk averse
- Don’t fight the tape (market trend)
- Don’t fight the Fed
- Beware of the crowd at extremes
- Those who don’t study history are condemned to repeat its mistakes
- Apply money management rules: primarily cut your losses and let your profits run
- Don’t fight the government (e.g., fiscal policy)
Rule #10 is new to Joe’s list and it perfectly captures what Dalio is saying about debt monetization and coming fiscal spending: the slow squeeze. Since we don’t yet know how we are going to solve for it, let’s add rule #10 to our list. Don’t overlook rule #9 either—it will play an important role, given where we sit in the market cycle.
“In a world where growth is meager and monetary policy less effective, governments will have a much greater effect.”
“Ugh,” you say. Me too. Strap in.
Go grab a coffee and click on the orange On My Radar button to continue reading. You’ll find a quick summary of my takeaways from the NDR breakfast meeting, as well as what I believe to be two of the most important signal charts to help us navigate the period ahead. Both are leading recession indicators and one of them has served me since I formed CMG in the early 1990s. Finally, I’ve got a personal story about coaching—and a moment of real pride—to share.
In your favorite chair? Read on…
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Included in this week’s On My Radar:
- Breakfast Notes
- Two of the Most Important Charts to Keep On Your Radar
- Trade Signals – Recession Update (No Current Sign of U.S. Recession Next Six Months)
- Personal Note – My Favorite Coach
While I don’t agree with all that NDR’s Chief Global Macro Strategist Joe Kalish has to say, I really like the way he thinks. It’s balanced. And he may be right and I wrong; thus, the importance of dialogue.
Here are some general takeaways:
- Joe believes there’s no sign of U.S. recession ahead. Of his 10 favorite recession indicators, only one—CEO Confidence—is flashing a warning. According to Joe, we are not in a recession, but if there is a downward shock to the economy we are not in great shape to deal with it.
- He puts less weight on the inverted yield curve (which I disagree with) and believes the market is pricing in one more rate cut, with a 25% chance of recession in the next 12 months. If recession happens, rates go to zero.
- Inflation is ticking higher and has surprised to the upside, but it will take a prolonged period of higher inflation to move the Fed. (I agree.) Keep a close eye on this.
- He believes the Fed is on hold for six to 12 months. (I agree.)
- There is a good chance the long-term bond market rally (which began in the early 1980’s) has ended. He suggested, “Maybe we are done.” (I think we need to start thinking about that dynamic.)
- Expect low economic growth. Perhaps 1.9% GDP next year. (I agree.)
- Joe said that capital flows are leaving the U.S. and going back to Europe. (I’m not sure I agree with this. It’s counter to the argument I made in last week’s OMR. I believe a sovereign debt crisis begins in Europe and capital will be safer here. Joe is going to send me the NDR data he looks at. I’ll share it with you if I am allowed to do so. I didn’t know they had that data and I’m really looking forward to more charts.)
- Joe suggested that currency hedging is costly, despite the higher U.S. yields, due to the cost of hedging itself.
- Wages are pressuring corporate profit margins. This is a concern for earnings. (Agreed, especially given how far prices are above trend. Yet for now the beat goes on.)
- Corporate credit risk is big concern. (I address that in the next section but, in short, the risk is rising in HY and in Bank Loan Funds. Related liquidity risks will present in crisis, too.)
- Joe likes stocks over bonds. (I agree—overweight stocks.) He noted the world has changed and asked, “Shouldn’t we have a higher P/E if interest rates are low (all securities are priced relative to those rates, making them the discount factor)?” Bonds yields have to matter for valuations. (I agree… and high and growing dividend payers look attractive relative to 1.70% yielding Treasury notes.)
- He suggested we pay close attention to investor sentiment, as it has done a good job at calling the swings in the market this year. (As you’ll see in Trade Signals, investor sentiment is currently signaling “Extreme Optimism.” This suggests caution.)
- Joe talked about how negative interest rates destroy the “time value of money” and encourages speculation. (I agree. The plan is backfiring. Because of the aged demographics in the developed world, savers are saving even more to compensate for their lack of yield. Low rates are not encouraging individuals to go deeper into debt to spend. Instead, people are saving even more and spending less, and that is not good for economic growth (recall that 70% of US GDP comes from consumer spending). The global central bankers are stimulating the exact thing they are trying to avoid: more saving and less spending.)
- Growth in China is slowing and will remain slow. They had been the globe’s economic engine. This is not good news, particularly for many emerging market (EM) countries. EM does not do well when there is no global engine of growth. And if we (that aged population) don’t want to buy stuff, the EM won’t grow. Recall that much of what we buy is manufactured in EM countries. (I agree. Continue to avoid or tactically trade those exposures—and favor U.S. exposures.)
What really struck me from our discussions was the new rule Joe added to his list, especially given my early morning listen to the Rubenstein/Dalio interview and my writings over the last year or so about MMT (Modern Monetary Theory). Rule #10: Don’t fight governments (fiscal spending). Like me, John Mauldin, many of my friends at Camp Kotok, Dalio, and others, Joe believes something more is in the cards.
Two of the Most Important Charts to Keep On Your Radar
Long-time readers know I’ve traded the intermediate-term trends in the High Yield Junk Bond market since the early 1990’s. From experience I can share that down trends in HY lead to down trends in the stock market, which lead to down trends in the economy. The really big investment mistakes come during economic recessions, so it is important from a money management perspective to avoid the big dislocations that recessions tend to bring.
This first chart plots the price trend of a large and popular high yield mutual fund. The solid green line is a simple 50-day moving average price line. The idea is to invest when the price trend is up (above the green line) and move to Treasurys or cash when the price trend is down (below the green line). In particular, focus in on 2000-2001 and 2007-2009.
While not all crosses work, a number of false signals, the end result is worth the effort. The most meaningful signals occur when price is far above trend (today’s condition) or far below trend (tomorrow’s next great opportunity).
Now, where I think we can really zero in on timing is to combine what price is telling us (above data) with lending conditions. When the lending conditions turn from “Favorable” to “Unfavorable,” that’s when high risk borrowers default. Or as Warren Buffett says, when the tide goes out we’ll see who’s swimming naked. And this time around a lot of swimmers have left their swimsuits on the beach.
Here is how you read the chart:
- Note the three red down arrows. They mark the times when the NDR Credit Conditions Index dropped below a reading of 50 (horizontal green dotted line in the lower section of the chart).
- The grey bars indicate periods of recession.
- Finally, note the green “We are Here” arrow.
- Bottom line: Nothing to worry about at this moment.
With both HY in an uptrend and lending conditions “Favorable” do go into the weekend with ease and take comfort in knowing there are things you can do to cover your backside.
As you’ll see in the next section, the Trade Signals remain green. Do click through (see link in the TS section) if you haven’t before. I share my favorite technical signals.
Trade Signals – Recession Update (No Current Sign of U.S. Recession Next Six Months)
November 6, 2019
S&P 500 Index — 3,076
Notable this week:
The monthly recession watch charts are updated below. The equity market technical trend indicators remain bullish. Investor sentiment, both short-term and intermediate-term, is showing extreme investor optimism. Such readings are historically short-term bearish for equities and suggest caution. The Zweig Bond Model remains bullish, the CMG Managed HY Bond Indicator is bullish and the gold trend indicator is bullish.
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.
Personal Note – My Favorite Coach
The ride home from Susan and Kieran’s high school soccer playoff game was a long one. The Malvern Prep Friars had been ahead 2-1, with less than two minutes to go. But a trip from behind foul led to a direct kick in front of the goal. The Friars’ goalie, standing at a tall 6’3,” tipped the shot away. With 1:30 left on the clock, the resulting corner kick went to the far post and the opponent headed it in. Tied 2-2. After two five-minute overtime periods, the game came down to penalty kicks. The good guys lost. A nail-biter, and so fun to watch.
I reflected on the long path we’ve been on with our six kids (three from my former marriage and three from Susan’s) and how sports has played such an important role in their growth. Kieran is the youngest and will be headed to college next year. I loved watching all of our kids play, and sadly the end of those days is near. But Susan will always be my favorite coach.
While I was writing this morning, my phone vibrated. Susan was sitting in her favorite chair next to me. She had humbly texted me a link to an article about her. What a nice surprise.
MALVERN — Susan Barr calls her team together for a postgame huddle. It’s early October, and Malvern Prep had just lost a 1-0 decision to Haverford School, a tight game in keeping with the Inter-Ac’s usual parity and density of skilled players.
Her short blonde hair under a hat, Barr directs her intense coach’s stare at the huddle as she runs through talking points, illustrating things that went well, highlighting areas for improvement, lauding the team’s fight.
There’s little in the postgame confab, short of uniform color, to differentiate it from the one the Fords conduct at the other end of the field or from any of the other high school squad in the area. To Barr, it’s just a coach convening her players.
From the outside, though, something is notably different: Barr is one of a select number of women coaching boys/men’s soccer scholastically in the United States. Her qualifications as a coach and knowledge of the game make her vastly qualified. But the prevailing demographics suggest that for many other qualified women in her profession, such facts don’t always win out.
Barr insists that being hired to coach a boys team — even at a centuries-old, all-boys school like Malvern Prep — was a “non-event” back in the summer, when she became the first female varsity coach in the school’s history. Gender wasn’t a consideration: She saw a soccer opportunity, with all its complexities, and like countless others in her long career, she jumped at it. And she’s reticent to have her role serve as anything more than a coach seeking the next challenge in soccer.
“I think for the longest time, the last thing I wanted to be was any kind of representative for equality within the sport,” Barr said recently. “I was just focused on my own development to be honest. I think now that I’ve been doing this for a long time, that I’m older, I realize that I probably could break down some of those barriers that are there just by being present.
“It’s not something I want to talk about, but just by being here and being responsible and being good at my job, hopefully that lends itself to that. I love a challenge, so where else do you want to do this but an all-boys school where athletics is a big part of who they are?”
When Malvern found itself needing a coach in the spring, Barr stepped in to help players, including youngest son Kieran, keep fit in the offseason. She’s familiar with the school’s mission as a parent dating to when her eldest son played there.
It made for a perfect marriage on and off the field.
“She’s been a fantastic example for the kids,” said Malvern athletic director Jim Stewart, who made Barr his first coaching hire. “Her coaching ability is extraordinary. What she’s been able to put together with these guys, even though their record is still under .500, what she’s been able to put together and for the most part keep their heads in it, has been really amazing to watch.”
The article talks about the gender barrier in coaching. Susan has played an important role in breaking that down, but to her, it’s about developing players and helping young people grow through the lens of sports more than anything else.
The article continued, “The Friars have had a tough go of it this year, with a young team that has won just four games in a league stocked with talent. But Stewart raves about the job that Barr has done.
Barr has managed a number of challenges, and a gender divide is low on that list. (The biggest issue? Sending an assistant to fetch guys from the locker room.) For one, moving from club to high school is a different animal, given the holistic scope for four long months, a nearly full-time job to coach varsity and managed three other levels in the program. While this wasn’t the intended destination of her coaching journey per se, Barr’s long lens of experience has helped — her poise as a well-respected coaching fixture, her connections for recruiting and the wisdom of a mother who’s cared for students at his level.
All those far outweigh what locker room she can go in. And they mean she can focus on why she took the job: To teach through soccer.
‘We’ve never talked about’ the gender question with her players, Barr said. ‘It was pretty much, ‘let’s go, it’s time to get down to business, we have a lot of work to do. … I think they appreciate having someone that’s qualified and that cares about them.’”
This weekend’s line-up is looking good. The Friars’ final game is tomorrow and the team banquet is Sunday evening. Switching gears, son Matthew is coming home for the weekend and our Penn State football team is up against undefeated Minnesota Saturday at noon. A win will make next week’s Nittany Lions vs. Ohio State the deciding game for the national title playoff spot. Fingers really, really crossed. And maybe some golf with Matt on Sunday… 54 degrees and sunny. Fun times.
Thanks for reading. Wishing you a fun weekend and great week ahead.
Stephen B. Blumenthal
Executive Chairman & CIO
CMG Capital Management Group, Inc.
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.
Click here to receive his free weekly e-letter.
Follow Steve on Twitter @SBlumenthalCMG and LinkedIn.
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