May 13, 2016
By Steve Blumenthal
“Invest in good companies, don’t use leverage, invest in liquid investments, don’t do private deals and light a candle and pray for a positive outcome.”
-Leon Cooperman, Omega
“Debt drains away vital resources from economic growth. Fighting a debt crisis with more debt is doomed to failure, yet that is not only what global central banks did during the crisis but long after markets stabilized (though the crisis never truly ended, just slowed). This was an epic policy failure that continues today.”
-Michael Lewitt, The Credit Strategist
Speaker Boehner stepped to the stage for a one-on-one discussion with Democratic activist Steven Rattner. Rattner didn’t hold back. Private equity great David Rubenstein sat with Robert Rubin and Larry Summers. “What are the most significant risks you see?”
I arrived home late last evening from the SALT Conference in Las Vegas. A quick in and out to listen to Michael Bloomberg, Leon Cooperman, Paul Brewer, Kyle Bass, T. Boone Pickens, Sam Zell and Ken Griffin, to name just a few, share their thinking on fiscal policy, central banks and investment implications.
Promising you a summary of my notes, let’s waste no time and jump in. I hope to story this for you in a way that has some flow but hey, it was Vegas and that plane ride home was a bit longer and choppier than hoped – this morning’s coffee may not kick in in time to clear the few extra cobwebs.
You’ll find a consistent negative investment theme on China, thoughts on Fed policy and market illiquidity. Additionally, a few investment ideas were shared. Ok, here we go:
Private equity great, David Rubenstein (Co-Founder & Co-CEO of The Carlyle Group) interviewed former Treasury Secretaries Robert Rubin and Larry Summers. My notes in bullet point form:
- Rubenstein: Low growth for a while, low inflation for a while
- Summers: Not likely to see economic growth accelerate. Risk of recession by the end of 2017 is 1 in 3. We are seven years into recovery – not a time when you are likely to see the economy accelerate.
- Summers: The right things to do are tax reform and education reform.
- Rubin: There are a lot of risks out there. If the political system would begin to function with a well-structured fiscal policy, then I’d have a better view. The facts on the ground – unlikely/not going to get it.
- Rubin: Advice to Hillary… Engage with Congress. The whole key is the willingness to engage in the types of compromises that gets our system to work. She’ll try. Unlikely to be received.
- Summers: need a pro-investment mindset. It is insane that we don’t take advantage of low rates and low raw material prices. This will get growth starting then advancing. (SB here: seven years in to recovery… this will get growth starting? We’ve taken trillions of bonds off the banks’ balance sheets and parked them in the Fed’s parking lot to “run off” over time. The “this will” statement, at least to me, speaks volumes)
- Rubin: On infrastructure, big mandates make a difference. We need it and the financial conditions are right (ultra-low interest rates); however, we are unlikely going to get it. (SB again: this is the hand-off from the Fed’s monetary policy to Government fiscal policy we’ve been writing about. El-Erian’s “T-Junction” where the central bank road we’ve been traveling on is coming to a stop sign. We have come to a T in the road. One turn is the road in which our fiscal authorities implement tax reform, infrastructure projects and education reform, etc. The other turn we can take is on the road to which they do nothing.)
- Rubin: We need fiscal reform. (SB: Rubin is saying that road appears “unlikely”.)
- Rubin on Glass Steagall: The repeal of Glass Steagall had nothing to do with the crisis. It was, in practice, repealed long before the final legal strike of the pen put it into law. (SB: I found that statement interesting as it speaks to the power of large banks’ influence.)
- Summers: Canada came through the crisis best. Why? Because substantially diversified financial institutions are much safer than not. (SB: amen that, in my view. I found it an interesting comment that immediately followed Rubin’s Glass Steagall remarks.)
- Rubenstein asked, “What advice would you give to Yellen on interest rates?”
- Summers: Data dependence is the right course and the most important data is the state of inflation and the state of inflation expectations. The goal of the policy is to react and stabilize. We can’t predict the economy – Fed Reserve reacts and stabilizes. The most important thing I would advise her is to do what you feel is the right thing to do at the time.
- Summers: There is less evidence that the Fed is politically influenced.
- Rubin: I’d advise Yellen that there is a vast over-focus on the Fed. She should have raised rates sooner. The Fed is only one piece of the equation and a relatively small piece. (SB: tell that one to the markets… “All About That Fed”)
- Rubin: The economy is more likely to soften than not. It is ok if she raises a little. Our elected bodies are much more important.
- Rubenstein asked, “What is your most significant economic worry outside of the U.S.?”
- When you talk to Chinese economists off to the side, there is more worry. This is a big risk we should be cognizant of.
- Geopolitical risks. The markets are not thinking about such risks.
- China – something substantial is happening there.
- Political risk driving huge economic risk. (SB: What he sees rising up outside of the U.S., especially in EMs, is a risk that is rising inside the U.S. – Something he never thought would happen.)
The discussion around China was a big theme at the conference. And rightfully so. Debt remains the most significant global issue. And that debt continues to grow.
Speaker Boehner was fairly candid in his responses. Asked about his opinion of Trump’s views on banning Muslim entry into the U.S., building a wall along the U.S. border with Mexico and raising tariffs—and whether he agreed with them. Boehner’s responded, “No, No, No.”
But let’s move on. Here are a few comments that I believe may help us assess the probabilities as to which turn we take:
- Steven Rattner asks Boehner, “Over the next two years, do you see Congress making substantial entitlement or tax reform?” Boehner responds:
- Don’t hold your breath on entitlement reform. No one is going to touch it.
- Taxes are teed up well for reform, with a lot of effort put in by both sides of the aisle. [America] has the most complicated tax system in the world. Not even the IRS understands it. (SB again: Good news… fingers crossed)
I can’t say I felt any better about the probabilities for taking the correct turn at the T-junction. In my view, we have pulled up to the stop sign. I put the odds of needed structural fiscal reform, absent a crisis, at 25% (and that might be generous). Reform in crisis? I put the odds at 100%.
There were several sessions that I found meaningful. Particularly the panel discussion quarterbacked by Bloomberg Television’s Erik Schatzker. On the panel were several hedge fund greats: Leon Cooperman, Founder, Chairman & CEO, Omega Advisors; Kyle Bass, CIO, Hayman Capital Management; Paul Brewer, CEO, CIO & Founding Partner, Rubicon Fund Management LLP; Ken Tropin, Chairman & Founder, Graham Capital Management.
Following are my bullet point notes presented in step with the panel conversation:
- Markets are uncertain – most investors confronted with a central bank environment where monetary policy is losing its effectiveness… effect becoming less pronounced, less successful, less effective.
- Risk “on” trades running out of gas.
- Sees interest rates dropping from current levels in the U.S. and equity markets soft.
- The market is broken.
- The Volcker Rule, Dodd Frank, elimination of the Uptick Rule… has caused limited liquidity in the system.
- As money gravitates from active to passive investments, there is far less liquidity in the market – you go from an active manager at approximately 30% annual turnover to 3% from passive.
- Liquidity is a concern and you need to do your homework before you take a position…
- Biggest problem is how do you relate fundamentals to the markets – there are few good opportunities.
- In speaking to liquidity: Closed risk positions between July and December last year and it took a long time to exit due to low liquidity
- Air pockets are there because there are no specialist desks
- We are in a March or April of 2007-like period in terms of where we are…
- Sees another crisis coming
- Feel similar because central bank policy running out of runway – see a repricing at some point…
- Sees the market going higher
- Adding – bull markets are born on pessimism, grow in optimism and die in euphoria – he doesn’t see euphoria yet (SB again: agreed)
- Bubble is not in equities – it is in bonds
- Individuals conservatively postured in equities
- Four reasons you have a bear market:
- Stock market feels an oncoming recession…
- Market becomes overvalued and euphoric in its pricing
- Fed takes punch out of the punch bowl – not happening here
- Geopolitical event – can’t forecast it
- Going to see a risk off trade of some significance but doesn’t see it in the short-term environment.
- In speaking to the underperformance of the hedge fund industry, “everything is cyclical.”
- “Money goes where money is treated best.” Hedge fund industry is not over.
- HFs don’t do well in running bull markets – the shorts detract from return.
- In a low return environment, you have to lower fees because you can’t justify the fees.
- The HF model is being challenged but everything is cyclical.
- All investors have become more sophisticated…
- In an environment with risk free rates at 0%, 10% is a great return.
- Topin is a macro manager. Said, “No one wanted to invest in macro strategies in 2000 then macro came back in 2000 to 2003.”
- If you are a stock picker, you have to be patient because the system is broken.
- One of the biggest imbalances that the world has ever seen is the Chinese banking system…
- He suggested to Cooperman he might add a 5th bear market indicator to his list – credit market bust indicator.
- Chinese balance sheet has $30 trillion in debt with a GDP of $10 trillion – a huge liability mismatch.
- China is one of the biggest opportunities of all time. (Referring to shorting China like he did subprime. Noting this problem is much bigger than subprime.)
- The currency is the afterthought as the problem is in the credit system.
- He said he has the same view. (as Bass and Cooperman)
- M2 and credit growth should grow at the same rate – not happening.
- This problem is much bigger than the subprime problem.
- Agrees but the question is when – how much longer can the Chinese Central Bank kick the can down the road?
- We are seeing signs that this could start to unravel but the government really wants to make it happen down the road on somebody else’s watch so the question is timing.
- Look at their trading partners– Seeing rising defaults in Chinese trading partners.
- Real Estate is in free fall in Hong Kong.
- Look at credit growth in South East Asia. Thailand at 350% of GDP…
- All of these Emerging Markets have grown credit recklessly.
- China may lie about economy but what is happening to their trading partners is telling us the truth.
- As for timing: This is happening right now – and right now means the next two years. (Emphasis mine)
- It is really difficult to position yourself in front of that if you don’t have duration in your vehicle.
- The bubble is in fixed income. It is close to a 2SD (standard deviation) move from normal valuation.
- Loved this quote: “Buying government bonds is like walking into a room, seeing a rattlesnake and kicking it and hoping to stay alive.”
- Two stocks he likes:
- TFG_NA – stock yields 7%… 14% equity with about 45% of that in cash… 9½ stock price with a $19 book value yielding over 7%.
- The principles have options on 10% of the stock that expire next April.
- First Data – largest investment in the history of KKR…
This is not a recommendation by me to buy or sell any security. If you are a stock picker – do your research and size each risk appropriately.
- Going to see psychology of the investor become more negative over time.
- Debt levels are so high that there is no way to get growth going.
- We are in a long-term depreciating world.
- He thinks Gold is an asset people will want to own.
- Likes shorts on risk assets …
- Sees yield 130-140 on 10-year… (SB again: no rattle snake bite just yet)
- Inflation is picking up.
- Unit labor costs are going to be rising.
- What do you want to do with your money… not in cash, not in bonds as yields are too low…
- Alternatively, you can buy your favorite stock that yields more than other things.
- Agrees on gold – thinks 100% right on gold.
- Central banks are in a race to the bottom…
- Problems in the Europe project – haven’t addressed the structural problems – nominal GDP is coming in 10% of forecast for the countries in the south.
- Seeing a big move to the left in the south and to the right in the north (SB: this is what Summers was alluding to).
- The idea that the ECB has your back is a folly…
- All of the countries are running large deficits, all have been increasing their debt. Especially France.
- When you look at spreads, they don’t look right…
- Italy has 140% debt to GDP.
- French Germany spread (likes short France – long Germany) – as a median-term trade.
- When asked about investor staying power (as HFs are seeing client withdrawals), he said, “it’s easy to maintain conviction; it’s hard to maintain investors (speaking of China and the similar problem his HF faced prior to hitting the great home run on his subprime shorts in the last crisis).
Cooperman concluded with the following advice:
- “Invest in good companies, don’t use leverage, invest in liquid investments, don’t do private deals and
- Light a candle and pray for a positive outcome”.
So we keep an eye on China. To this end, I found the following quote shared in an Art Cashin letter earlier this week. Quoting Bob Hardy from Geostrat Report:
China – Economy is likely to follow “L-shaped” trajectory for foreseeable future: The Party’s mouthpiece, the People’s Daily, published an interview Monday with an “authoritative figure” who said the country’s growth trend for the next two plus years would be “L-shaped”, not “U-shaped” or “V- shaped.” The person listed a number of “emerging difficulties,” such as overcapacity, non-performing loans, illegal financing, a real estate bubble and local government debt. The person also said various markets should not be used “as a means of maintaining growth.” The individual made a policy stance statement that China would end its practices in the first quarter of boosting growth with an unprecedented credit injection. The person called high leverage the “original sin” that led to risk taking (speculation) in various markets. The individual said, “A high leverage ratio could lead to a financial crisis.” The figure called for transparency in debt and said non-performing loans should not be hidden, while labeling deleveraging a priority. The individual is likely Liu He or someone close to Xi Jinping who is a senior figure on the Party’s leading group for economic and financial affairs, which Xi chairs. The person’s statements were a clear repudiation of Premier Li Keqiang’s policies, signaling Xi is asserting his control over economic policy.
Let’s just say the evidence is mounting. Systematic risk remains high.
Below, you’ll find two great reads should you wish to click through below. Print them out and read them when you have some downtime. One is from Rob Arnott on inflation. In short, the price inflation that is real to you and me is actually 3% and not the less than 2% that is reported. Flat wages and higher prices. No wonder people have had enough.
The second is from Danielle DiMartino Booth titled, Central Banks and the Rise of Extremism. She worked at the Federal Reserve with Richard Fisher. And – wow – can she write.
Do you remember the great movie Chariots of Fire? It tells the fact-based story of two athletes in the 1924 Olympics: Eric Liddell, a devout Scottish Christian who runs for the glory of God, and Harold Abrahams, an English Jew who runs to overcome prejudice.
Eric Liddell (Ian Charleson), born in China of Scottish missionary parents, is in Scotland. His devout sister Jennie (Cheryl Campbell) disapproves of Liddell’s plans to pursue competitive running. But Liddell sees running as a way of glorifying God before returning to China to work as a missionary.
When they first race against each other, Liddell beats Abrahams. Abrahams takes it poorly, but Sam Mussabini (Ian Holm), a professional trainer whom he had approached earlier, offers to take him on to improve his technique. This attracts criticism from the Cambridge college masters.
When Eric Liddell accidentally misses a church prayer meeting because of his running, his sister Jennie upbraids him and accuses him of no longer caring about God. Eric tells her that though he intends to eventually return to the China mission, he feels divinely inspired when running and that not to run would be to dishonor God, saying, “I believe that God made me for a purpose. But He also made me fast, and when I run, I feel His pleasure.”
The two athletes, after years of training and racing, are accepted to represent Great Britain in the 1924 Olympics in Paris.
While boarding the boat to Paris for the Olympics, Liddell learns the news that the heat for his 100-metres race will be on a Sunday. He refuses to run the race – despite strong pressure from the Prince of Wales and the British Olympic committee – because his Christian convictions prevent him from running on the Sabbath.
Hope appears when Liddell’s teammate Lindsay, having already won a silver medal in the 400-metres hurdles, proposes to yield his place in the 400-metres race on the following Thursday to Liddell, who gratefully agrees. His religious convictions in the face of national athletic pride make headlines around the world.
Liddell delivers a sermon at the Paris Church of Scotland that Sunday and quotes from Isaiah 40, ending with: But they that wait upon the Lord shall renew their strength; they shall mount up with wings as eagles; they shall run, and not be weary; and they shall walk, and not faint.
Abrahams is badly beaten by the heavily favored United States runners in the 200-metres race. He knows his last chance for a medal will be the 100-metres. He competes in the race and wins. His coach Sam Mussabini is overcome that the years of dedication and training have paid off with an Olympic gold medal.
Before Liddell’s race, the American coach remarks dismissively to his runners that Liddell has little chance of doing well in his now far longer 400-metres race. But one of the American runners, Jackson Scholz, hands Liddell a note of support for his convictions.
Liddell defeats the American favorites and wins the gold medal.
The British team returns home triumphant. As the film ends, onscreen text explains that Abrahams became the elder statesman of British athletics. Liddell went on to missionary work in China. All of Scotland mourned his death in 1945 in Japanese-occupied China.
I cried. For character, for friendship, for love, for conviction. And I’m going to cry again when I force my kids to watch it with me this weekend. Force because any movie that is older than them is too old school.
Danielle DiMartino Booth takes us back to that great movie and eloquently writes of our need for Champions of Conviction, concluding,
“The migrant crisis promises to exact its own costs, at first political and inevitably economic. It is then that the past 30 years’ bad habit of borrowing from Peter to pay Paul will be tested. What happens, one must ask, when Peter himself runs out of money?
Perhaps the world will have to wait a good long while to finally be graced with leaders who are willing to stand by their convictions and make hard, maybe even highly unpopular, choices. Such leaders might have to risk sacrificing their political careers to be crowned the next true Champions of Conviction, giving us all a shot, once again at a storied fate.
It is simply awesome…
I enjoyed listening to author Michael Lewis (The Big Short, Blind Side and Liar’s Poker) and will leave you today with a something that actor Will Smith shared during his SALT Conference interview,
“Life is not about the number of breaths you take, it is about the number of moments that take your breath away.” – Author unknown
I’ll share a bit more next week – my notes from the session with Sam Zell and T. Boone Pickens. I spent a few minutes with T. Boone Pickens post his session and was blown away by his passion to do right. One super Champion with Conviction.
I’ll be in NYC for several media events next week then on to Dallas for Mauldin’s Strategic Investment Conference May 24-27 – Richard Fisher, James Grant, Lacy Hunt, David Rosenberg, Gary Shilling to name just a few. Expect more bullet points.
Wishing you an inspired weekend!
With kind regards,
If you find On My Radar helpful, please share it with a friend.
♦ 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:
- Government Underestimating Inflation – Rob Arnott
- Central Banks and the Rise of Extremism – Danielle DiMartino Booth
- Trade Signals – Investor Pessimism, Momentum and Trend
Here are the links to the two articles I mentioned:
Trade Signals – Investor Pessimism, Momentum and Trend
♦ If you are not signed up to receive my weekly On My Radar e-newsletter, you can subscribe here. ♦
With kindest 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.
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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.
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:
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