IN THIS ISSUE: When it comes to seeking financial advice, investors want to be confident in their advisor’s knowledge base and ability to stay on top of the market. We often hear about “investment conferences” and other such events held for financial advisors. But what exactly does one gain by attending? What kinds of concepts and discussions are on hand? What do advisors really learn? In this issue of Tactics, John Nicola offers us a glimpse into the value of these conferences by summarizing his time at the “Strategic Investment Conference” in San Diego. With a list of well-credentialed presenters offering their views on macro-economic and global investment strategies, John relays their views and opinions, while offering his own insights as well.
I recently returned from a very good event in San Diego called the “Strategic Investment Conference” which focused on a combination of the current economic and geopolitical situation in the world today (primarily the U.S.) and alternative investment strategies that have worked well over the last few years. For the purposes of this piece, however, we will keep our focus on the headline speakers and their economic views.
As a bit of background, this conference is arranged and sponsored by Altegris, a U.S. investment firm that works very closely with John Mauldin, whom I have referenced many times in my articles and whose weekly newsletter I highly recommend (you can subscribe at www.johnmauldin.com).
By reporting on the information and opinions absorbed over the course of this conference, I hope to provide our clients with a peek into the latest ideas and noteworthy concepts being discussed by today’s leading investment minds. The following is a brief summary of the speakers and their credentials, the key talking points discussed, and our final thoughts and observations on the conference.
- Martin Barnes:
Managing Editor for Bank Credit Analyst, based in Montreal, trained in England, but obviously Scottish. BCA Research is one of the most respected economic forecasting firms in the world; most of their clients are institutions and governments.
- Woody Brock:
Founder of Strategic Economic Decisions, and a frequent writer for the New York Times and International Herald Tribune. He has also spoken at the World Economic Forum in Davos.
- John Mauldin:
Created this conference six years ago and is founder of Millennium Wave Investments Ltd., a financial advisory firm. John has written two best-selling books including Just One Thing. His weekly newsletter has more than 1,500,000 readers.
- Dennis Gartman:
An economist of over 35 years who became a futures trader. He produces a daily newsletter (The Gartman Letter) and has since 1987. He is an advisor much soughtafter by many banks, investment dealers and brokerage firms. He has also taught classes on derivatives for the Federal Reserve Bank’s School for Bank Examiners.
- Paul McCulley:
Co-CEO of Pimco, the largest fixed income manager in the world. He is also the author of their monthly research publication. Paul spoke specifically about the relationship between the Fed, the U.S. Treasury, the banks and the “Shadow Banking System” as he calls it.
- George Friedman:
CEO of Stratfor, a company he founded in 1996. He speaks on geopolitical issues and his most recent book is a New York Times best-seller The Next 100 Years: A forecast for the 21st Century. Amongst other accomplishments, George has a PhD in government from Cornell.
In addition, there were a number of very good presentations by alternative strategies managers on their investment views and the results they have achieved for their clients over the last 15 years.
While this group of speakers was not in total harmony, there were some strong themes that were supported by many — if not the majority — of the presenters.
- The U.S. Government (and by inference all major governments) will print as much money and create as much quantitative easing as is required to stimulate the economy. If the initial rounds of fiscal stimulus and interest rate cuts do not work, they will continue to buy toxic debt and get credit flowing.
- Deflation is the overwhelming current concern, which is why governments (as noted above) will try to prevent it at all costs. If it gains traction, then spending will drop at a faster rate and the relative cost of debt and debt servicing will increase. Eventually the creation of new credit will be inflationary, but that battle is a future one and not a priority for governments today. They had a specific warning for gold bugs, noting that this initial environment is bad for this asset.
- Consumer spending in the U.S. peaked at about 71% of GDP up from a long-term level that was in the low 60’s. Most of this was financed by Mortgage Equity Withdrawals (MEW) when housing prices were rising and consumers were using their homes as if they were ATMs. It was also financed by a savings rate that has dropped from more than 10% in the 1980’s to negative numbers in 2007. Spending is going back to the low 60% range and the savings rate has already climbed back to almost 5%. An 8% reduction in GDP spending is about $1-trillion, and it would appear that this spending is not coming back. The combination of lower spending and increased savings is deflationary and also is a natural brake on interest rates.
- If both consumers and financial institutions are deleveraging, it means they are selling assets to reduce debt. That means a lot of assets are being offered, but there are very few bids on the other side of the transaction. That explains why mark-to-market pricing has arguably underpriced some good quality assets and why companies in particular are having to pay so much for new or rolled over debt. While this was not a consensus view, speakers like Paul McCulley said that the government is now the buyer of last resort and creating a market for “toxic” debt so it can be removed from banks’ balance sheets (more on this later).
- The U.S. has far better demographics than most of its competitors (especially Europe and Japan, and in the long run likely also China).
- Overall, most presenters felt relatively bullish, although not always about the same thing. Some did suggest that when the recovery takes place, the commodity producers will do very well. Therefore, Brazil, Canada, New Zealand and Australia are expected to have higher growth and would likely see a recovery of their currencies in relation to the U.S.
- Nobody had any doubt that this is the biggest financial crisis and worst recession since the 1930’s (even though we have yet to reach the unemployment rates experienced in 1980-1982).
- Several believe that we will retest the market lows this summer (a drop of about 20% from where we are now), but if one has a 5-year horizon, this is a period of time to be building assets such as equities, high-yield bonds and commodities.
Other Notable comments & observations:
- In 1933, FDR came in with a lot of programs that are similar to Obama’s recent stimulus package and they worked quite well. By 1937:
1. Unemployment had dropped from 25% to 14%
2. The stock market regained most of its losses since 1929 and, after inflation and dividends, was ahead by 25%.
Because of this “recovery,” he chose to try and balance the budget in 1937, reduce government spending and increase taxes. Within 18 months the unemployment rate went back to 19% and the markets dropped by about 40%. Ben Bernanke is an avid student of the depression and, as such, it is highly unlikely the government will make those same mistakes.
- The U.S. Housing market will not bottom until 2012, mainly caused by a significant excess supply and a lot of resets of variable mortgages that have to take place. I have to admit, I am not sure I see the picture as bleakly as John does. First, resets now are occurring at the lowest mortgage rates in well over 50 years and are far more affordable than they were a year ago. Secondly, the graph below shows that house prices in relation to rents are at their lowest levels since the late 90’s and below the long-term average as well. Perhaps this recession will bring them even lower, but I would be surprised if that takes another three years.
John’s simple explanation for inflation vs. deflation comes from this basic economic formula: Money x Velocity = Price x GDP (where velocity represents the rate at which people circulate and spend the money they have).
This, then, also suggests that Price = Money x Velocity /GDP. Generally, increasing the money supply is inflationary, but if the velocity of money drops faster than the supply increases, then prices will fall (deflation). One way that can occur is if people increase their savings and reduce debt (deleverage), and that is exactly what we are experiencing now.
McCulley, as mentioned above, is the Co-CEO of Pimco and a personal friend of both Ben Bernanke and current U.S. Treasury Secretary, Timothy Geithner. Two years ago, he warned about the “Shadow Banking System” made up of unregulated securitized vehicles that used large amounts of leverage and received questionable ratings from the major rating agencies. He was a very entertaining luncheon speaker.
Paul’s major focus was on the paradox of deleveraging. We may all agree that overall consumer debt and bank leveraging need to drop, but if both banks and consumers try and sell assets to reduce debt at the same time, then the price of the assets will continue to drop (lots of assets being offered, but no one bidding to buy them) while the debt related to them will not change. In effect, their net worth will drop even faster if they try and do this with no buyers on the other side. This has already occurred. Martin Barnes of BCA showed a slide that indicated in the last 12 months U.S. consumer net worth has shrunk by over 20% in just one year.
McCulley argues that if banks continue to sell assets at mark-to-market with few buyers, then the proceeds they receive will almost certainly guarantee they will become insolvent. So he sees the biggest problem being solvency vs. liquidity.
He concluded his remarks by saying that the government has to be an overwhelming force that will finance the acquisition of these assets. What will be distasteful to the public is that many hedge funds will participate in the PPIP (Public-Private Investment Program) and many of them will make some large profits. In very simple terms, PPIP involves private companies investing money equally with the government to buy debt. The Treasury will also provide non-recourse financing at very attractive rates for 85% and, as such, the private investors have a limited loss if things do not go well, but 50% of the profits if they do.
In the end, the government sees the alternative as a depression and would much rather deal with 10% unemployment for five years than 25% unemployment for two.
On the long-term outcome he also said:
- The U.S. dollar will not self-destruct against other currencies, because the majority of them are in the same boat and will end up employing similar tactics.
- Inflation will be the “fat tail” event at some point in time, so he is a fan of buying inflation protected bonds and other assets that would do well assuming a rise in inflation.
Overall, this was a very good conference with a combination of warnings about the seriousness of the situation we are in and the potential for some of the best investment opportunities we might see in a generation.
In today’s economic climate and market uncertainty, it is easy to get caught up in the swirling torrent of opinion and prognostication. As trusted advisors to our clients, it is our responsibility to stay current, assess the information, and be aware of the possibilities that lie ahead. It is just as important to us that our clients be knowledgeable, competent and informed. Whether it is a Tactics newsletter or the Monthly Market Commentary written by Chief Investment Officer, Rob Edel, education is critical and never more so than with today’s incredible market conditions.
As the great American essayist and philosopher Ralph Waldo Emerson succinctly noted, “Knowledge is the antidote to fear.”