Tower Private Advisors
I’m composing this from the Hyatt Aventine hotel in La Jolla, California, where I’m at the 8th annual Strategic Investment Conference. It’s put on by Altegris and John Mauldin. I’m going to try to summarize the presentations of some of the world’s best investment minds. John’s latest book is called “Endgame; the End of the Debt Supercycle and how it Changes Everything.” I’m banging it out on an iPad, so you’ll have to excuse me if it’s cryptic.
Gary has been a bond bull since the early ’80s and he continues with that thinking. His latest book is called “The Age of Deleveraging.” He argues that $ trillion deficits will continue for “many years,” and he backs that with data showing that a GDP growth rate of 3.3% is needed just to keep unemployment changed. At the 1.8% rate we saw in the first quarter, his model suggests that the unemployment rate will increase by 1% per year, and that’s intolerable for politicians; thus, big deficits will continue. How this can happen in light of debt ceilings, S & P downgrades of the U.S, and the like is not yet clear–but he’s still talking.
He has five things that worry him–five things that could turn a slow-growing economy into a receding economy.
It’s a problem of excess inventories. Excess inventories are “the mortal enemy of prices.” Gary’s firm estimates that there are 2-2.5 million excess homes over and above normal levels. They see another 20% decline in home prices.
It’s not inflationary when unemployment is high; rather, it’s a huge tax. He likens what is going on in the Middle East (i.e. Uprisings) with the uprisings in Europe in the 1840′s.
Sees a risk that Japan will have to import capital, and if it has to pay a market rate, it could send the company into a debt spiral, but he could have said “death” spiral–not sure.
4. Eurozone Debt Crisis
Then discussion has changed from one of bailing out the PIGS to one of sovereign debt crises and defaults. He claims that U.S. banks hold 28% of Eurozone debt and that the discussion is now shifting to include those banks.
5. Hard Landing in China
China needs 8% GDP growth just to keep workers migrating from the hinterlands employed. They have 12% inflation in food prices, which exerts a huge impact on an economy where food expenditures take a bigger slice out of budgets. They also have a continued property bubble, as a result of limited savings opportunities; i.e. savings go into property. Gary says that China’s string of reserve requirements increases represent a pretty blunt monetary policy tool. At least with increased RATES, borrowers that want to borrow can. Commodity prices have already peaked, says Gary, but few acknowledge that.
A sampling of investments that Gary likes includes the folowing:
1. Long term U.S. Government bonds
2. North American energy producers
3. Productvity enhancers (technology companies? I wonder)
4. U.S. Dollar
5. Small luxuries (‘says to short large luxuries)
[Presentations by strategists and economists are interspersed with presentations by hedge fund managers. I won't report on those unless they're they're earth shaking.]
Neil Howe, historian, economist, demographer
Neil is half of the great Strauss-Howe demography team, a common resource for the Wiliams Inference Service we employ. From the bios, “by the 2020s, global aging is likely to have a profound effect on economic growth, living standards, and the shape of the world order. His talk will analyze the implications of an aging Europe, Japan and China and offer reasons why the U.S. Will remain a dominant player in geopolitics.”
Four Keys for Decoding America’s Future
1. Fundamentals Regress to the Mean
Financial markets–especially the U.S.–don’t look good. Non-financial debt is at record-high levels. We still haven’t experienced the deleveraging the has followed every post-WW II crisis. P/E ratios too high; corporate profits are at all-time highs. Interest rates are the lowest ever for a nation with a fiat currency and a free-floating currency.
2. What is unsustainable tends to stop; aka when your horse dies we suggest you dismount.
In the eyes of the CBO everything (ie debt levels) stabilizes after 2014, but on one in Washington believes it. On any reasonable basis, however, it increases at an unsustainable rate. Congress, however, is “not there; not even close.”
3. Demography is Destiny; Global Aging
The U.S. looks to be the best of all the developed nations. Our population growth rate is at least at replacement rate. The rest of the G-7 are all below that, and it’ll lead to some things we’ve never seen, like a first-ever decline in the working age population; elder care will consume 22.5% of U.S. GDP by 2050. In 1950 the median global age was 32.1. By 2020, it’ll be 45; by 2050, 49.3.
4. Generations and history have rhythms, or turnings
We’re in the Fourth Turning, the worst one, the winter of history. Winter is needed. It’s likely to last until 2028, about the length of a generation. Recent turnings have been these (season, archetype, example, characterization)
All in all this would have been rather gloomy if it hadn’t portrayed the U.S. as the best-positioned of the developed nations.
That tied in well with the lunch presentation by Marko Papic of Stratfor, which characterizes itself as a “private geopolitical intelligence-gathering and forecasting” firm. Marko is in charge of Eurasian analysis.
Marko Papic, Stratfor
Marko’s key contention that there will not be a global hegemony (preponderant influence or authority over others) shift from the U.S. to another. He bases that on three factors:
1. Demographics – in line with Neil Howe’s contention.
2. Geography – benign neighbors, relatively lightly populates, little external threats, while acknowledging the economic situation in which we find ourselves.
3. Navy – the U.S. Navy is so superior that it could defeat the rest of the world’s navies–combined.
In response to a question from the audience about Mexico and its drug cartels, Stratfor sees great investment opportunities in Mexico. They see it as the next China. It has no regional power aspirations, and it has no interest in stealing technology, neither of which can be said of China.
The US$ wil be fine for 15-20 years, and one reason for that is the U.S. has its foot on the throat of the Persian Gulf.
China trades in toys; the U.S. trades in essentials (ie security)
Greece serves to deprive Russia of a warm water port. It’s air force is one of the world’s best. It’s pilots regularly defeat U.S. pilots in simulations. It could defeat Germany.
Germany – Russian relations are a big concern to the rest of the Eurozone countries. Russia has a huge unemployed, but highly skilled workforce, which Germany covets.
Martin Barnes, BCA Research
BCA research is one of our key research providers, so I was looking forward to his presentation. BCA has been around since 1949, and Martin has almost 40 years analyzing global markets and economies.
Martin started off by referring to the conference thus far as a “bear fest,” that he needed some antidepressants. He characterized bears as more intelligent sounding, that bulls come off as sounding like complacent, naive, Wall Street brokers. Still, as hard as he tries, he has a hard time being pessimistic, even though there is a long list of things to be worried about.
He broke his presentation into two parts:
1. How safe are equities?
How safe are equities?
He presented a summary of recent bear markets and what seemed to catalyze them. He boiled these down into four broad categories and proceeded to score the current envioronment.
1. Monetary policy – fine
2. Economy – fine
3. Valuation – neutral – never a good bear market indicator, but this one is probably a neutral factor
4. Techical indicators – fine
While born in Scotland, a highly socialistic country, he insisted he was “not a leftie–honest.” Still, he disagreed sharply with Mitch McConnell that the U.S. does not have revenue problem, that it has a spending problem. Martin presented several charts that showed that EFFECTIVE tax rates for individuals and corporations in the U.S. are quite low, both historically and relative to other nations. He did agree with a murmur that went up from the audience that the U.S. does have a tax distribution problem.
He finished by outlining some things that would signal an approaching debt crisis. Countries facing a debt problem exhibit these characteristics.
1. They isue debt denominated in foreign currencies.
2. They issue debt in shorter-term maturities
3. They exhaust their ability to increase taxes
4. Interest payments crowd out spending
5. Exchange rate falls because of a currency crisis (ie the risk premium rises) – the US exchange rate has fallen but not for these reasons.
6. Political shifts occur – the Tea Party may be an early indication of this.
Economic Panel Discussion: John Mauldin (JM), Marc Faber, (MF) Marko Papic (MP), Martin Barnes (MB), Jonathan Tepper (JT) (co-author with John Mauldin of “Endgame”)
1. What happens when quantitative easing ends?
MB – things that are unexpected are what hurt most
JM – only one previous experience; it wasn’t good for markets
MF – everything that went up will go down; the US$ and bonds will rebound
JT – it will be $ positive
2. Will the current Eurozone problems (eg PIGS) be worse than the US 2008 Credit Crisis?
MP – European governments aren’t serious about addressinig their problems
JM – fears that any European banking crisis will lead to problems in the US
MB – there is so much at stake that Euro governments won’t allow a collapse
JT – it’s a lot easier to print money than to address the problems
JM – if the governments just kick the can down the road, it might be the best outcome, as they’ll be better able to deal with the problems with a little more growth under their belts
3. Can a US recovery continue without Quantitative Easing II [which is slated to end in June]?
MB – 2-3% growth isn’t bad given the headwinds the economy faces. Housing is a huge overhang. The market will clear but it’s going to take a while. The key is “jobs, jobs, jobs.”
MF – the downside risk in housing is low. Dollar weakness represents inflation, and if inflation equates the global money supply, then there is a lot of inflation.
4. Is it possible for the US to inflate its way out of its debt problem?
JM – becoming increasingly worried this possibility after discussions with politicians
MB – it would be wonderful. Refers to this as “Greece coming to a theatre near to you.” He sees it playing out as the Fed neutralizing the bond vigilantes by buying all the bonds they sell the dollar melts down. Markets crash as traders dump dollars. Bottom line: can’t happen; the government won’t allow it.
MF – real assets would go through the roof, from farmland to fine art to potatoes. This would lead to more and more handouts as politicians seek to ease the pain of the poor. The ultra-rich and the ultra-poor would benefit. It would be really painful and would require a “reboot.”
JT – such bearish views on the dollar expressed by market participants that the dollar could actually be in for a rally.
5. How sustainable is the growth in emerging markets?
JT – Eastern Europe is toast. Asia is underleveraged and has good demographics.
MB – we want them to become more like America. They will become more us. Eventually they’ll have credit cards and NINJA (no income, no job, no application) loans.
MF – some of emerging market countries have already emerged. From lower bases than the developed world it’s much easier for them to grow. It might be volatile growth.
MP – India is not attractive. China has a history of cycles where a bubble bursts, regionalism sets in, the central government loses control, and any growth that eventually resumes is, at best, disunited.
6. Marc Faber, what are your three top country choices for where to live?
3. Cambodia (like Asia forty years ago)
Where to invest?
MF – easy to build a stock portfolio from these countries with solid dividends netween 4-7%, more than bond yields in those countries.
7. What keeps you up at night?
JT – European credit crisis, oil price spike, inflation spike
MB – Greece coming to a theatre near you (ie the US) – not within five years, fragile recovery falters
JM – European debt crisis, Middle East turmoil leading to an oil price spike
MF – the US is making a mistake going against Qaddafi. China sees this as an attack on itself since it has investments in Libya. This limits the US’s ability to do something against Iran. The world perceives a hegemon to have weakened and tries to take advantage, miscalculating.
MP – European banks. Bahrain (pivotal in the Middle East; Iran is probing there.)
8. Name 2-3 of best investment ideas.
JT – precious metals, US stocks
MB – boring dividend payers with global exposure, not gold (“it can come down just as fast”), emerging markets
JM – managed futures, 10% of monthly income to buying physical gold as insurance not investment (“I just don’t trust the b**tards”)
MP – uranium (if it were possible), German industrial companies
Marc Faber, Managing Director, Marc Faber Ltd.
Marc is a regular member of the Barron’s Roundtable, and he is fascinating to listen to, notwithstanding his accent; for example, he pronounces “fluctuation” as fluck-to-a-shun. Before listening to Marc Faber it is advisable to put sharp utensils away. As he put it himself, “I am the most pessimistic person about everything.” And yet, he also says we will never again see 666 on the S & P 500 in our lifetimes. He also thinks that equities and precious metals are great investments.
Those recommendations, however, come in the context of governments printing money, an environment in which cash and bonds will perform terribly.
Marc’s presentation was a peregrination of the investment and economic landscape, ranging from inflation and deflation to skewering Federal Reserve officials to asset class observations. So, too, are my observations and takeaways from the presentation. If it seems like a stream of consciousness, well, so was the presentation.
We tend to characterize inflation as good; deflation as bad–at least that’s how the Fed characterizes it. Yet the entire 19th century could be characterized as deflationary.
The Fed, however, is intent on priming the inflation pump, not having learned from the past. Marc lists two consequences. First, commodity prices rise, and he estimates the rise in oil prices, aloe, imposed a $500 billion tax on US consumers. Second, credit (ie debt) rises excessively. The Fed primes the inflation pump by keeping rates low in an attempt to push up asset prices, namely, housing. Instead, everything else rises.
Marc sees negative, inflation-adjusted interest rates “as far as the eye can see.” This is due, in part, because any increase in interest rates will cause interest payments on US government debt to rise to 25-30% of GDP, something that cannot happen. That’s because when Social Security and Medicare are included, total debt approximates 800% of GDP, and,y as a result, we will never agaib experience the tight monetary policy of Paul Volcker, when the Discount Rate rose to 20%.
The primary beneficiary of the US’s monetary policy largess are the emerging markets (EM). EM car sales now exceed car sales in the developed world; the same can be said about demand for oil. He shows a chart from the now-deceased Angus Maddison that goes back to the 1600′s, showing that China is only on the way back to resuming its place at the top of the world in terms of GDP. He seems to extrapolate this to EM, in general, in a sense, and advises a 50% allocation to EM.
He thinks bonds are entering a bear market, and has wagered a bottle of Scotch with Dave Rosenberg, a later presenter, who, along with Gary Shilling, things bonds are attractive in a deflationary environment. He doesn’t like cash either–not surprising, either, given his view toward inflation.
He finishes up with a quote from economist Ludwig von Mises.
“There is no means of avoiding a final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of voluntary abandonment of further credit expansion, or later as the final and total catastrophe of the currency involved.”
Louis-Vincent (LV) Gave, CEO, GaveKal
GaveKal is a Hong Kong based research and money management firm. It publishes the China Economic Quarterly. His talk is to cover the structural and cyclical challenges of investing in Asia and how to overcome them.
LV began by calling China the story of two Jims. On the one hand, Jim Rogers is bullish on China, ging so far as to move his family there. On the other hand, Jim Chanos says China is a bubble ready to burst, as LV put it, “on the treadmill to hell.” LV provided fuel to both, living there as he does, himself.
This was the first time in history that the global economy was pulled out of its slump by China, a role traditionally played by the US. Now, China and the emerging markets are tightening monetary policy before the US.
He cited three drivers of economic growth for, not just China, but all nations.
2. Productivity of labor
3. Productivity of capital
The first factor has been the source of much of China’s amazing story, but as a result of its one-child policy, that factor will begin to weigh more heavily on that country. Its demographic pyramid was, in the ’90s, much like other EM nations, heavily weighted toward youth. By 2020, however, it will have some old people, and the one-sided profile of its demographic pyramid looks more like a pregnant woman. In 2014, the Chinese workp force will begin to decline, the first time in modern history that has happened.
There is also the matter of the Wen Ji Bao put. This is similar to the Greenspan put, where if growth flagged, Fed Chairman Alan Greenspan was expected to rescue the stock market by cutting rates. The Wen Ji Bao put says that if growth declines below the government’s 8% target, the government will boost infrastructure spending to boost the economy. One problem with that is that existing workers have been squeezed as much as possible to eke out productivity gains; therefore wages will have to increase.
Historically, China had been agriculturally self sufficient. That ended in 2007. The biggest constraint for China’s agriculture is its water usage. What’s more, much of China’s water is polluted, rendering it unsuitable for irrigating crops. There is an upside to China’s crop situation. Presently, 20-23% of China’s grain harvest rots, largely because of logistics. That may be close to ending, as China appears to be at the same point as the US when the interstate highway system was started. That could both address the rot problem and usher in a new, transformational era of growth.
In conclusion, it’s too early to be bearish on China.
Paul McCulley,, formerly of PIMCO, now retired
Paul waxed existential for his lunch address, starting out by talking about:
Capitalism: 1 dollar = 1 vote
Democracy: 1 person = 1 vote
Imperialism: 1 gun = 1 vote
This lead one to wonder why the esteemed Fed watcher didn’t spend any time at all talking about the removal of QE II. On the other hand, perhaps retirement has been good to Paul, decked out, as he was, in a Kenny Loggins mop of hair and a Grizzly Adams beard.
He’s fairly optimistic about the outlook for the US, its marriage of democracy and capitalism habing survived its rough patch in 2008/09. He sees a pretty easy fix for our debt problem: simply subject entitlement programs to means testing.
One thing that keeps him up at night is the future of the Eurozone, which is a monetary union, not a political one. A positive resolution would involve the northern countries holding their noses to help bail out the southern countries. The worst case would involve a breakup of the Eurozone.
The emerging markets are a great story but they’re overbout. Those countries need to develop their citizens into consumers, establish identities as individual countries, as well as develop their own monetary policies.
He sees the Middle East at a watershed moment. Those countries find themselves on the wromg side of Capitalism, Democracy, and Imperialism. He sees a caution light in each.
David Rosenberg, Chief Economist, Gluskin Shef
Deflation remains the primary trend outside of commodities. He sees several things suggestice of an ebbing even in commodity price pressures. First, any time the
Conference Board’s index of inflation expectations has risen as fast as it has most recently, it’s always reversed. Second, speculative (dumb money) futures positions in crude oil are at their highest levels ever.
We focus on core inflation not because people don’t need to eat, but because that’s what the bond market responds to, historically, and it’s the bond market that determines interest rates. Core inflation has been lower when food and energy prices have been HIGHER. Also, serbices represent 60% of the US consumer’s shopping basket, and inflation there is running at about 1%. What’s more, unit labor costs have had an 88% correlation with inflation, and most Americans know all too well that wages have not moved.
Oil is often cited as an inflationary pressure, but counter inituitively, David sees oil prices as a DEFLATIONARY pressure, since they repesent a tax on consumption and are now at a level–when combined with food prices–that has resulted in demand destruction in the past.
Finally, David sees a number of other factors arguing for deflation and long-term bonds as a sound investment:
Historically, inflation has come down for a long time following asset bubble bursts. Not this time; ie, it’s still to come. Bonds have not yet ratified the inflation expectations of the Conference Board.
While most argue that with low interest there’s nowhere to go but up, David reminded that bond prices are more sensitive to changes in interest rates at lower yields than at higher yields. That’s another way of saying that duration is higher at lower interest rates. Put in terms we can all understand, from 2%, a 0.5% reduction represents a 25% drop. From, say, 8%, the same drop percentage change requires a drop of 2.0%.
John Mauldin (JM), President, Millenium Wave Investments, author of the just-released book, “Endgame.”
He wrapped up with a discussion of THE endgame, that time when countries can no longer borrow.
He said that, in history, there has only been one nation that has had a debt to GDP level greater than 150% and has lived to talk about it. That was Great Britain in the 1800s. So we’re about to engage in a great experiment amongst four dead white economists:
John Maynard Keynes
Ludwig von Mises
At the point of the endgame there are headwinds to growth, namely that a nation can’t cut taxes to spur growth, so Republicans are going to have to realize that “increase” and “taxes” can be in the same sentence. Along with higher taxes there will have to be less government spending, and the accounting identity for GDP means it will fall.
GDP = C + I + G + X
C = consumption
I = investment
G = government
X = net exports
G goes down. Taxes go up so that reduces I and C.
JM thinks there’s a 75% chance of a fix by 2013, but there’s also a chance that Japan (“a bug in search of a windshield”) and Greece will so spook the bond market that the time window in which we have to get our fiscal house in order will be compressed.