December 12, 2014
By Steve Blumenthal
“That men do not learn very much from the lessons of history is the most important of all the lessons that history has to teach.”
Aldous Leonard Huxley (1894-1963)
Put me down as a long-time Philadelphia Eagles fan. But let’s just say I’m on the good sportsman side of the fan base. Snowballs at Santa. It really did happen. I think we are the only stadium in the country with a courtroom that exists in its basement and it’s active on game days. I know – not good.
However, we are very excited about Chip Kelley as head coach. With game plan in hand, Chip has the team executing plays at warp speed. I’d love to get a look at his pre-game notes to better understand the opportunities he sees and how he plans to respond when things are not going his way. Perhaps the investment game is not too dissimilar.
Each year I sift through piles of research and do my best to note what seems to make the most sense to me. I imagine a 2015 playbook of sorts and set out to note the probable issues and highlight potential opportunities. The goal, of course, is to score and win. Like in football, offense is important but defense wins you championships.
This week, I thought I’d take a crack at the 2015 playbook. In short, I forecast a good start and a rough finish. Investing is ultimately about combining diverse sets of risk. Establish your game plan and find a disciplined way to manage risk. The current cyclical bull is aged and 2015 may prove to be a turning point.
Included in this week’s On My Radar:
- 2015 Outlook: Strong First Half, Challenging Second Half – Blumenthal Viewpoint (My Two Cents)
- How the Rising Dollar Could Trigger the Next Global Financial Crisis, John Mauldin and Worth Wray, December 11, 2014
- Taxpayers to Stand Behind Another Bank Bailout – Now Backing Derivatives
- Trade Signals – Trend Positive, Sentiment Remains Too Optimistic 12-10-14
2015 Outlook: Strong First Half, Challenging Second Half – Blumenthal’s Viewpoint
Central banks of the world have come to the conclusion that low interest rates and currency creation are the ways to cure all that ails us. The fact that Japan has now just entered recession is challenging that notion. People have reached for yield and increased risk because there has been nothing else they could do.
“So-called high quality bonds from governments in the U.S. and Europe “provide horrendous value,” famed hedge fund manager Paul Singer said, “As they do not price in the risk of inflation and that central banks have been the major buyer for years.” Bonds are “very, very over-priced for the risk-reward,” he added.
Normal risk and pricing mechanisms have been tampered with by central planners. Markets do clear and economies correct and heal when individuals seek their own self-interest. Failures are a healthy part of a capital market system. Put me firmly in Adam Smith’s camp.
The invisible hand: the collective action of millions of individuals seeking their own best interest is far better than a small group of central planners.
My 2015 playbook: Strong first half, challenging second half. Own equities but hedge market exposure. The U.S. equity market is overvalued but remains the number one game in town.
• Momentum is favorable and Don’t Fight the Fed remains a primary theme
• Capital flows has been and will continue to put their money into U.S. stocks and real estate
• If there is going to be a crash, it is going to be in bonds particularly sovereign debt (Europe and Japan first). Supporting additional capital flows to U.S. and particularly U.S. equities
• Relative to Europe and Japan: higher relative U.S. yields and the end of Fed QE vs. early stage Japan and Eurozone QE favors a strong U.S. dollar, U.S. equities and U.S. real estate
• Global currency wars accelerate
• Extreme investor sentiment should cause periods of market weakness – for now, such corrections should be viewed as buying opportunities (unless charts below turn bearish: Big Mo and 13/34 Week EMA)
• Two steps and a stumble – expecting first Fed rate increase in June 2015 and second in September/October 2015. Historically the market stumbles after the second Fed rate increase.
• Strong first half, challenging second half
Second half of year turning point tied to second FOMC rate increase – best guess September/October 2015
• Global issue remains one of too much debt. Too much government debt: Japan, EU, USA
• Reduce and/or fully hedge equity exposure by Sept 2015. Best to have hedges in place today.
• A sovereign debt default waive remains ahead – crisis in late 2015 into 2016 (central bank creativity can extend the timing but ultimately some form of default/debt restructure must happen)
• Pensions own considerable government debt exposure. I expect capital flows will favor equities over debt (i.e.: Japan’s largest pension fund’s recent portfolio allocation shifts)
• Rising interest rates, government funding crisis, tax grab, accelerated economic decline, write-downs, pension gaps, further economic impact…
• Sovereign debt crisis will lead to a global pension crisis, global slowdown – severe recession, EU banking crisis (who own much of the sovereign debt). Challenging default wave 2016-2020
Thoughts on the Economy:
• Mildly bullish on the U.S. economy for now.
• Small business hiring plans shows good employment growth
• Jobs have increased over 300,000 each month on average
• The unemployment rate has decreased with the rise in the labor force
• Faster wage growth ahead – supporting first Fed rate hike June 2015
• U.S. – North America is holding up the world. When we turn down economically, the world roles over. Timing -September/October 2015.
Looking forward – slower growth
• Fed QE3 has ended yet I expect rates to remain low; I continue to believe the FOMC’s first rate hike is June 2015
• Absent QE, too much debt remains the big drag on U.S. and global growth
• It is the second rate hike that is generally negative for the equity markets
• U.S. real monetary base is falling sharply – What happens when the Fed moves away
• Japan and Europe are accelerating their QEs and to some degree picking up some of the liquidity the Fed had provided
• U.S. QE exit and higher rates continue to favor U.S. dollar over Japan and Europe as they continue to ease. This could/will hurt U.S. manufacturing resurgence.
• Risk is trade war – growing currency war – real war. Risk of war.
• U.S. budget deficit’s rate of improvement has been deteriorating for some time – this is consistent with slower growth
• Rising dollar, weakening in the trade deficit, a deteriorating budget deficit, recessions in Europe and Japan, slowdown in China (cement cities and fracturing real estate investment pools), end of U.S. QE all point to slower growth in the U.S. economy moving into 2015
• Too much developed market debt, unmanageable pensions (looming crisis) and entitlement programs all point to a sustained period of slow growth
• Eurozone economy mixed to worsening – recession. Deflation.
• There will be a bear market. There will be a U.S. recession. Timing? My best guess is the economy begins to turn lower in September/October 2015, but it is really just a guess. The “what” we can do is size up forward return potential based on the current level of market overvaluation (just 4.28% next ten years – here ) set in place a risk management process today that can help us better protect our assets. Such a game plan will enable us to be in a position to take advantage of the buying opportunities the next crisis brings.
Watch the following for change in trend evidence.
How the Rising Dollar Could Trigger the Next Global Financial Crisis, John Mauldin and Worth Wray, Dec. 11, 2014
John is a good friend and one of the best writers I know. I’ve mentioned before a story about the greatest birthday present. I had just exited the tram atop 11,000 feet at Snowbird, Utah when the phone rang. I was expecting the call. John was to have joined me the night before for my 50th birthday celebration but cancelled as he was invited to meet at a hunting ranch for a special dinner that included then House Speaker John Boehner. Mauldin shared the cliff notes – simply the plan was to print and print and keep on printing. I’ve since written a number of pieces about currency wars.
We are deep in the currency battle today and the pace is picking up. There will be consequences. To get a better understanding of this, following is a note from John that crossed my desk this week:
“This week’s Outside the Box continues with a theme that I and my colleague Worth Wray have been
hammering on for some time: the very real potential for a rising dollar to trigger the next global financial
crisis.
We are concerned about the consequences of multi-speed economic growth around the world and the
growing divergence between major central banks. In our opinion, if these trends persist, they likely mean (1) a major US dollar rally, (2) a rapid unwind of QE-induced capital flows to emerging markets, (3) a hard slide in fragile emerging-market and commodity-exporter currencies, and (4) financial shocks capable of ushering in a new global financial crisis.
Alongside true macro legends like Kyle Bass, Raoul Pal, Luigi Buttiglione, and Raghuram Rajan, Worth
and I have written about this theme extensively in 2014 (“Central Banker Throwdown,” “Every Central
Bank for Itself,” “The Cost of Code Red,” “Sea Change,” “A Scary Story for Emerging Markets”). Now it’s quickly becoming a mainstream macro theme on almost everyone’s radar. Virtually every economist and investment strategist on Wall Street has a view on the US dollar and the QE-induced carry trade into
emerging markets… and anyone who doesn’t should start looking for a different job.
Policy divergence is really the only macro theme that matters right now. And on that note, the Bank for International Settlements just released its predictably must-read quarterly review, with an urgent warning:
The appreciation of the dollar against the backdrop of divergent monetary policies may, if
persistent, have a profound impact on EMEs [emerging-market economies]. For example, it
may expose financial vulnerabilities as many firms in emerging markets have large US dollar denominated liabilities. A continued depreciation of the domestic currency against the dollar
could reduce the credit worthiness of many firms, potentially inducing a tightening of financial
conditions.
Echoing those comments on Twitter, the “bank for central banks” reiterated how this trend affects all of us (feel free to follow us at @JohnFMauldin and @WorthWray):
@BIS_org: US dollar as global unit of account in debt contracts means a stronger dollar constitutes tightening of global financial conditions.
This is in spite of continued efforts by central banks to ease monetary conditions. Calling attention to that very risk in our Halloween edition of Thoughts from the Frontline, Worth explained that the catalysts are already in position to spark a collapse in a number of fragile emerging markets if the dollar moves even modestly higher (into the low 90s on the DXY Index); but we have struggled to quantify the actual size of the nebulous USD-backed carry trade that could now come unwound at any moment.
Reasonable estimates range from $2 trillion to $5 trillion. The true number could be even larger if more speculative money has slipped through the cracks than has been officially reported in places like China; or it could be smaller if a significant portion of recent inflows represents a more permanent deepening of emerging-market financial systems rather than an attempt to escape financial repression in the developed world. It’s hard to know for sure, and that’s why this week’s Outside the Box is so important.
In a recent presentation at the Brookings Institution, BIS Head of Research and Princeton University Professor Hyun Song Shin shared his research revealing that dollar-denominated credit to non-bank offshore borrowers is now more than $9 TRILLION and at serious risk in the event of continued policy divergence.
I’d encourage you to listen to or download an audio recording of Dr. Shin’s presentation, and take some time to flip through his slides; but David Wessel’s cogent summary, which follows in today’s Outside the Box, will give you an idea of what may happen as the US dollar rallies. It’s short, sweet, and REQUIRED READING for anyone who wants to understand where the global financial system is heading in the coming quarters.
Then we wrap up with an essay on the same theme by my friend Mohamed El-Erian, who is typically not as strident in his wording; but for those of us who know Mohamed, this is the equivalent of him pounding the table:
Avoiding the disruptive potential of divergence is not a question of policy design; there is already broad, albeit not universal, agreement among economists about the measures that are needed at the national, regional, and global levels. Rather, it a question of implementation – and getting that right requires significant and sustained political will.
The pressure on policymakers to address the risks of divergence will increase next year. The consequences of inaction will extend well beyond 2015.”
Here is a link to John and Worth’s full piece.
Taxpayers to Stand Behind Another Bank Bailout – Now Backing Derivatives
In a last minute passage, the government was provided a $1.1 trillion spending allowance with Wall Street’s blessing in exchange for assuring banks that taxpayers would stand behind another bank bailout, as a result of the swaps’ push-out provision. This allows financial institutions to trade certain financial derivatives from subsidiaries that are insured by the FDIC. Basically, taxpayers are on the hook for potentially trillions in potential losses on derivative contracts.
This was a major win for the four largest U.S. banks but a sad day for taxpayers. We will look back one day and ask, “What in the world were they thinking?” I have one clear conclusion: the political system is bought and broken.
A few weeks ago I read an article in the Huffington post titled, Wall Street Demands Derivatives Deregulation In Government Shutdown Bill. Here was the gist of the article:
“WASHINGTON — Wall Street lobbyists are trying to secure taxpayer backing for many derivatives trades as part of budget talks to avert a government shutdown.
According to multiple Democratic sources, banks are pushing hard to include the controversial provision in funding legislation that would keep the government operating after Dec. 11. Top negotiators in the House are taking the derivatives provision seriously, and may include it in the final bill, the sources said.
The bank perks are not a traditional budget item. They would allow financial institutions to trade certain financial derivatives from subsidiaries that are insured by the Federal Deposit Insurance Corp. — potentially putting taxpayers on the hook for losses caused by the risky contracts. Big Wall Street banks had typically traded derivatives from these FDIC-backed units, but the 2010 Dodd-Frank financial reform law required them to move many of the transactions to other subsidiaries that are not insured by taxpayers.”
Just four banks dominate the derivatives space.
The total estimated exposure at the top four banks is $219 trillion. Source
Also here.
Trade Signals – Trend Positive, Sentiment Remains Too Optimistic 12-10-14
“We are 5.75 years into the mega-bull market that began in 2009. That is a very long period for even mega-bulls.
Compare it with bulls from 1923 (5.83 years), 1994 (5.75 years), and 2002 (5.0 years).”
Ned Davis (Ned’s Insights December 10, 2014)
Included in this week’s Trade Signals:
- Cyclical Equity Market Trend: Cyclical Bullish Trend for Stocks Remains Bullish
- Volume Demand Continues to Better Volume Supply – This Too Remains Bullish
- Weekly Investor Sentiment Indicator:
o NDR Crowd Sentiment Poll: Extreme Optimism (Caution)
o Daily Trading Sentiment Composite: Extreme Optimism (Caution) - The Zweig Bond Model: Cyclical Trend for Bonds Remains Bullish
Click here for the full link, including updated charts, to Wednesday’s Trade Signals post (trend and sentiment charts)
Conclusion
I’ll provide my thoughts on the Global Indexing and ETF Conference next week. There are a number of good takeaways to share. As a quick aside, I was able to sneak some golf in last Sunday morning and played the TPC Scottsdale Stadium course. For golf fans, you may have seen the par three hole that is completely surrounded by fans. Not too dissimilar to Philadelphia Eagles fans on a Sunday afternoon, the crowd is rowdy and drunk. All golf etiquette is thrown out the window. Boos scream out to any golfer who fails to land on the green. The tournament is in early February and the workers were putting the stadium seating in place. It was great fun.
I landed home late Wednesday evening and walked off the plane to a chilly 35 degrees. Something that has me thinking about the future. This weekend, my oldest son, Matthew, is trying out for a local ski team. The good news is that it has been cold enough to make snow. Ice is no fun. We are off to a local mountain at 6:00 am tomorrow. Living the dream.
The holidays are fast approaching and I hope you are in good spirits.
Have a great weekend!
With kind regards,
Steve
Stephen B. Blumenthal
Founder & CEO
CMG Capital Management Group, Inc.
CMG Advisor Central and Other CMG Related Links
Please know that we here at CMG Capital Management Group are committed to bringing you the latest intelligence on the markets and tactical investing strategies.
We launched Advisor Central six months ago to offer advisors a quick read on trade signals in the fixed income and equity markets, commentary on economics and investing, and trends in the financial advisory business.
You can sign up here http://advisorcentral.cmgwealth.com for updates and you’ll get a weekly digest delivered to your in box.
We also created a LinkedIn Showcase Page devoted to tactical investing. Tactical investing has been our sole focus for 20+ years. We aim to give this investing style clear definition and scope as investor awareness of ‘tactical’ develops. Follow the LinkedIn Tactical Investing page here for periodic updates. https://linkedin.com/company/tactical-investing
Important Links
- CMG’s AdvisorCentral: http://advisorcentral.cmgwealth.com
- CMG’s Tactical Investing LinkedIn Page: https://linkedin.com/company/tactical-investing
- CMG on Twitter: @askcmg
- Steve Blumenthal on Twitter: @SBlumenthalCMG
- CMG Research and Insight: http://www.cmgwealth.com/research-insight
IMPORTANT DISCLOSURE INFORMATION
Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk. Therefore, it should not be assumed that future performance of any specific investment or investment strategy (including the investments or investment strategy (including the investments and/or investment strategies recommended and/or undertaken by CMG Capital Management Group, Inc. (or any of its related entities-together “CMG”) will be profitable, equal any historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. No portion of the content should be construed as an offer or solicitation for the purchase or sale of any security. References to specific securities, investment programs or funds are for illustrative purposes only and are not intended to be, and should not be interpreted as recommendations to purchase or sell such securities.
Certain portions of the content may contain a discussion of, and/or provide access to, opinions and/or recommendations of CMG (and those of other investment and non-investment professionals) as of a specific prior date. Due to various factors, including changing market conditions, such discussion may no longer be reflective of current recommendations or opinions. Derivatives and options strategies are not suitable for every investor, may involve a high degree of risk, and may be appropriate investments only for sophisticated investors who are capable of understanding and assuming the risks involved. Moreover, you should not assume that any discussion or information contained herein serves as the receipt of, or as a substitute for, personalized investment advice from CMG or the professional advisors of your choosing. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisors of his/her choosing. CMG is neither a law firm nor a certified public accounting firm and no portion of the newsletter content should be construed as legal or accounting advice.
This presentation does not discuss, directly or indirectly, the amount of the profits or losses, realized or unrealized, by any CMG client from any specific funds or securities. Please note: In the event that CMG references performance results for an actual CMG portfolio, the results are reported net of advisory fees and inclusive of dividends. The performance referenced is that as determined and/or provided directly by the referenced funds and/or publishers, have not been independently verified, and do not reflect the performance of any specific CMG client. CMG clients may have experienced materially different performance based upon various factors during the corresponding time periods.
CMG Global Equity FundTM and CMG Tactical Futures Strategy FundTM: Mutual Funds involve risk including possible loss of principal. An investor should consider the Fund’s investment objective, risks, charges, and expenses carefully before investing. This and other information about the CMG Global Equity FundTM and CMG Tactical Futures Strategy FundTM is contained in each Fund’s prospectus, which can be obtained by calling 1-866-CMG-9456. Please read the prospectus carefully before investing. The CMG Global Equity FundTM and CMG Tactical Futures Strategy FundTM are distributed by Northern Lights Distributors, LLC, Member FINRA. NOT FDIC INSURED. MAY LOSE VALUE. NO BANK GUARANTEE.
Hypothetical Presentations: To the extent that any portion of the content reflects hypothetical results that were achieved by means of the retroactive application of a back-tested model, such results have inherent limitations, including: (1) the model results do not reflect the results of actual trading using client assets, but were achieved by means of the retroactive application of the referenced models, certain aspects of which may have been designed with the benefit of hindsight; (2) back-tested performance may not reflect the impact that any material market or economic factors might have had on the adviser’s use of the model if the model had been used during the period to actually mange client assets; and, (3) CMG’s clients may have experienced investment results during the corresponding time periods that were materially different from those portrayed in the model. Please Also Note: Past performance may not be indicative of future results. Therefore, no current or prospective client should assume that future performance will be profitable, or equal to any corresponding historical index. (i.e. S&P 500 Total Return or Dow Jones Wilshire U.S. 5000 Total Market Index) is also disclosed. For example, the S&P 500 Composite Total Return Index (the “S&P”) is a market capitalization-weighted index of 500 widely held stocks often used as a proxy for the stock market. Standard & Poor’s chooses the member companies for the S&P based on market size, liquidity, and industry group representation. Included are the common stocks of industrial, financial, utility, and transportation companies. The historical performance results of the S&P (and those of or all indices) and the model results do not reflect the deduction of transaction and custodial charges, or the deduction of an investment management fee, the incurrence of which would have the effect of decreasing indicated historical performance results. For example, the deduction combined annual advisory and transaction fees of 1.00% over a 10 year period would decrease a 10% gross return to an 8.9% net return. The S&P is not an index into which an investor can directly invest. The historical S&P performance results (and those of all other indices) are provided exclusively for comparison purposes only, so as to provide general comparative information to assist an individual in determining whether the performance of a specific portfolio or model meets, or continues to meet, his/her investment objective(s). A corresponding description of the other comparative indices, are available from CMG upon request. It should not be assumed that any CMG holdings will correspond directly to any such comparative index. The model and indices performance results do not reflect the impact of taxes. CMG portfolios may be more or less volatile than the reflective indices and/or models.
In the event that there has been a change in an individual’s investment objective or financial situation, he/she is encouraged to consult with his/her investment professionals.
Written Disclosure Statement. CMG is an SEC registered investment adviser principally located in King of Prussia, PA. Stephen B. Blumenthal is CMG’s founder and CEO. Please note: The above views are those of CMG and its CEO, Stephen Blumenthal, and do not reflect those of any sub-advisor that CMG may engage to manage any CMG strategy. A copy of CMG’s current written disclosure statement discussing advisory services and fees is available upon request or via CMG’s internet web site at (http://www.cmgwealth.com/disclosures/advs).