December 6, 2012
By Steve Blumenthal
As I dive through a broad range of independent research each week, following are several bullet points I found important:
- Rob Arnott – 2012 IMCA Winter Specialty Conference
I was in Scottsdale this week speaking at the IMCA Winter Specialty Conference. My topic was a shorter version of what I presented in last Friday’s Blumenthal Viewpoint – The Portfolio Construction Game Plan for 2013.
Rob spoke about what he calls the “3D Hurricane”. Debt, Deficits and Demographics. Rob sees 1% real GDP growth for some time to come, equities delivering low returns and bonds under pressure due to rising inflation and rising interest rates. I know he left the attendees in the room feeling a little numb with his forward outlook.
He recommended investing in what he called a “third pillar” exclaiming there is a whole world of alternatives and other investments that may profit. He said high yield bonds are a good inflation hedge and have a higher correlation to CPI than TIPS. He likes commodities and emerging markets adding that emerging markets are underweighted in most portfolios.
Rob warned the audience that while his outlook might look depressing, there is opportunity. It is a question of positioning. He offered that there are opportunities other than 60/40 and suggested adding a third pillar to include within client portfolios. We’ve been calling this third pillar: tactical/trading strategies/alternatives.
- Bill Gross PIMCO’s Picks and Pans – December 4, 2012
“Developed global economies have too much debt – pure and simple – and as we attempt to resolve the dilemma, the resultant austerity should lower real growth for years to come. There are those that believe in the “Brylcreem” approach to budget balancing – “a little dab‘ll do ya”. Just knock a few percentage points off the deficit/GDP ratio, they claim, and the private sector will miraculously reappear to fill the gap. No such luck after two–three years of austerity in Euroland, however. Most of those countries are mired in recession and/or depression. Political leaders there should have studied the historical evidence presented by Carmen Reinhart and Ken Rogoff in a critically important paper titled, “Growth in a Time of Debt”. They conclude that for the past 200 years, once a country exceeded a 90% debt/GDP ratio, economic growth slowed by nearly 2% for both developed and developing nations for an average duration of nearly a decade. Their work, displayed below in Chart 1, shows the result in the United States from 1790–2009. The average annual U.S. GDP rate growth, while clearly influenced by the Great Depression, was -1.8% once the 90% barrier was exceeded. The U.S., by the way, is now at a 100% debt/GDP ratio on the basis of the authors’ standard measuring yardstick. (Note the 5½% average inflation rate during the same periods.)
In addition to sovereign debt levels that were the primary focus of the Reinhart/Rogoff studies, it is clear that financial institutions and households face similar growth headwinds. The former needs to raise equity via retained earnings and the latter to increase savings in order to stabilize family balance sheets. The combined need to increase our “net national savings rate” highlighted in last month’s Investment Outlook is a long-term solution to the debt crisis, but a near/intermediate-term growth inhibitor. The biblical metaphor of seven years of fat leading to seven years of lean may be quite apropos in the current case with the observation that the developed world’s growth binge has been decades in the making. We may need at least a decade for the healing.”
Here is the link to Bill’s piece. Included is a PIMCO list of future Picks and Pans based upon the ongoing structural changes. http://www.pimco.com/EN/Insights/Pages/Strawberry-Fields-Forever.aspx
- How Currency Wars turn into Trade Wars
In April 2011, I wrote a piece called “A Race to the Bottom”. It was about currency wars. Frankly, whatever I know on the subject pales in comparison to James Rickards, the author of Currency Wars, published earlier this year. I highly recommend Jim’s book.
It is clear that our government’s plan is to inflate our way out of debt. Print new currency units and buy bonds. Our goal is to devalue our currency making our goods less expensive to our global partners, monetize our unmanageable debt buying the bonds and putting them on the Fed’s balance sheet to wither away and die. There are unintended consequences (or intended consequences as we seem solely concerned about our own self interest), which are shared in the link below.
The currency wars are just beginning. This one from Brazil is about import gates or trade tariffs:
Brazil hiked tariffs on dozens of industrial products, limited imports of auto parts, and capped how many automobiles could come into the country from Mexico — an indirect slap at the U.S. companies that assemble many vehicles there.
As Brazil’s currency inflates against the U.S. dollar, their buying power strengthens, making our exports cheaper to buy. “We are only defending ourselves to prevent the disorganization, the deterioration of our industry, and prevent our market, which is strong, from being taken by imported products,” Brazil’s outspoken finance minister, Guido Mantega, said in an interview.
“These are unhelpful and concerning developments which are contrary to our mutual attempts to strengthen the world economy”, outgoing U.S. Trade Representative, Ron Kirk, wrote in a strongly worded letter to Brazilian officials that criticized recent tariff hikes as “clearly protectionist”.
I believe we are in the early stages of a global currency war. The debasement of our currency has consequences. Here is the link to the full article. http://www.washingtonpost.com/business/economy/amid-slowdown-brazil-turns-inward/2012/12/03/32b49050-3a42-11e2-8a97-363b0f9a0ab3_story.html?wpisrc=nl_cuzheads
Recommending you build that third portfolio pillar.
With warm regards,
Steve
Stephen B. Blumenthal
Founder & CEO
CMG Capital Management Group, Inc.
steve@cmgwealth.com
610-989-9090 Phone
PS: When I look at the world, I try my best to view it from a probability perspective. I read endlessly and have access to some outstanding hedge fund and independent investment research. Fortunately, if you dig deep enough you have access to a great deal of information on the internet. This certainly wasn’t the way it was in 1984 when I started in the business.
I believe we are in a challenging low return environment and that most individual investors hold higher return expectations; those expectations will not be met and investors will seek a better solution. I see an unprecedented opportunity for you to grow your advisory business.
With this piece I try to share some information that I have found to be important. To me the evidence is clear, but I most certainly could be wrong.
Whether I am correct or incorrect in my thinking, my overriding belief is that you can create and manage successful portfolios for the period ahead. This environment requires more work (mixing a diverse set of risk drivers and more active beta hedging) than exists in a secular bull market cycle, but also offers you the ability to separate yourself from the 98+% of your competition that is heavily weighted in the old 60/40 stock/bond construction model.
The good news is that investment opportunity has been greatly expanded and solutions exist. While risk is an inescapable companion in the investment process, I believe it can be quantified and minimized by expanding the asset classes you include in your portfolios.
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