Created November 2016 by Minyoung Sohn and last updated April 28, 2017
Dear Investor: Our Strategy to Weather this Current Investment Environment is Steadfast: Focus on Fundamental Research with a Patient Time Horizon, and Foster Collaborative Culture.
We Were Living in "The New Normal"
In 2010, Mohamed El-Erian created an Analytical Framework to explain the risk of secular economic stagnation in developed economies.
"First, the international monetary system suffered a “sudden stop” two years ago, the adverse impact of which is still being felt today by millions, if not billions, of people around the world."
"Second, the causes of the crisis were many years in the making and included balance sheet excesses, risk management failures at virtually every level of society, antiquated infrastructures, and outmoded governance and incentive systems in both the public and private sector."
Third, the dynamics coming out of the crisis management phase—particularly the combination of deleveraging, re-regulation, debt overhangs and structural challenges in key industrial countries—are combining with an accelerating secular re-alignment of the global economy to create what US Federal Reserve Chairman Ben Bernanke correctly called an “unusually uncertain outlook”.
The symptoms of these challenges include muted economic growth in industrial countries; persistently high unemployment which is increasingly structural in nature; continuous private sector de-leveraging; large public sector deficits and debt; regulatory uncertainty; and a much greater influence of politics on economics. They also show up in the accelerated migration of growth and wealth dynamics to the emerging world. (Mohamed El-Erian)
<The Stock Market Crash that Never Happened>
<The 12-month period ending June 30, 2016 reflective of the battle between Fear & Greed in the markets>
.
"As for market performance, if the unhappy statistics weren't so tragic, they'd be funny" - wrote Carter Worth, Technical Analyst for Cornerstone Macro Research and regular CNBC contributor, in a Strategy piece for Cornerstone
<The Biggest Surprise of 2016>
"The End of the World is like the Cubs winning the World Series" -- unattributed quotation
The Bigly Surprise of 2016
@RealDonaldTrump #Election2016 #TrumpPence16
America joined the Populist wave rippling around the world, and the Midwestern voter, at the margin, rejected the clear hands-down Establishment candidate, Secretary Hillary Clinton.
<The Failure of Polls and Polling>
<The Failure of the Betting Markets>
The Conventional Electoral College Math going into Election Night
Populism Perked over 100 Years Ago when American Farmers were caught in Tough Deflationary Times
William Jennings Bryan may have been the Original Celebrity Politician and he was the Democratic Nominee for President in 1896, 1900 and 1908.
In my opinion, to understand 2016 and what may happen in the year beyond, we must try to understand 1896 and what happened in the years after.
- Cyrus McCormicks's Mechanical Reaper greatly increased harvesting efficiency and later led to invention of a self-propelled harvester in 1871
- Steam engines (later gasoline engines) improved tilling efficiency
"American farmers have often expressed dissatisfaction with their lot but the decades after the Civil War were extraordinary in this regard. The period was one of persistent and acute political unrest. The specific concerns of farmers were varied, but at their core was what farmers perceived to be their deteriorating political and economic status."
Echoes of 1896
"The Middle Class is Losing Ground"
Populism Failed in 1896 when Democratic Candidate William Jennings Bryan (the "Cowardly Lion) lost to William McKinley.
The "Cross of Gold" Speech is one of the Greatest Oratorical Moments in American History. In our Twitter world, this original celebrity politician would have set the world on fire as #CrossOfGold would have been amplified 100 million times or more in Social Media. The Message of The Cross of Gold was under-powered by the speed of Analog communications.
Instead, the Democrats lost. Although the Populist agenda did influence reforms pushed by Progressives in future years, as a Political Movement, populism withered.
So, despite the historical significance of the late 19th century Populist Movement, we lack any historical precedent for a Populist President.
During Election Night
After markets closed and with CNN turned on around the country, all of a sudden, county-by-county election returns mattered a great deal. North Carolina was the first hole in the dike. Mrs. Clinton had a 5% lead in North Carolina, as measured by every poll in the Real Clear Politics database. The Polls were wrong. Trump beat the Polls by over 5% and captured 15 electoral votes. Markets noticed . . .
After Election Night 2016
- Inflation Expectations Have Increased in a dramatic reversal from the lowest forward inflation expectations on record
- Nominal Interest Rates Have Increased such as the 10-year Treasury where yields have risen from 1.5% to 2.5%
- Dollar is Strengthening For the third time in 18 months, the Dollar Index has risen above 100
- U.S. Equity Markets are Setting All-Time Records
Inflation Expectations are Rising
Regarding Inflation, it is the Expectation of Future Inflation that matters. In Finance, one common measure of future inflation expectations is the "5-year, 5-year" which is what the market thinks the Five Year Inflation Expectation will be . . . In five years.
Wall Street dealers, Central Banks and other Financial Institutions use the 5Y5Y as a reference price for complex financial transactions.
Interest Rates are Rising from Generational Lows, Ending A 30+ Year Secular Decline in Interest Rates
Last Generation, Controlling Inflation was the primary challenge of the Federal Reserve.
When Paul Volcker became Chairman of the Fed in August 1979, Inflation was running at 15%. Volcker's Monetary Policy was to raise the Fed Funds Rate (then 12%) to 20% which also resulted in the 10-year interest rate (depicted below in yellow) to peak at 16% in 1981.
In recent years, the 10-Year Treasury Yield has dipped below 2%, in line with lower inflation expectations. Since the Election the 10-Year rebounded to 2.5% but has since retreated.
The U.S. Dollar will follow the path of the 10-Year Interest Rate. All things equal, higher U.S. interest rates (versus rest of the world) will drive dollar strength as Investors buy Dollars to buy U.S. Treasuries (as well as U.S. Stocks)
Mapping the U.S. 10-Year Treasury Yield (white line) with the Strength in the Dollar Index (red line)
The Dollar Index Peaked in 1984-1985. By 1982, Volcker's Fed pushed the U.S. Into Recession. My best guess is that recession quickly dampened inflation as well as future inflation expectations. Lower inflation makes Bonds more valuable, so as soon as inflation came down, U.S. Treasuries became generational buying opportunities.
The U.S. Dollar Index = 75% Europe + 25% (Canada & Japan)
Consumer Confidence Has Improved
The University of Michigan Consumer Sentiment Survey
The Conference Board Consumer Confidence Survey
Car Sales in the U.S. Have Surged to an All-Time Record, with the Strongest December recorded, all happened after the Election
- Inflation (not Real Growth) This risk is best explained by James Bianco, of Biano Reseach. Jim asks the $4 trillion question: Is the market going up due to expectations for Real Economic Growth (in other words, "Are things really better"), or is the market going up just because of Inflation?
- China Currency Peg and Potential Devaluation (in fact, the Federal Reserve lift-off may put pressure on other Dollar Pegs
- Geopolitical
CHINA
Remember when all of the discussion was around China's hoarding of US Dollars and its massive pile of U.S. Treasuries?
Slowing Growth for China is Bad, Bad News for "Stability"
China has maintained a Dollar Peg (in various forms) since 1983, thereby tying China's interest rate and monetary policy to the U.S. Federal Reserve.
- Blue Shaded Area = China Exports to the USA . . . The size of that blue shaded area in 2015 and 2016 is approximately USD $500 billion per year
- Red Dashes and Red Boxes = CNY Renminbi Exchange Rate Renminbi has been weakening. In the beginning of 2015, it took 6.2 RMB to buy $1 US Dollar. By the end of 2015, it took 6.5 RMG to buy $1 USD. This is a 7-8% weakening of the Chinese currency, which is supposed to be "Pegged" to the dollar.
- Note that despite the RMB weakening to RMB 6.5 in 2015, Chinese Exports to the U.S. Were Negative (see the red shaded area) and that RMB continues to depreciate.
All is not well in China
The Wall Street Journal had an Extensive Feature on Passive Investing in the Q3 2016 Personal Finance Review
What is the Best Way to Make Money Investing during the Trump Presidency?
Forget Conventional Thinking, Stop Passive Investing, Invest in Companies, not Indexes
Empathy, Not Scorn. Midwestern Genius, Not Silicon Valley Genius
The Art of the Deal / Opening Bid / Make America Great Again
Bullish on Digital Worlds, Mobile Personal Computing
Bullish on Gold
(Gold requires, and I guess deserves, an updated Presentation)
Bullish on American Oil & Gas via U.S. Energy Policy
Envision American "LNG Diplomacy" with former Exxon Mobil CEO Rex Tillerson is confirmed as Secretary of State
The sub story here is that Senator Marco Rubio swallowed his pride and confirmed Rex Tillerson, disproving taunts of being #LittleMarco
One of my Best Ideas in 2016 = California Resources Corporation debt, purchased at Distressed Price of $40 (now trading $90)
Let's continue the conversation. Thank you for your trust and investments with us.