In his letter to investors for the first quarter of fiscal 2013, Mark Yusko, chief investment officer and CEO of Morgan Creek Capital Management shared his opinion on the current situation of the market and his outlook. Morgan Creek currently manages approximately $6.7 billion in assets. Below is a brief summary from Mark Yusko followed by the full shareholder letter.
According to Mark Yusko, “some political and economic challenges are timeless and we have been doing the same thing over and over for decades and expecting different results.” He used some of his favorite episode titles from the “The Rocky and Bullwinkle” television show in discussing the current condition of the market. The show features the character of two spies, Boris Badenov and Natasha Fatale. It is about the current events, economic, market conditions, political and social satire during the height of the Cold War.
Similar to the episode, “A Fault in Vault or Banks a Million,” which suggested the world economy became so dependent on box top refunds that enabled Boris and Natasha to sabotage the world through counterfeiting. Yusko emphasized that there is nothing new in the world and the QE appears as a substitute for box top refunds.
“Many commentators might say that printing fiat currency without limit is a form of counterfeiting and that global Central Bankers are "nogoodniks" just like Boris and Natasha,” wrote Yusko. He added that a “small” inflation is necessary and change word Million to Trillion (and actually Quadrillion in Japan) in the episode title. He also emphasized that given the huge numbers of the QE, he said, “We may find out soon that there is a fault in the vault.”
“Boris Goes for a Broke, or A Fiend in Need, Is a Fiend…Indeed,” in this episode, when fiends Boris and Natasha get desperate, the situation turns from bad to worse. According to Yusko, the situation perfectly describes the existing condition of the Europe wherein the neediest peripheral countries will become increasingly desperate as unemployment skyrockets, capital flees the banking system, and confidence in the entire Euro experiment wavers. He pointed out the when someone is in serious need; the person might resort to fiendish behaviors.
Further reading Morgan Creek Memo to Clients on The Great Rotation
Mark Yusko wrote, “We are beginning to see the unraveling of social fabric in places like Greece and Cyprus…and Spain and Italy appear to be teetering near the edge. Let’s hope that they don’t go for broke all at the same time, as a broke Europe will be expensive for U.S. given all the loans to the European banks from Mr. Big himself (Ben the Banker) which might suddenly go missing.”
“Squeeze Play or Invitation to the Trance,” Yusko said that lowest trading volume of the equity markets since 2008 should give us the reason to question the truthfulness of the claims that the global economic challenges are fixed, and the great rotation from bonds to stocks has begun. He pointed out that the frequency and severity of short squeezes was the primary cause of lower volumes, and it is the main contributor to the nearly straight-line appreciation of equity indices during the QE periods.
Mark Yusko said, “It is a short at your own risk” market environment when the Fed is doing an open market transaction of $85 billion a month, and described the daily levitation as very “trance-like.” He added, “Investment logic would dictate that the new liquidity from Japan would seek the lowest valued equities in Emerging Markets, Europe, and Japan rather than the U.S.” Furthermore he commented that the Global Titans in U.S. will likely get increasing amounts of flows, and just like in the years right after the show ended, we could see a new Nifty, Fifty of companies that sell at truly silly valuations…”
The episode, “Hello Orient or That’s Some Dandy-Looking China You Have There,” indicated that something is special in China and after 50 years, China’s economic development exploded & matured. It became the world’s second largest economic power.
According to Mark Yusko, investors can still find numerous opportunities or places to invest or deploy capital in China and earn outstanding returns such as the private markets. He said investors will still find a significant edge in private equities or real estate if they have local knowledge and relationships in the country.
Mark Yusko Is Bullish on China
Mark Yusko told its investors that Morgan Creek Capital is fortunate because it has strong team on the ground in China, and they continue to find "dandy" opportunities in private markets. They have tremendous relationships in public markets wherein they worked with a number of hedge fund managers whom were able to navigate volatility to generate strong returns over the past years. He emphasized that his firm increased its exposure in China and agreed on the recommendation of Tom DeMark to buy China-A Share Index based on his projection that it will increase by 48 percent within six months.
“Down to Earth or The Bullwinkle Bounce”- Yusko called the 130 percent rise of US. Equity markets since the 2009 crisis a Bullwinkle bounce citing that it is clearly a rocket fuel induced in terms of zero percent interest rates and massive amounts of QE. He notes that average forecasts call for a meager 2 percent returns for stocks.
In addition, Yusko said the recent excitement in the markets and the commitments of global Central Bankers to do whatever it takes is truly “Tough to Fathom” that we will experience a “Deep Six Dive.” He suggested, “It is a good time to force ourselves to imagine what the worst case scenario is” saying that business entities in Greece never contemplated that the GDP of the country will drop by 25 percent. Business owner never imagined waking up with 40 percent less cash in their bank account and no ability to access more than $5,000 per transaction.
Furthermore, he pointed out that the willingness of the U.S. government to extend help to the remote corners of the globe for decades and the current extension of massive amounts of credit to European banks is confusing. He raised concerns as to why the U.S. government wants to make their bad debt problem its problem.
Mark Yusko on Japan
Mark Yusko notes that the U.S. equity markets were not the best performers in the first quarter, and his firm had “materially more exposure in Japan", the best performer during the quarter. Morgan Creek Capital became very bullish in Japan since November last year.
Mark Yusko pointed out that during the quarter, the Bank of Japan and Prime Minister Abe “did all the right things, and the Topix surged 10.8 percent in Yen and an astonishing 20.6 percent in Dollars.”
He also observed that the Defensive stocks (utilities, health care, and consumer staples) in the U.S Equities outperformed the usual leaders in a bull market (technology, energy, and materials) despite the fact that the quarter is in a fully risk on environment.
In terms of the global currency war, he pointed out that the two biggest losers of the continued weakness of Yen will be Korea and Germany. He projected the Korean Equities will be confronted with tough challenges unless its Central Bank will move to defend the Won. Japanese companies are expected to gain market share.
With regard to the commodities sector, Yusko said two factors are worth monitoring such as the potential for strong returns from commodities if the dollar were to resume its longer–term downward trend, the potential for strong returns if the rising global money supply actually lead to a rising inflation.
Yusko strongly believes that the best investment ideas is in the private markets where lower valuations, better information, management control, and lower level of competition still dominate. He concluded his letter stating the overall market outlook is in a state of confusion saying that companies with the worst fundamentals are rising the most again, countries with huge amount of debt, and huge banking problems.