“Hubris is one of the world’s greatest renewable resources.”
-Humorist P. J. O’Rourke
As indicated last week, this is the second installment of a two-part Evergreen Virtual Advisor (EVA)—Exchange version—dedicated to the Mauldin Economics’ Strategic Investment Conference (SIC). It was held in Dallas at the end of last month and for the three days we were there, the sun wasn’t. The clouds were thick, the air was heavy, and, on the last night, we experienced the worst thunderstorms this Left Coast boy has ever seen.
Inside, as relayed in the June 3rd EVA, the conditions were largely the same. Gloom was the dominant sentiment, despite the fact that the financial markets have been on a roll over the past three months. It’s been a long time since I felt like the token bull but my brief speech on why I felt the corporate bond market would now be supported by central banks gave me a bit of a Pollyanna sensation.
My short talk also generated a mild amount of controversy. Former Dallas Fed President Dick Fisher told the crowd on the final day that there was zero chance the Fed would emulate the ECB in buying corporate debt to lower credit spreads. Though I have the utmost respect for Mr. Fisher, I would love to take that wager (what would the odds be when the probability is zero?) However, we won’t know until the next crisis strikes which one of us is right. According to the majority of speakers we heard, we won’t have to wait very long.
As Mark Nicoletti expressed last week, perhaps that should be viewed as bullish indicator. Typically, such intense negativity means a bottom is close at hand. Yet, again, we are at record high prices for real estate, stocks, and high-grade bonds. Consequently, like so many things these days, it’s a most confusing state of affairs.
Besides my talk, there were certainly some other occasional rays of optimism, as Jeff Dicks noted last week in his piece on Mexico. And, as I will explain below, our esteemed colleague Anatole Kalestky was also a lonely—though eloquent voice—of bullishness. On the other hand, his partner Charles Gave, was every bit as persuasive that the façade of prosperity central banks have created is beginning to crack. In addition to having my first chance to speak at the SIC, I was also given the honor of interviewing Charles, as you will soon read.
But, before we get to that, Jeff Eulberg summarizes his perception of one of the most important factors in the investment world today: the future path of the US dollar. Like all of us, Jeff came away a bit bemused by all the contradictory opinions on the greenback he heard at the SIC. It’s possible, though, based on last week’s stunningly weak US jobs release, that we now have a clearer sense of the path of least resistance. (Hint: it isn’t up!)
BREAK ON THROUGH TO THE OTHER SIDE
During his impressive presentation at last week’s SIC, Mark Yusko, the founder and Chief Investment Officer of Morgan Creek Capital Management, quoted a friend: “He longed for the days when he didn’t know the names of the world’s central bankers.” This statement struck a chord with me; it seems that forecasting the moves of the world’s central bankers is increasingly being used to achieve investment outperformance. I was amazed at the quantity of presentations at the SIC that focused on this topic. It seemed that nearly every question coming from the audience was focused on past mistakes of the world’s central bankers and the eventual direction of future policy decisions. Until recently, these policy decisions have played a large role in dictating the values of the world’s currencies. Central banks of struggling economies have sought to depreciate the value of their currency relative to rival countries, thus making their goods more attractive on the global marketplace.
In 2013, after years of quantitative easing designed to depreciate the value of the dollar, Ben Bernanke started to taper the program, reversing the dollar’s decline and sending it on a significant uptrend measured against a basket of global currencies. As we wrote extensively back then, this was a dramatic change for the global economy. As much as China would love to have an increasing share of global trade settled in its currency, the yuan (aka, the renminbi), over 80% of global trade is currently financed in US dollars. Therefore, the fallout of a significantly stronger dollar has had immense ramifications for the global economy, as well as for asset prices.
Over the last three years, the stronger dollar has played a significant role in sending oil prices down over 70%, causing commodities in general to decline over 45%, and S&P 500 earnings per share to drop more than 6% year-over-year. Further, throughout the developing world we’ve seen those emerging markets that have high US dollar-denominated debt experience crisis after crisis.
Yet, in the last few months, the dollar’s appreciation has subsided, triggering a substantial recovery in all of the risk assets mentioned above. Therefore, since every market participant seems to be focused on the next moves of the world’s central bankers, and with the high correlation seen with many asset classes to the dollar, forecasting the eventual direction of the US dollar may be the sole determinant to an outperforming portfolio in 2016.
Recently, our partner Louis Gave—who was one of the headline SIC speakers–wrote a succinct and well-thought-out piece on this topic for Gavekal Research titled Much Ado About Nothing. In it, Louis outlines three scenarios for the dollar.
1.) Economic data remains weak; the Fed sits on their hands; interest rates are not raised. (In this scenario the dollar likely depreciates.)
2.) The Fed hikes in the near future but remains dovish about future rate increases in 2016. (In this scenario the dollar would likely remain range-bound.)
3.) The Fed hikes and forecasts further rate hikes in the near future. (In this scenario, the dollar likely starts a new uptrend and the assets that have recently recovered—like energy—will turn back down.)
For the last 12 months, Evergreen, as well as our research partners at Gavekal, have been a few of the lone wolves calling for the dollar rally to end. After attending SIC, and as Louis mentions in his piece, it seems that the consensus is that Scenario 3 is inevitable. Our good friend, Grant Williams, founder of RealVision TV and author of Things That Make You Go Hmmm, is firmly in that camp. During Grant’s panel discussion at the conference, he expressed his belief that the dollar rally is merely taking a breather and the ascent is about to regain steam. Brian Lockhart, the Chief Investment Officer of Peak Capital Management, took it one step further and proclaimed that the Fed will not only raise interest rates in June, they will also raise rates two more times in 2016. If that does happen—with no other central bank even close to raising interest rates, and in spite of the increasing US trade deficit—the dollar rally would likely induce a considerable unwinding of recent gains seen in energy, gold, commodities, and emerging markets.
Honestly, I left