Being fully invested is a myth.  You shouldn’t always be fully invested.

Mark W. Yusko, Founder, CEO and CIO

Morgan Creek Capital Management,

at the 2016 Morningstar ETF Conference

Last week, I shared some of my notes from the recent Morningstar ETF Conference.  I received a number of positive responses.  It really helps me to go back through my notes, reflect on what I wrote and summarize it in On My Radar.

I hope you find this week’s letter equally interesting as I share with you the remaining notes from the Best Ideas panel.  Mark Yusko stole the show.  He was direct with ideas, bold and clear on his forward outlook and, in my view, right on point.  I learned a lot and walked away with several actionable ideas.

Investor behavior matters, and I believe we should factor these probable tendencies into our game theory minds.  In short, it is best to go against the crowd at points of market extremes.  You’ll find that there was consensus on the panel that we are at the beginning of a reflationary environment and that will not be good news for the billions of dollars that have herded into high dividend paying stocks, funds and ETFs.

[drizzle]I believe we investors should always be putting together a shopping list of best ideas so that we are in a position to act when the getting gets good.  To that end, you will find some ideas below to start to consider (if you haven’t already).

Also, Deutsche Bank keeps bumping on my systemic risk mind.  Much like structured mortgage bonds, no doc mortgages and Fannie Mae and Freddie Mac did in 2007.  The following is from a smart trader friend of mine:

Counter-intuitively, Central Bank policies have created a more difficult environment for banks to improve net interest margins because QE policies have flattened yield curves.

In Europe, the ECB’s policies have also subtly allowed dysfunctional and toxic assets to remain unresolved as can be seen in the Italian bank problem and more recently in Deutsche Banks’ difficulties.

Without being dramatic, it seems DB’s recent equity woes are becoming more of an eyesore for German authorities and may overtake Italy on ECB examiner sights.  Obviously, the concerns around credit-worthiness are extremely impactful to collateral agreements as well as business continuity.

Adding this to the well-known ECB opposition to the Basel III enhanced capital standards heightens need to address DB issues… Both CDS and Libor spreads have been moving up over the past two days.  Both of these factors show a concern that would be wise to hedge.

— Jim Ryan and team, EAB Investment Group.

If none of that translates into English for you, simply think Lehman Brothers.  Click through on the orange “On My Radar” link that follows below.  You’ll find a hedge idea that I personally think makes good sense – pair it against certain long-term equity risk exposures you may have within your current portfolio.  Investing is a compound interest game and losing 15-20% is one thing.  Losing 50% is the killer.

I hope you enjoy this week’s post.  Last night, I presented at the 2016 Indianapolis Financial Forum.  Coach Lou Holtz was the keynote speaker and, boy, did I find myself mesmerized.  To that end, I conclude for you today with his inspiring message.

Grab a coffee and jump right in.

Included in this week’s On My Radar:

  • Morningstar ETF Conference Best Ideas Panel (Part II): Bernstein, Yusko and West
  • Deutsche Bank – Troubles Surfacing
  • Trade Signals – Bond Market Sell Signalsa

Morningstar ETF Conference — Best Ideas Panel (Part II)

Richard Bernstein (Richard Bernstein Advisors), Mark Yusko (former UNC Endowment CIO and founder, CEO and CIO, Morgan Creek Capital Management) and John West (Research Affiliates)

Last week, I shared Part I of my notes from the Best Ideas Panel.  You can find last week’s letter here.  Following is the second half of my notes presented in bullet point format.

Yusko:

  • McKinsey did a study:  The e-commerce segment in China, the next decade, is going to grow 26% compounded and there will be a lot of earnings there.
  • The mobile segment is going to grow 52%.  So, add this in, 1.52 to the tenth power… you get 66.  Not 66%, that means that that market is going to be 66 times larger than it is today.
  • So companies like Alibaba could double from here easy and it’s up 60% in the last four months.
    • It’s the largest e-commerce company in the world.
    • It’s approaching Amazon in becoming the largest cloud company in the world.
    • It is the largest payments company in the world.
    • It is a monster behemoth that we can’t comprehend.
    • The middle class in China is bigger than the population in the United States and Europe combined.

West:

  • What we are focusing on in emerging markets (“EM”).  Generally, long-term real earnings growth for publically traded companies is about 1.5% per year.  In emerging markets, you get 4.5% real (after inflation) annualized with the dividend yield that is closer to 3% than it is to 2%.
  • We next look at valuations to see if they are trading cheap or rich.  EM was trading at 10 (P/E) at the start of the year.  Now it they are trading near 12 (P/E).
  • Add in all the positive demographics and the tailwind that they provide and you compare that to a P/E of 12 vs. 25 here in the U.S.  We add it all up and we get a return of about 8% real annualized returns for the next 10 years in EM.
  • Now that’s the 10-year forecast.  We have confidence that EM will return plus or minus 2 or 3% above or below that 8% forecast (so a return range of 5% to 11% annualized) but the journey is what is the hard part.
  • We have no inclination as to what that journey to those returns is going to look like.  For the advisors that are able to walk their clients through the opportunity and have an honest dialogue and explain to them the 1% annualized real return forecast in the U.S. … so the hard part isn’t trying to figure out what returns are likely to be over the next 10 years, the hard part is actually getting clients to buy into it and make choices today.
  • And if they can’t do that, prepare them for 1% real (after inflation) annualized 60/40 returns over the next 10 years and tell them to save more.

SB (Blumenthal) here:

We work with thousands of advisors and see a broad range of strengths.  Unfortunately, we see many (not my readers, of course) selling what worked, chasing yield and I get it… it is hard to tell your client what is best and get them to move past the emotional tendency to jump in and run with the herd.  It’s hard for a doctor to get his heart patient to go on a diet.  The right message is hard for the consumer to digest.  Channel your inner Sir John Templeton.  “Buy when everyone else is selling and sell when everyone else is buying!”  They are buying high dividend payers and chasing yield.  More below…

West:

  • People jump back and forth between passive investing and active investing, chasing into recent winning managers.  Given that, most individuals will be lucky to get that 1% real return in the U.S.

Yusko:

  • Here is the data on that: