“The biggest mistake investors make is to believe that what happened in the recent past is likely to persist.
They assume that something that was a good investment in the recent past is still a good investment.
Typically, high past returns simply imply that an asset has become more expensive and is a poorer, not better, investment.”
– Ray Dalio
Founder, Bridgewater Associates, LP
“As I was waiting to be introduced, I got the latest headline from the North Korean government saying ‘a super preemptive strike will reduce the United States to ashes.’ So we have that to look forward to.” Ian Bremmer said as he began his presentation yesterday afternoon at the iShares Multi-Asset Summit in New York City. “… [T]hat to look forward to.” The crowd laughed. I was looking forward to his presentation and it didn’t disappoint. He continued,
Seth Klarman: Don’t Underestimate The Power Of Uncertainty
Since founding his investment partnership in 1983, Seth Klarman has offered a stream of wise and timeless commentary on markets and the craft of investing. His commentary from periods of market volatility is incredibly insightful. Klarman's letters to clients around the time of the dot-com bubble and financial crisis in 2008/09 contained timeless insights on Read More
On the one hand, there is a level of absurdity to the headlines on geopolitics these days, on the other hand, if we really were to think about it, the uncertainty of the geopolitical environment for the market place is higher than any of us have experienced in our professional careers…. Never in my career before would I have stood in front of you and said I think the greatest uncertainty in the medium-term comes from the geopolitical side.
I would have said there’s a hot spot here, worry about this, here’s a headline you don’t need to worry about, that generally the macro geopolitical environment is pretty stable, it isn’t really going to affect the way you think about investing. I can’t say that anymore.
Is the risk of an event 5%, 10% or more? Bremmer said he didn’t know and said, “It isn’t 1%.”
To say there is little geopolitical event risk would be naive. The tremors appear to be everywhere. At the same time President Trump was having dessert with Chinese President Xi Jinping at Mar-a-Lago in Palm Beach, he was bombing Syria. Russia’s taken a Trump u-turn. From North Korea to the French elections… Brexit, China, Turkey, Russia and Trump. Ian gave us a tour around the world as he shared his insights. It was thought-provoking. It was important.
You’ll find a summary of my high level notes below.
Seek gain… manage risk. Investing is a game of risk and risk management. It’s about compound interest. It’s about the Merciless Mathematics of Loss. Today we find ourselves late in the business cycle and while the S&P 500 could most certainly gain another 20%, asset prices are not cheap, the business expansion cycle is aged, the system is leveraged up and the Fed has turned course.
To manage risk, absent no other process in place, the simple 200-day moving average stop-loss rule can help. I’m trying my hardest to prepare my clients for the next great opportunity. I recall the same in 1998 (I was early) and again in 2007 when I felt Freddie and Fannie might collapse and that no-doc mortgages and Wall Street-engineered, AAA-rated subprime mortgage junk was just that: junk. I wrote a piece in December 2008, “It’s So Bad it’s Good.” Problem is it got even worse, it was two months later before it got great.
In late February 2009, I crossed paths with a wealthy friend. He was racing into a large wirehouse brokerage firm. My friend was sure that his custodian was the next Lehman Brothers. He was in a state of panic. He was not alone, investors were in panic mode everywhere. As margin debt unwound and selling accelerated, few buyers were found. It was an outstanding buying opportunity, as we know today. Valuations were cheap and the forward 10-year returns were signaling mid-teens like opportunity. But few saw it that way.
I haven’t shared this with you before, but one of my great personal and professional failures was not being about to keep my father from panicking that same February in 2009. It hurt him and it hurt me. We were always close and that remained, but the sting lingered heavy. A few days before he passed (April 19, 2011), I was laying with him in his hospital bed. We had Starbucks coffees in hand and the Masters on TV. Just the two of us huddled together as we sipped and watched. Out of nowhere he reached to me, held my face and said, “I am so sorry, please forgive me, I was scared.” I thought this long ago healed but it hadn’t. We hugged and we cried. I am grateful for that moment.
Dad was retired. We had a large percentage of his money invested in our high yield trend following strategy (a moderate risk strategy). Those monies were risk managed and did well. The smaller allocations to a diversified mix of private hedge funds declined. That was the scary stuff. He sold everything at the low and missed not only the HY re-entry trade but the recovery of the markets. An advisor friend of his put him in a fixed annuity. Ugh. It still stings.
Risk management sets in place the ability to seize great opportunity. But absent mental preparation and game plan, there is no opportunity.
“You don’t get rewarded for taking risk; you get rewarded for buying cheap assets. And if the assets you bought got pushed up in price simply because they were risky, then you are not going to be rewarded for taking a risk; you are going to be punished for it.” – Jeremy Grantham, GMO
“There is a simple, although not easy, alternative [to forecasting]. … Buy when an asset is cheap, and sell when an asset gets expensive. … Valuation is the primary determinant of long-term returns, and the closest thing we have to a law of gravity in finance.” – James Montier, GMO
“Rule No. 1: Most things will prove to be cyclical. Rule No. 2: Some of the greatest opportunities for gain and loss come when other people forget Rule No. 1.” – Howard Marks, Oaktree Capital Management
A special hat tip to Lance Roberts for sharing the quotes in a recent MarketWatch piece.
Buy when cheap and sell when expensive. Hard to do. Takes patience. If you’re 30 and have many years to invest, put it in a smart beta equity ETF, use the 200-day stop-loss exit and entry rule and keep saving and adding to your position. I advised my daughter, Brie, to follow dad’s Ned Davis Research CMG U.S. Large Cap Long/Flat indicator (posted each week in Trade Signals) to trade her firm’s large-cap equity ETF when it launches. Until then, use a low fee S&P 500 ETF or smart beta ETF. She can afford to take that targeted risk. If you are a pre-retiree or retired, well, you (and me) just don’t have the same runway. Risk manage your long-term equity exposure and add more diversification. Utilize trading strategies that diversify to asset classes. Risk manage everything.
As I wrote in a Trade Signals post a few weeks ago, Ride, Captain Ride Upon Your Mystery Ship… The equity market trend continues to lean bullish. Let the trend be your friend, but know that forward return expectations are low and global debt and leverage are exceedingly high. It feels to me like it’s 1999 all over again. Another 20% to the upside may very well be in the cards, but the move is aged and like then and always, “Most things will prove to be cyclical.”
The next great buying opportunity remains in front of us. It’s not today. Let’s get to it in a healthy way and be prepared to act.
Grab a coffee and find your favorite chair. I share my select notes from Ian Bremmer’s outstanding presentation. I found his comments on Putin and Trump particularly interesting. You’ll find those near the end of the Bremmer section.
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Included in this week’s On My Radar:
- Ian Bremmer – 90 Days In: Clues for the Future
- Trade Signals – Equities: No Progress since March 6. Bullish Trend Signals in Fixed Income
- Personal Note
Ian Bremmer – 90 Days In: Clues for the Future
Following are my high-level notes from Bremmer’s iShares Multi-Asset Summit presentation:
- I (Ian) think the greatest uncertainty for the markets in the medium term comes from the geopolitical side.
- Not that I think that war is likely but it isn’t unthinkable (Straits of Hormuz, U.S. and Iran, the North Korea situation, the impact of U.S. vs. Russia or visa versa and the use of cyber attacks and the potential of escalation).
- The risk is low but it is real.
Ian’s presentation goal was to present the structural reasons that is going on that ties all of these things together.
- We are entering a “geopolitical recession” – his new term.
- The last time we had a bust cycle in the geopolitical environment was World War II (a geopolitical depression).
- Since then, it effectively has been an era of what he calls Pax Americana (Marshall Plan, Japan-U.S., Soviet Union falls apart… leading to an American-lead global agenda) – That’s all kind of just unwound.
- Globalization is continuing but Americanization is not.
- There are lots of reasons, much self-imposed, that we could have expected this would happen.
- Look at the U.S. – post 9/11 the massive overreaction of the U.S. Two failed wars in Iraq and Afghanistan … 2.5 million American men and woman having fought in those wars, coming back not feeling like heroes, incredibly expensive, Veterans Administration not working well… I (Ian) was not surprised that a large majority of those people and their families ended up voting for Trump and not Hillary.
- There was a large group of Americans saying, “Do not be the world’s police force.”
- There is another group saying “We don’t benefit from globalization.” NAFTA didn’t help us, Trans Pacific Partnership… not going to help us. Might help the economy, might help Wall Street but it won’t help me.
- The U.S. really used to need the Middle East for energy. Suddenly, we’re the swing producer. How much do we really need to care about what’s happening in places like Saudi Arabia and Iran?
- So there are these structural reasons why we are entering into a global geopolitical recession: economically, technologically and from a defense perspective… a lot of Americans are saying we don’t want that global role.
- We no longer want to support this multi-lateral global architecture that, by the way, we created after WWII.
- And then you have the fact that the most important global alliance the U.S. has in defending this global architecture is the Transatlantic Partnership that is at its weakest point because of Brexit, because of the populism, because of the unprecedented refugee crisis across Europe, because of the unprecedented terrorist threat across the continent of Europe.
- For all of those reasons, which was making the U.S.-lead globalization stronger suddenly was unwinding.
- Then we have China. China rising. Second largest economy in the world is the one country in the world today of size with a global economic strategy. Building global economic architecture… one belt – one road, the Asian Infrastructure Investment Bank, the China Development Bank, which is large in what they invest than the World Bank and the IMF put together.
- This is all useful from a global economic perspective but they don’t co-exist easily or happily with U.S.-lead institutions. Because of course the Chinese are not trying to support rule of law, they are not trying to support liberal democracy, they are not trying to support global free markets.
- They are not interested in multilateral rules, they want bilateral deals where they can have more influence one on one.
- Very much in economic decline. Their economy is smaller than Italy and smaller than Canada.
- But from a cyber perspective (according to the head of the CIA), Russia is now a peer of the U.S. That wasn’t true a year ago.
- From a nuclear capability and military capability, the only country that holds a candle to the U.S. is Russia.
- Lead by a man, Putin, who is actively trying to undermine the influence and the footprint of the U.S. globally on the security side.
- Both by indirect warfare and direct warfare in the case of Syria and the Ukraine.
Economic Nationalism, Security Nationalism
- For all of these reasons, you would have expected the U.S.-lead global system was going to unwind and indeed I (Ian) had been saying that for the last six years. It came faster than I expected.
- The election of Trump, with an explicit endorsement of an America First policy (which is not isolationist)… but it rejects we are doing these things for allies and says we are doing these things for us. It’s actually a very Chinese like foreign policy.
- The election of Trump made a lot of people who were questioning under the Obama administration if the U.S. had their backs now say to themselves we need to actively hedge.
- Ok – now a new chapter in the geopolitical world but who is going to replace the U.S. in the leadership role. If anyone were to, it might be Angela Merkel but their answer to that question is “no.” There is nobody.
- Is anyone going to replace the U.S. as the world’s policeman? If anybody were, I guess it would be Putin. So in other words the answer is “no.”
- Is anyone going to replace the U.S. as the global architect of trade? If anyone were it would be Xi Jinping. He gave a speech in Davos that sounded like it came from a U.S. representative. So it would be China but nowhere close to the role that the U.S. had been playing so the answer is “no.”
- This means we are in an environment that leadership doesn’t exist, so to the extent that we have a shock, the same degree of safety we might have in place isn’t as strong.
- Ian provided an example of the World Health Organization that is only getting half of the funding it received five years ago, you are probably not going to respond as effectively to the next global health outbreak (e.g., Ebola).
- If the U.S. and China don’t have the same level of engagement, you probably won’t respond as effectively to the next H1N1 outbreak.
- Name your crisis, health, economic, war… the geopolitical resilience is much less than it used to be.
So that is one set of things to help us understand why we are seeing the headlines today. But there is a second set of things – if this one is not top down macro but actually bottom up from the people:
- We have an increasing large set of people who look at their government and say, “not fit for service.”
- Not legitimate, not effectively representing me. The social contract is broken.
- Seeing it in England, the U.S., France, Spain, Italy, etc.
- How are you letting these refugees in when you’re not taking care of me.
- Some is coming from technology worker replacement.
- All of the established governments are getting weaker, except Germany due to the relative success of their middle class. No election concerns from far right movements there…
The big point here is that you have a structural weakening of governments in most of the developed countries (“not fit for service”) at the same time the U.S.-lead global order has unwound.
- This at the same time you have strong leadership in China and India with Modi. Globalization is still working for them… for now. Though Ian believes within 10 years as technology replaces workers, they will experience the same angst workers in the U.S. feel globalization has done to them today.
The above concludes Bremmer’s big picture macro view as to why over the next year we are going to continue to see more and more of these geopolitical headlines that will support increased instability and volatility. This is not because of Trump. This is systematic not causal.
On France (Frexit?)
- The markets are way too comfortable that Le Pen can’t win.
- Ian would bet on not Le Pen but he thinks she is close to 50/50.
- Does this mean Frexit – no. She will not be able to get support for a referendum, but she will be able to influence other areas that will make the markets punish France, which could lead to a crisis on its own – so I (Ian) would worry about that.
On Germany and UK
- Not worried about Germany.
- Theresa May’s move for snap elections very smart, very bold. It helps her with the bilateral negotiations with the EU. It makes Scottish independence a little less likely, assuming she does well and picks up a few more seats in Scotland.
- There are risks, she is way ahead in the polls but that could change.
- It still means hard Brexit in a few years, but he believes the markets are likely to react favorably.
- The other big risk in Europe is Italy.
- The Five Star Movement probably wins next year but won’t be able to form a government so more of the same there… Italy doesn’t produce good governments.
- Meaning it is unlikely they gain control to govern.
On North Korea
- First of all, we need to recognize that North Korea is becoming a greater threat.
- We’ve been ignoring them for 20 years, now they can miniaturize nukes and put them on long range missiles. They can hit Alaska and Hawaii. All true, but if they were to do so, we could most likely shoot it down and it would be the end for all North Koreans, so I don’t think that is a decisive risk.
- Pakistan has nukes and they are potentially much more dangerous.
- But also keep in mind that the North Korean’s just hit the Central Bank of Bangladesh for $81 million. They broke in through the SWIFT system. They tried to get $1 billion. Sloppy work kept them from getting the billion but they did get $81 million.
- North Korea’s cyber capabilities are vastly greater than the U.S. assessed them to be just three years ago.
- There is a very real cyber capability that makes them both an economic and a security threat to the U.S. well before we talk about the nukes.
- So when you have a Clinton administration, a Bush administration and an Obama administration who have essentially kicked the can down the road and you ignore a problem this big for 20 years and you have the world’s only remaining totalitarian state with at 10 nukes minimum, major ballistic missile capabilities, extraordinarily well militarized across the South Korean border and cyber capabilities… some things are going to happen.
- If you ignore a problem that big in your body for 20 years, you’re probably going to die.
- The fact that we’ve ignored this for so long means the Japanese and the South Koreans have a real problem right now and the U.S. has some too.
- This is a bigger deal than has been treated by the press and the U.S. has reported.
The fact that Trump took action on Syria while having dessert with the Chinese president in Florida was a really big deal. It sent a message to North Korea. And Ian thinks that Xi took it seriously.
- Ian believes the Chinese are more willing to deal with the seriousness of the threat and will unilaterally take greater action against North Korea because of Trump.
- Things like cutting of flights, reducing oil imports, others.
- Will this be enough to neutralize them?
- Ian believes there has to be an Iran type deal. Current U.S. policy is they need to de-nuke. That’s like Obama saying Assad must go. This when the Russians are supporting him militarily. That’s the exact analogy with North Korea and China.
- The U.S. is going to have to find a way to allow a normalization of NK having nukes. NK de-nuclearizing is actually suicide for them. Not going to happen.
- NK is willing to take risks. They assassinated Kim Jung Un’s half-brother when he was under the protection of the Chinese government. They did it anyway.
- So if you think you will hit them economically, they’ll remove their nukes – it’s just not going to happen.
- Ian believes an Iran-like deal that suspends further research and allows in inspectors, that helps them economically in ways that lift the leadership, their families and their people.
- What we need to watch is do we start to see the beginnings of an offer. Not just the stick but the carrot.
- If not, in a few years the U.S. will probably engage in a direct strike against NK.
- NK’s military parade last week was a smart thing. They were saying that don’t think we can’t quickly strike if you strike us.
- Ian thinks there is a deal to be done. We’ll have to give them some stuff that we don’t want to give them because they are evil. If that doesn’t happen, then our allies will be very vulnerable and their markets don’t reflect the risks.
- With Trump not declaring China a currency manipulator, we do start to see the beginnings of executive orders on steel dumping, etc. China has been much softer than many people expected.
- Keep in mind Steve Bannon taken out of the primary role on China is positive. He was the single most hawkish guy on China. He wanted a fight with them now.
- Commerce Secretary Wilbur Ross is leading trade and is hawkish on China. American corporations doing business in China are not happy.
- The general trajectory for the U.S.-China relationship is negative but not perilously so.
- Xi Jinping is stable. Strong leadership and in control.
- The most positive thing out there for markets is a stable China.
Final point on Russia
- When Trump came into office, he clearly wanted a favorable relationship with Putin.
- The fact that Trump doesn’t support the global push for U.S. exceptionalism is something that Putin likes. He wrote an op-ed in The New York Times four years ago that reflected how much this gets to him.
- So there were reasons why Trump would want to fix the U.S.-Russia relationship, but there were also reasons that were less legitimate like the fact that people like Mike Flynn and Carter Page and Paul Manafort were on the payroll of the Kremlin and were parroting talking points for Trump that were supporting a Kremlin line and now there is an active FBI investigation looking into those things. I fully expect that you’ll have at least a couple members of Trump’s former team being indicted as a consequence of this.
- So Trump’s ability to step forward on his Russian agenda is not viable right now.
- Russia state media was pro-Trump… not anymore.
- Fighter bombers flying near Alaska again, a statement.
The Russians in hacking the DNC and putting that information out… there is one thing we also know is that they also hacked Trump and the RNC.
- If Putin starts getting upset, expect to see that information come forward.
- He will put out the information he has and that will prove problematic.
This is the biggest issue Trump has faced in his first 90 days and it’s not going away soon.
Trade Signals – Equities: No Progress since March 6. Bullish Trend Signals in Fixed Income
S&P 500 Index — 2,342 (4-19-2017)
The Zweig Bond Model moved to a buy signal this past week and the weight of evidence for the equity market as measured by the Ned Davis Research CMG U.S. Large Cap Long/Flat Index remains bullish. Our bond signals are both bullish: the CMG Managed High Yield Bond Program remains on a buy signal. Tactical Fixed Income sees the strongest relative price strength in muni bonds and emerging market sovereign debt. Our Tactical All Asset Index sees strong relative strength in fixed income and emerging market equities (pie chart of positions below).
Both the long-term and short-term gold trend indicators are in buy signals (suggesting some exposure to gold). Investor sentiment remains excessively pessimistic which is historically a short-term bullish signal for equities.
On the economic front: from both global and domestic perspectives, risk of recession remains low, however, risk of inflation is elevated and warrants regular monitoring.
Click here for the charts and explanations.
It’s been a whirlwind of a week and I missed my annual cold beer toast to my old man. I feel him with me from time to time and yes, I do speak to and send my love often (and to mom). I believe it lifts them. I know it lifts me. So tonight with cold beer in hand, I’ll do my annual toast though it won’t be his favorite Michelob Ultra. It’s a cold Victory Hop Devil held high in the air for me.
I fly out early Monday morning to Sonoma, California where I will co-host an advisor event with my friends from Peak Capital. Wine country… No Mich Ultra there. Dallas follows on May 15-17 and then I will be in Orlando on May 22-25 for the Strategic Investment Conference. The Orlando lineup includes David Rosenberg, Dr. Lacy Hunt, Mark Yusko, Neil Howe, Ian Bremmer, David Zervos from Jeffries and, of course, my good friend and conference host, John Mauldin. You can learn more about the conference here.
Susan is in Boston this weekend coaching her soccer team and the boys are heading to visit their cousins at Penn State. I told them I’m sending “Igor” to shadow them. Igor is a make-believe character I created long ago. I told them he works for me and his job is to keep a close eye on them. They believed me in those early days. Matt is a rising PSU freshman, which makes his Penn State crazed dad pretty proud. Both he and Kyle better be drinking unspiked Kool-Aid. Igor’s watching.
Here is a toast to those you have lost. May they walk with you always.
Have a great weekend!
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