Morningstar ETF Conference: Bernstein, Yusko and West : Deutsche Bank – Troubles Surfacing

Morningstar ETF Conference: Bernstein, Yusko and West : Deutsche Bank – Troubles Surfacing

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.

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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.


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.


  • 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.


  • 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…


  • 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.


  • Here is the data on that:
    • Over the last 20 years, if you bought and held a stock index fund, you made 8%.
    • If you bought and held a bond index fund, you made 6½%.
    • The average institutional 60/40 mix returned 7.5% (per year).  Do you know what the average investor made?  3.4%.
    • They buy what they wish they had bought, hold it for three years and then they sell it when it goes down.  They then buy what they wish they bought then sell when it goes down and they keep doing it over and over.
  • It is so hard to commit.  There is this exercise program called P90X.  The mantra is decide-commit-succeed.  It’s a 90-day program.
  • The average person stops at day 18.
  • If you don’t make it to 90 days it does no good.
  • The same thing goes for investing.  If you can’t decide and commit to a 6- to 9-year time horizon for a strategy, it is not going to work.

A question was posed to Yusko.  He was asked his thoughts on commodities and energy.


  • Exxon Mobil might be the most dangerous stock on the planet right now.  It has traded for 35 years at a 12 P/E.
  • Do you know what the P/E is now?  30!
  • Because all of the money that has gone into low volatility ETFs and cap weighted energy indices.  It is not an oil company.  It is a diversified conglomerate.
  • But true energy companies… like did you see the story about Apache and the new find in the Delaware basin that could be worth $10 billion to that company?  That’s just Reeves County and it doesn’t count Pecos County, which is just below it, which is even bigger.
  • There is more oil in the Permian Basin and the Delaware Basin than there is in Saudi Arabia.  We just didn’t know how to get it.
  • Technology has opened up the most unbelievable opportunity that we have seen for many, many years.
  • He spoke to an active oil trader located in London (hedge fund guy) and asked him what does he do with his personal money outside his fund.  He said all of his money not in the fund is invested in private investments in the Permian Basin in Texas.

SB – If you are curious like me, here is where that area is located (red area)…


  • Oil is a commodity that is very cyclical and people go to extremes. 1998 was the last time it was this bad.
  • Then, the cover of the Economist said the world is awash in oil… no one should ever buy oil again.
  • Oil was $11. The article said it was going to $5 and even mentioned that someday it could be free.
  • Yusko put 5% of UNC’s endowment in oil and gas. That 5% generated 25% of the return for the next decade.
  • Today we are at the same kind of opportunity set.
  • The key is you have to be at the right basins, you have to be with the right technology providers and you have to be with true E&P companies and not big integrated companies that make profits on refining and servicing and processing.
  • The thing about commodities is that the cure for low prices in commodities is low prices. 90% of coal companies have gone out of business.
  • The iron ore companies that are left are going to make more money.
  • You make lots of money when companies survive.
  • I am a little more bullish on natural gas than I am on oil (but bullish on oil). We think it is a tremendous time to be an investor in commodities and cyclicals because people don’t appreciate the cyclical nature of commodities.


  • Best ideas in portfolio construction?
  • Rich was asked how gold figures into his portfolio. He began by saying, “I am not a gold bug.”  But when do you buy real assets?  It’s at the time that inflation expectations are about to go up.
  • Well, guess what’s happening? Inflation expectations are starting to go up, so we have put gold into our portfolios because it is one of the ways to play the change in inflation expectations.
  • In our multi-asset portfolio, we are always balancing out the risks of our portfolios with different investments that have low correlation with other assets.
  • Gold used to have a high correlation to equities, but now it is slightly negative. It allows us to play the change in inflation expectations and it allows us to diversify our diversifiers in our multi-asset portfolio.


  • This is the time to get real assets. We consider all real assets and gold is one of the real assets.
  • There are only four things we can own in this world: stocks, bonds, currencies and commodities.
  • Everything else is a derivative of those four things.
  • Hedge funds are not a thing, mutual funds are not a thing. There are stocks and bonds and currencies and commodities.
  • You should own a little bit of each and that’s what we do.
  • We run a fund based on global tactical asset allocations.
  • The one thing that people forget about is cash. I think one of the greatest assets on the planet now is cash.
  • Everybody hates cash. You can’t pay managers to hold cash most say.
  • In a recent letter, Yusko recounted a conversation he had with Seth Klarman [founder of the Baupost Group]. One of Seth’s investors called him telling him he is worried he is paying Seth 2% and 20% of profits and you’ve got all this cash.  Seth said, “You think you’re paying me to hold cash?  I’m happy to send you your money back tomorrow (even though his investors can only get out once a year).  You think you’re paying me to hold cash, you are paying me to know when to hold cash, when to invest, when the risk-reward is right.  You think you are paying me to hold cash then get out of my fund.”  The investor said, wow…wait I’m not saying I want to get out.
  • The amazing thing is these guys at Baupost have compounded wealth at 16.4% net of fees for 33 years. There have been three negative years.  The key is they did it with 30-40% cash at all times.
  • People would say how did you return that much with all that cash. One of the former employees said, “We don’t return 16.4% in spite of the cash, we return 16.4% because of the cash.”
  • Because what cash does is it keeps you calm. And it forces you to only swing at the fat pitches.  Being fully invested is a myth.  You shouldn’t always be fully invested.

Yusko was asked about his portfolios:

  • “Right now we’ve got close to 65% in cash.”
  • One of the reasons to hold cash is that you believe that the opportunity set going forward will be more attractive than the current.
  • Our view is that equities, over the next 12 months, is going to give us an opportunity to buy them at a discount.
  • The other problem is bonds. Traditional fixed income here (U.S.), corporate bonds.  Someone just issued a corporate bond at negative interest rates.  Are you kidding me?
  • One last point on cash. When there is nothing to do, do nothing.  There is no law that causes you to have to be fully invested.
  • There may be some day that requires you to be fully invested in your 401k’s and “buy government bonds” (a laugh from the crowd), but right now there is no law.
  • If there is nothing to do, do nothing, especially if you don’t like the valuations of stuff.


  • We don’t like the valuations of developed market stocks.
  • We do like the valuations of emerging market stocks, so we are nibbling there, and we like gold, so we are nibbling there too.


  • On the role of alternatives in their larger portfolio allocations:
    • This is a way to add diversification in your portfolio. We see it as a place to put money in place of cash.
    • Things like long/short strategies, unconstrained bond portfolios. Things that are looking for additional structural sources of excess returns.  Unconstrained strategies.
    • Momentum and value for example can provide good sources.


  • In talking about investors buying in at market tops…
  • Yusko added, “Human beings are herd animals.”
  • There is no question that buying REITs in a falling rate environment with lots of people clamoring to buy REITs and not enough commercial real estate has been a fantastic investment, bar none, the best investment over the last 10 years.
    • It has beaten the heck out of the stock market, beaten the heck out of the bond market and I would have been wrong a year ago saying it was over.
    • At this point, I would say it might be one of the riskiest places around.
    • And when interest rates start to rise, there will be massive liquidations.
    • But the thing I’m more worried about though is that in bubbles we tend to see really stupid stuff.
    • To that end, there are mutual funds in Japan that pay 25% yields.
    • Do you know how they do that? Well, they buy U.S. REITs that pay 4%.  Do they then leverage it 6 times?  Oh no, much worse.  They issue new shares to pay out the old shareholders.
    • That is a Ponzi scheme. And there are billions and billions and billions of dollars in Japan in these funds, and they are just like these non-traded REITs.  They are a Ponzi scheme and they work until they don’t.
    • Dividend stocks are in a bubble. Their valuations are in a bubble.
    • PepsiCo – volumes are declining, profits are only stable because they reduced the share count by borrowing money (increasing their debt) to buy back shares. That’s just financial engineering.  It’s not real.
    • So, this mania, and I’ll call it a mania, and I will call it a bubble or this chase for yield has created the riskiest assets you could possible own. (emphasis mine)

SB (Blumenthal) again:

  • I’ll conclude by saying that almost every investor I speak with is either buying or looking to buy REITs and other high dividend payers and high yielding ETFs.
  • My friends are buying this stuff. And buying it with great confidence.  This is concerning.
  • Don’t do it. This is going to end badly and I believe it ends sometime within the next 12 months.  Of course, our regulators and my compliance team remind me that past performance means zilch, nada, nothing.  No guarantees but death and taxes.
  • The dumb money is chasing into this stuff. The smart guys are saying don’t do it.

Use trend following strategies to help you diversify and better stay on the right side of the trade.  To that end, please read my white paper, Trend Following Works.

And build that shopping list and, maybe even more importantly, be prepared to act when the next dislocation creates the next great trade opportunity.  Or scale into what you like.  And don’t be afraid to utilize cash.  We most certainly do in our tactical all asset, fixed income and high yield strategies.

I have to find a way to get me some of that Texas oil.  “There is oil in them there hills.”  Remember Jed Clampett and the television show “The Beverly Hillbillies.”  “Oil that is, black gold, Texas tea…”  For fun, here is a link to the theme song and video.


Believe it or not, my kids really do read this piece.  To which I say, sorry guys for that 1970’s black and white TV show diversion.  Though I should make you watch it.  It was a staple in our house.

Deutsche Bank – Troubles Surfacing

I think DB is in trouble.  This is something I’ve had on my radar for months.  The fallout could be potentially systemic and widespread.  I share the following, which I received this morning, 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 Bank’s difficulties.  Without being dramatic, it seems DB’s recent equity woes are becoming more than 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.  Additionally, recent stories regarding German authorities’ concerns on DB warrant an analysis of potential positioning should such an event include an ECB backstop.

Our view is that if DB is required to raise more capital and needs governmental (and likely ECB) backstop, this could be a Euro negative event.  While DB equity options might be a reasonable play, we find that shorting the Euro a more affordable play and one that has several catalysts to make it viable.  Interestingly, both CDS on Deutsche debt and Libor spreads (See Ted Spread below) have been moving up over the past two days.  Both of these factors show a concern that would be wise to hedge.  With the recent Central bank activity supporting equities, we continue to bias tail risk strategy towards credit concerns.

— Jim Ryan and team, EAB Investment Group.

Ted Spread looks to have moved to widest level since Grexit fears:


In the “what you can do” category:  think about the trade idea as a potential hedge in your portfolio.  Call your advisor or if you’re an advisor, call your options team or send me a note and I’ll point you to a few people I trust.

Here is what my friend suggested to me:

Increasing the tail risk short on the Euro (FXE) as DB issues portend authorities’ action. Tail risks moving towards a Euro Bank led credit event for Germany and the ECB.

  • Short the Euro – FXE short
  • German and ECB action likely to shore up risk
  • Stress adds fuel to already sensitive Italian bank considerations
  • ECB action to provide liquidity and stability impacts Euro

Strategy: Buy December 107 Puts in FXE

Please note that I may put a trade on in my personal trading account next week, but I will size according to the rules I have in place.  This is not a recommendation for you to buy or sell any security.  Talk to your advisor about investment suitability.  Option trading involves great risk.  You could lose some or all of your money.  Never trade naked options.

The overall point is for us to remember that there are a number of systemic risks whether it is European Sovereign debt, a coming pension crisis, insurance companies who can’t match actuarial assumptions due to current ultra-low yields, China debt structures, Japanese 25% yielding Ponzi schemes or the bubble in the bond market.

I’d be far less concerned if valuations were attractive.  They are not.  But there is much we can do.  Stay tactical, stay hedged and stay patient.

Trade Signals – Bond Market Sell Signals

S&P 500 Index — 2,140

Posted each Wednesday, Trade Signals looks at several of my favorite stock, investor sentiment and bond market indicators.  It is my weekly risk management dashboard, designed to keep me better in sync with the major technical trends.  I hope you find the information helpful in your work.

Click here for the most recent Trade Signals blog.

Personal Note

Playing Quail Hollow Golf Club on Wednesday was an absolute treat, but meeting and listening to Coach Lou Holtz was priceless.

His message was about life.  Keep it simple.  Do right.  Stay optimistic.  We all have problems, but let’s not get stuck in them.  Find a passion and create something, find someone to love, be kind and don’t be bitter.  If you are bitter about something or someone, get over it… it is no way to live.

He told stories about his teams and he was funny and entertaining.  He is a man of faith but did not preach.  In his youth, one of his coaches had he and his teammates write letters to their parents.  Letters of appreciation.  Letters of love.  One day he found all of those letters he wrote in his mother’s drawer.  “A phone call lasts a few minutes, letters of love last a lifetime and are read over and over again.”  He is still coaching all of us today.

I thought of Susan and our children.  Do they know how crazy I am about them?  I need to write more letters.

When I approached Coach Holtz to introduce myself, I told him that I’m a former Penn State student-athlete and so enjoyed the competition between our schools during my time and the years since.  His school, of course, is Notre Dame.


We shared a private discussion about Coach Joe Paterno and the NCAA.  I know there is a lot of emotion around what happened.  So I’ll keep my personal thoughts to myself.  Yes, that other coach, not to be named because he disgusts me, did horrific things.  Let’s just say that I’m trying hard not to be bitter.  “Be kind and don’t be bitter”… thank you Coach.

And here is a special hat tip to Brian Hayes and his team in Indianapolis for hosting such an outstanding event.  If you are an individual investor located in Indianapolis and need a great advisor coach, Brian is a man of outstanding integrity, compassion and heart.

To my friend Danielle at Brookstone, there is oil in them there hills and there looks to be great promise in Alibaba, Chinese mobile companies, EM and cash.  Put a few ideas on your shopping list and be prepared to act when the getting gets good (a.k.a. buy the next crisis dip).

Next week I’ll be in NYC for the Bloomberg Markets Most Influential Summit then back home with less travel in October.  I’m looking forward to meeting hedge fund legend Julian Robertson Tuesday evening.  I’ll be taking notes!

If you find the On My Radar weekly research letter helpful, please tell a friend … also note the social media links below.  I often share articles and charts via twitter that I feel may be worth your time.  You can follow me @SBlumenthalCMG.

? If you are not signed up to receive my weekly On My Radar e-newsletter, you can subscribe here. ?

Finally, here’s a hat tip to you.  Thanks for reading.  And write a love letter to those you love most.  In some powerful way, I believe it lifts us all.  I know it does.

Wishing you a wonderful day.


Stephen B. Blumenthal
Chairman & CEO
CMG Capital Management Group, Inc.

Stephen Blumenthal founded CMG Capital Management Group in 1992 and serves today as its Chairman and CEO.  Steve authors a free weekly e-letter entitled, “On My Radar.”  Steve shares his views on macroeconomic research, valuations, portfolio construction, asset allocation and risk management.

The objective of the letter is to provide our investment advisors clients and professional investment managers with unique and relevant information that can be incorporated into their investment process to enhance performance and client communication.

Click here to receive his free weekly e-letter.


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