Muhlenkamp December 1, 2016 Webinar [Transcript]

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Is the economy back to pre-recessionary levels? Your answer may depend on what data you use and how you define your terms. Jeff and Ron Muhlenkamp walk through over 20 economic charts from foreign currencies vs. the dollar, to their 10-point checklist they use as a guide.

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Muhlenkamp Webinar Transcript

Tony: Good afternoon everyone and thank you for joining us for today’s presentation. My name is Tony Muhlenkamp and I’ll be hosting our webinar this afternoon. Our goal today is to share our thoughts and observations about the current economic and market conditions that we are seeing as we prepare for a number of things we see coming down the pike. Particularly the opportunities we think will be available to active value managers like ourselves as a result of the recent shifts to passive investing and changing stock valuations. As different stocks rotate in and out of value or in and out of favor, we expect that some things that were expensive will get cheap and some things that have gotten cheap may get more recognition and how are we preparing to take advantage of that?

Frankly, we are probably near the end or very near the end of a 35-year bull market in bonds. So these are things we’ve been preparing for. And frankly despite the market rallies you’ve seen since the presidential election, we think investors still face an investment mine field. So today our portfolio managers, Ron Muhlenkamp and Jeff Muhlenkamp, are going to talk about some of those mines, where they are located, and how we are working to navigate past them for our clients.

We will have time for questions and answers during the second half of our presentation. I will let you know how to submit questions at that time. So with all of that being said, Jeff, please go ahead and get us started.

Jeff: Thanks Tony. Good afternoon everybody.

This is the rough agenda we are going to follow. We’ll start with currencies and global rates because they will end up having a bearing on a lot of the topics that we will cover later on in the discussion. So it’s important to give you the context in which decision makers are making choices when they weigh what to do with their money.

For most of the charts, we will actively discuss just the last couple of years, but we will include on the chart a much longer time frame, so again, you have the context with which to view what has been going on lately.

Just a little side note, I’m going to use the pointer here, the mouse has a laser indicator—a little red dot—so, I’m going to use that to help focus your attention on the portions of the chart that we are talking about. With that said, we’ll go ahead and get started.

Above is a chart of the exchange rate of four different currencies against the dollar. Red you have the Chinese renminbi, blue the Japanese yen, in green the euro, and the British pound is in brown—all of them since 2005. The rates have been normalized with 2005 levels equal to 100. So when the plot goes down that means the dollar is strong against that foreign currency—one dollar will buy you more of that currency than had been the case.

I want to focus on two time periods…the first is early 2014 to mid-2015—during that period, the dollar strengthened against the renminbi, the euro, and the pound (the big one being the euro), but not the yen. The strong dollar reduced overseas sales by about 5-10% for the U.S. exporters and U.S. companies that had large overseas portions of their company. It was a significant topic of discussion for many of those companies during their earnings calls. I highlight that to you because, in fact, the dollar and the movement of the exchange rates does matter to companies that we pay attention to and, in some cases, own.

The second period is from the end of 2015 until today, where the dollar is strengthening against all four currencies. This has not yet hit corporate earnings, and it has not yet been the topic of conversation on earnings calls, but if the recent strength of the dollar continues, I expect that it will become a topic of conversation and will become a drag on earnings and revenues.

Two other things that I would highlight—both of them have to do with the Chinese renminbi. In August 2015, the Chinese renminbi dropped overnight against the dollar. That was coincident or perhaps triggered a 10% correction in the U.S. stock market. A very similar event happened in January 2016, the renminbi dropped against the dollar and once again the U.S. stock market corrected. In January, there were also some additional concerns that the U.S. was entering a recession because of other things going on. Since then, the renminbi has continued to fall to levels far below where it had been during either of those two drops, and yet the markets have not seemed to care. I don’t know if that continues going forward or not. It’s something we are keeping our eye on.

Finally, I’d like you to remember that while a strong dollar reduces profits for U.S. exporters, it is a boon to U.S. consumers who buy goods produced overseas. So whether that’s a Japanese television, a Korean television, or French wine. You will get more for your money with a strong dollar than with a weak dollar. There are always two sides to a change—some folks benefit and some folks are hurt. A strong dollar will hurt our exporters and help our consumers.


This is an update of a chart we’ve shown a number of times before. The chart shows the nominal interest rates for government bonds with maturities from one to 30 years for a variety of European countries plus Japan and the United States. The green boxes are positive rates. Red boxes are negative rates. A negative nominal rate means that, at maturity, less money is returned to you than you originally lent, including any coupons that you may have received.

In Switzerland, for example, if you lend the government $100 for ten years at the end of those ten years, you would receive back $99.86. Lending $100 for ten years cost you fourteen cents! Negative real rates (which we’ll talk about on the next slide) are more common than you think, but negative nominal rates are, in my opinion, an historical aberration—we’ve never seen them before. We do think that negative nominal rates are causing massive dislocation in the allocation of savings by all those folks that normally save. So whether it’s you as an individual, or a pension fund, a bank, or an insurer—it causes them to completely rethink what they do with their money and some very strange things happen.

For instance, in Belgium, what you’ll notice is nominal negative rates out to five years. A lot of their mortgages are variable rate. So when rates went negative, banks started writing checks to the borrower, instead of the borrowers sending checks to the bank. Really weird things happening!


The above chart adjusts for inflation. So this is the very same chart you saw before except for now we’ve adjusted each of the rates for inflation in that local country. If it was green on the last slide but red on this slide, that means you’re going to receive your original loan back at maturity—at least in terms of the number of dollars that you received. However, inflation has eroded the purchasing power of the currency so you can actually buy less with it—inflation is eating up your returns faster than compounding interest is growing it.

These two charts illustrate the problem many savers are having on a global basis; they can’t get a positive return in safe government bonds like they used to and they are seeking that return elsewhere, whether that’s in junk bonds, dividend paying stocks, nontraditional assets…wherever they can find it. Money is being chased out of the traditional home, if you will, for a lot of savers because they can’t get the returns that they need to meet their economic requirements.

I’ll also highlight to you that the negative rates, both nominal and real, have been deliberately engineered by the central banks of the world. Their stated reason for doing so is to spur borrowing. The collateral damage is to savers, banks, pension funds, insurance companies—the natural lenders. Frankly, we think the cure has caused more harm than the disease, and continues to do so.

We are going to shift now from the global picture to the United States.

Ron: Just to bring that home a little bit…if people have been taught anything by their parents and others, over the years, it’s been “spend the income, don’t touch the principal.” During most of that time, you could get a 4-5% nominal yield on passbook savings, on CDs, and on money market funds which gave you a 2-3% real return. Those of you who are retired know that during the last decade, as your CDs rolled over and you tried to reinvest them at 4 or 5%, you got maybe 1-2%. So, there’s a whole lot of what’s been taught over the years that simply couldn’t be done in the last few years. And, if you have a financial plan that is more than five years old, it’s based on spending probably 3-5% of your assets every year which showed up as income. That hasn’t been doable for the last few years—it’s all been thrown out. The savers and retirees of the world know this. It’s also hitting their pension plan, most people don’t know that. If you go into pension plans, most of them have actuarial assumptions of 7-8%. Which might have been reachable when treasuries were at 4 or 5% and stocks did somewhat better—it’s been very hard to do that.

The last greater part of a decade has been very unusual. As Jeff said, it makes no economic sense to have negative interest rates. It’s very hard on the retirees and the savers to have low or negative interest rates. Hopefully, we’ve now turned the corner on that, where our central bank is starting to talk about raising rates. The markets themselves are raising rates a bit, but we are nowhere near out of the woods—we still have European and Japanese central banks pushing very low and negative rates.


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