Stock Markets Beat Hedge Funds

Warren Buffet made a bet with a hedge fund manager that stocks beat hedge funds in the long run

Actually, all studies of the last 50 years about stock markets would have predicted the outcome of the bet.

Trump Cards: What Hand Have Investors Been Dealt?

Trump on economic policy

Thursday, November 17, 2016 wecbcast by Caroline Miller, BCA Research. She made following points:

• Infrastructure program and tax cuts will increase budget deficit
• Tax reduction will not give a lot of bang for the buck compared to government spending programs regarding GDP growth
• Fed pressured by Trump policy to increase rates, leads to USD strength
• Europe needs 3 to 4 years to return to growth, Europe will not match rate increase
• Japan has still low inflation
• China is exporting structural deflation (overcapacity)
• Dollar strength, Trump protectionism will hurt emerging Asia most
• High corporate debt level in emerging markets
• US Equity: no visibility of corporate earnings growth, wild card of Trump appointees
• US protectionism and backlash are a threat to growth
• US deficit will steepen yield curve
• Trump tax program will benefit small caps not multinationals

Investment recommendations:

• Underweight of duration in US bonds, preference of TIPS
• Underweight of peripheral european bonds
• Overweight of USD vs. EUR
• Overweight in pharma, staples, utilities (defensive stocks)
• Underweight in tech, industrials and commodities (cyclical stocks)
• Underweight in US vs. European equities: strong USD will hamper US profits. Profit margins are very high in the US historically and compared to Europe. They can't grow on that level

We have entered a new economic environment in the US.

Trump Cards: What Hand Have Investors Been Dealt?

Trump about economic policies

Thursday, November 17, 2016 wecbcast by Caroline Miller, BCA Research. She made following points:

• Infrastructure programm and tax cuts will increase udget deficit
• Tax reduction will not give a lot of bang on the buck compared to government spending programs regarding GDP growth
• Fed pressured by Trump policy to increase rates, leads to USD strength
• Europe needs 3 to 4 years to return to growth, Europe will not match rate increase
• Japan has still low inflation
• China is exporting structural deflation (overcapacity)
• Dollar strength, Trump protectionism will hurt emerging Asia most
• High corporate debt level in emerging markets
• US Equity: no visibility of corporate earnings growth, wild cards of Trump appointees
• US protectionism and  Backlash of US is a threat to growth
• US deficit will steepen yield curve
• Trump tax program will benefit small caps not multinationals

Investment recommendations:

• Underweight duration US bonds, preference of TIPS
• Underweight peripheral european bonds
• Overweight USD
• Overweight pharma, staples (defensive stocks) 
• Underweight tech, industrials and commodities (cyclical stocks)
• Underweight US vs. European equities: USD will hamper US profits. Profits margin are very high in the US historically and compared to Europe. They can't grow on that level

I really think that we have entered a new economic environment in the US.

Brexit: Anti-Globalisation Backlash and economic consequences for the UK

The reason for voting for the Brexit can be found in rising economic inequalities in Britain paired with unique British Euroskepticism. The US and UK experience higher inequality and a losing middle class because of their pronounced laissez-faire economic policy. Furthermore, the ordinary Brit does not think of him being European but British only. This is in stark contrast to continental Europeans.

The economic consequences of the referendum is very difficult to forecast, because Britain needs first to define the relationship it wants to have with Europe. Specifically, it has to think hard about what sort of compromises it is willing to make in order to have access to the EU single market. As a reminder, the EU wants for its free market access the right of people to move freely, which was the core argument of the Leave campaign. No free market access creates a big problem for some industries. For instance, many cars produced in Britain are exported to other EU countries. Toyota’s UK factory sells 80% to continental Europe, and a 10% levy on export would most certainly mean that production will move elsewhere. The City of London is relying on its EU passport for financial services which allows banks, insurers and asset managers to operate and offer products across European borders. With the passport gone, relocation of financial institutions to other financial hubs like Paris, Frankfurt, Dublin or Luxembourg would be likely. Even if Britain can keep the financial services passport it has now lost its influence over the rule setting process, which it had as a EU member. In the past it used that influence, to shape the regulation according to its interest.

I expect that enterprises will put many investment projects on hold until the the question of the access to the EU market is answered. Only the the plunge of the Pound lessens the pain of the exporters. But a weak Pound will increase inflationary pressure, and hence, will push interest rates up.

Larry Summers: Rates will stay lower for longer than you think

Today's FT has an opinion piece of Lawrence Summers:

Real rates in the US will only increase mildly because of the following reasons:

1. Real rates are trending down for 20 years.
2. As rates rise in the US, foreign capital is attracted which will strenghten the dollar and in turn reduces demand for traded goods.
3. Low rates have already pulled demand forward, resulting in lower levels of demand for the future (e.g demand for cars).
4. Regularitory pressure is inhibiting lending to small and medium sized companies.
5. Inflation is getting more difficult to measure as services such as healthcare where quality is hard to measure
6. Most importantly is that global growth outlook is too weak for a rate hike of the usual 300 - 450 basis points. The markets expect a more realistic increase of 100 basis points.

Central bankers have less tools in their cupboard than they assume.

Investments and Demographics

BCA Research has published a special report about the economic implications of an aging global population:

• Global population growth has nearly halved over the past forty years and the labor force is expanding very slowly. 
• Health among the elderly in the OECD has been improving, but not quickly enough to compensate for the secular impact of aging.
• The reduced labor force participation rate among the 16-24 age cohort is reflective of deep social changes that won’t be easily reversed.
• A smaller potential workforce will not turnaround the slowdown in real wage growth because of technological destruction.
• An aging population and economic growth in the developing world will create an almost insatiable demand for health care services and products.
• Entitlement will increase as government revenues will be under pressure. Taxes have to rise.
• A more serviced based economy will have less need for energy.
• A smaller workforce means also a slower growing economy, as Japan is already experiencing.

BCA November Forecast

Latest Forecast from BCA:

• The monetary tailwind for global equity prices is strengthening, but the earnings support is weakening.
• It might be necessary to inject more fiscal policy into the mix to rekindle activity.
• Learned behaviors are still supportive of risk assets and more QE in Europe/Japan can be expected.
• Even if the Fed does raise rates in December we doubt more than one or two more will be in the cards.
• Stay neutral on equities, but position defensively and remain long duration in the bond markets.

BCA September Global Market Outlook

Keypoints of BCA Research's latest Report:

• Markets are expecting too much of policymakers who are behind the curve.
• The Fed is unlikely to raise rates in September, given the recent market volatility.
• This is not just a repeat of the 2013 taper tantrum as it reflects very real concerns about global growth.
• Stay neutral on equities, overweight in Japan and Europe and underweight in the emerging markets.
• Further fiscal ease in China and additional exchange rate depreciation would be a game changer for both the emerging market and global view.
• A non-technical recovery, driven by improved perceptions of global growth, could produce a sustainable recovery in high-beta sectors such as Energy, Materials and Industrials.

Outlook Q3 2015 (BCA)

BCA Research has hosted yesterday a webcast and focused on two hot spots of the global economy:

• China: The meltdown of equity prices in the past weeks was dramatic, but stabilized in the last few days and, the market is still up 44% year to date.
  
  Shenzhen Stock Exchange A Shares (ThomsonReuters)
  
  Only a small percentage of the population is invested in the stock market, so the influence on the real economy will be negligible. However, the economy is slowing down because of sinking exports, which is bad for commodity and energy exporters elsewhere. Moreover, commodity exporters are suffering from increased production capacity globally. Thus, stay underweight emerging markets, commodity/energy producers, and other importers to China.
• Greece / Europe: The impact of the Greek economy is of no importance to Europe and much less globally. The real question is: Is Greece an outlier or an omen for bigger problems in the Euro area. So far facts are inconclusive: On the one hand, only Greece suffered a depression and a contraction of nominal GDP of 25% in the last 5 years, which could lead to the conclusion that the tragedy in Greece is an exemption in Europe. On the other hand, one could argue that the high debt in Italy will depress Italy's future growth, because of the austerity measures that will be implemented to bring down debt. With Italy's size this would pose an existential threat to the Euro.

Implication for Asset Allocation:
Small overweight of stocks relative to bonds, and favor developed markets over emerging markets. US equties are expensive relative to European and Japanese stocks. Although Japanese stocks profited from the yen devaluation, the are heavily exposed to China. Furthermore, stay overweight defensives vs. cyclicals because global growth is slowing.

BCA Research on Greece

Marko Papic of BCA Research has sent out today a short report about implications of the greek crisis:

• Greece can  cause a correction in the context of high valuations (in the US) and upcoming Fed tightening.
• Things that went wrong this weekend in Greece? Policymakers are playing a “two-level” game, with domestic politics influencing international bargaining. As with previous euro area crises, market and socio-political turbulence is required to get policymakers to overcome domestic opposition.
• There is no timeline for future events. The key date going forward is the €3.5 billion redemption Greece owes to the ECB on July 20. That is it.
• The ECB will pull the plug on Greece:if the July 20 payment it is owed is not fulfilled.
• The upcoming referendum is not a vote on euro area membership: The referendum is important, but a ‘No’ vote does not preclude an agreement. Athens has two weeks between the July 5 referendum and the July 20 ECB redemption to get a deal. In fact, the odds are in favor of a ‘Yes’ vote.
• Greece would exit the euro area by printing drachmas.
• ‘Grexit’ could not produce substantive contagion beyond sentiment. It is a source of volatility in the short term, but a buying opportunity for European peripheral equities in the long term.
• Greece woud not be better outside the euro area.
• Geopolitical you Ramifications of the crisis: Positive for European integration, negative for Greece, and neutral for Russia.
• Investors should  prepare for short-term volatility, and look for long-term opportunities

Morgan Stanley Outlook 2015

Morgan Stanley published couple a days ago an investment strategy outlook for 2015:

• The Cycle Has Further to Go: Improving growth, bottoming inflation and supportive central banks are supportive for risky asset classes. They do not see a problem with high valuation in contrast to James Motier of GMO.
• And consequently, they argue "Equities: It Ain’t a Bubble Yet".
• They prefer developed equities over emerging equities. This is in contrast to other researcher who argue that Asia is cheaper than the US, and hence has to outperform.
• FX: significant USD gains.
• Underperformance of long treasury bonds of developed governments because their yield is on a historic low.

The graph below sums it up nicely:

MS Cross Asset Allocation 

Personally, I would be a bit more carefull. High valuations can cause easily accidents, and be neutral on US stocks!

High Frequency Trading: The Goldman boys leave the party

In today's Financial Times John Gapper writes (3.4.14), why Goldman sells his Seat at the New York Stock Exchange : The boom in high frequency trading combined with dark pools is over. Due to increased competition, profits are down massively. While the leading trader Tabb Group 2009 recorded revenues of USD 7.9 bn, the revenues for 2014 will shrink to estimated USD 1.2 bn.
Moreover reputational risks are rising: Michael Lewis managed to gain huge publicity with his new book"Flash Boys". And the FBI, the SEC, and New York State attorney general Eric Schneiderman are investigating. There is a lot of indication that even trades of big institutional investors are being front run and markets are manipultated on a big scale.

Time for Goldman  Sachs to say goodbye. They have not only a great sense for profit opportunities but also master risk management like nobody else.

High frequency trading was a typical Wall Street "Boom and Bust"!

The well bred contradict other people. The wise contradict themselves. (Oscar Wilde)

Today's presentation by Arthur Budhaghyan, Chief Emerging Market Strategist at BCA Research, has been negative on Emerging Markets overall. He is contradicting other analysts or editors of BCA research:

• China suffers from over investment (in real estates and heavy industries), and hence, profitability has been falling for couple of years. Also, the Chinese government will be more market oriented in the future and letting bankrupt countries fail. Most likely the government will introduce fiscal and monetary stimulus, should the economy seriously tank, but it will be rather lagging. This could hurt exporters (of commodities, capital goods and luxury goods) to China. Capital good exporters are Japan, Korea and Germany. 
• Russia: The fall of Russian stocks was an exaggeration of discounting geopolitical risks. But a slow down of China could depress oil prices and hurting the Russian economy.
• Brazil: Could enter recession, because Brazilian banks have to many non performing loans in their books (Brazilians are over indebted and the economy is already slowing).
• India suffers from under investment, mainly because of the lack of the populations financial savings. The country has entered a phase of zero growth. Arthur is only positive on India's IT sector, which exports to the US.

Valuation: Although valuation (P/E, P/B etc.) of emerging markets stocks are low, it is only because of the heavy market weight of badly run state companies which deserve low multiples.

BCA Long China, Short Treasuries and Long Europe

BCA Research just finished its  webcast on China, the US Fed and Europe .

China
The market is for China too negative. Although the Chinese government is determined, to let fail some smaller institutions, it would never risk its growth target of 7.5% p.a. by having a Lehman-like situation.
Please keep in mind China's currency reserves of USD 3.8 trillion and the high central bank rates which are at the government's disposition should a hard landing scenario become more likely.

The Chinese central bank has a lot of room lower rates

Fed / US Treasuries
The market is too complacent concerning the 10-year treasuries and the Fed rates. BCA also assumes that the first rate hikes will take place in June 2015, but they think that money market rates will increase swiftly thereafter; much more than the markets expects.

The market expects a nominal rate  of 2.25% as of 2016. This implies a real rate of 0.0%, while it averaged 1.8% in the past

Thus, USD bonds exhibit a high potential for negative surprises, and duration should therefore kept short.

Europe
The strength of the Euro is based on big current account surplus and a shrinking ECB balance sheet:

The big current account surplus confirms that there is a big demand for Euros. The shrinking ECB  balance sheet proofs that the ECB policy is restrictive, while the US Fed is still pursuing a expansive policy.

The Sage of Omaha has spoken again

Warren Buffett's 2013 annual letter to Berkshire Hathaway shareholders is out.
Buffett bulleted five fundamentals of investing, which we paraphrase:

• "You don't need to be an expert in order to achieve satisfactory investment returns." But Buffett also warns that the investor should recognize her limitations and "keep things simple.
• "Focus on the future productivity of the asset you are considering." Buffett notes that no one can perfectly forecast the future profitability of an investment. "[O]mniscience isn't necessary; you only need to understand the actions you undertake."
• "If you instead focus on the prospective price change of a contemplated purchase, you are speculating." Buffett has nothing against price speculation. But he emphasizes that it's important to be able to know the difference between investing for the productivity of the asset versus investing on hopes that the price of the asset changes.
• "With my two small investments, I thought only of what the properties would produce and cared not at all about their daily valuations. Games are won by players who focus on the playing field -- not by those whose eyes are glued to the scoreboard. If you can enjoy Saturdays and Sundays without looking at stock prices, give it a try on weekdays." In other words, focus on the long-run.
• "Forming macro opinions or listening to the macro or market predictions of others is a waste of time. Indeed, it is dangerous because it may blur your vision of the facts that are truly important." So mute CNBC, Bloomberg TV, and Fox Business. Unless Warren Buffett comes on.

Ben Graham: "Investment is most intelligent when it is most businesslike."

Copied from businessinsider.com. Read more: http://www.businessinsider.com/warren-buffett-2013-shareholder-letter-2014-3#ixzz2uigWv5N8

Forget Cyprus: Low Competitivness and High Unemployment Are the Real Drag

Lots of media space is given to the crisis in Cyprus. The real problem however, is the low competitiveness of Southern Europe. The chart below taken from the FT, displays the low unit labor costs of Germany against the rest of Europe.

Meditereanan countries used to devalue their currency once a while in order to regain competitiveness. After the joining the European Currency Union they no longer have this economic policy option. The result is rising labour costs, lower competitiveness and higher unemployment rates (see chart below):

Looking at the chart above, I do not see any solution of the Euro crisis any time soon!

BCA roundtable, 21st of March 2013: US Investment Strategy

I attended this morning a presentation of BCA about the US macro environment. That's what Mark McClellan had to say:

US growth should accelerate Q4 2013

US  is following a “Classic cycle” after a housing and credit bust (US is solid line; other countries dashed line)

… after the bubble breaks, the recovery is usually slow.

US can still disappoint if austerity measure kick in two front loaded in Q3. But BCA expects that congress will strike a watered down deal. Also state budgets are all balanced now, apart from Illinois.

In 2014 the growth should be strong!

US interest rates: Beware

Fed policy has changed: While the Fed historically increased rates 6 months before the anticipated closure of the output gap, they will only increase rates at the time were the gap is actually closed. The Fed hereby risks consciously an overshoot of inflation of 3 to 4% in 3 to 5 years years.

According to BCA calculations the markets imply in its forward rate, an increase of 0.14% per Quarter instead of a 0.25% increase expected by BCA (due to inflation pressure).

The likelihood of a bloodbath in bonds in the coming years is therefore high. 

US Equities:

The equity risk premium has been high in the last few years. It willl eventually come down because of higher multiples (increased stock prices) and higher inflation (which will drive nominal bond yields up).

However in 3 to 5 years, when inflation hits its peak the outlook for equity is bad:

As long as inflation is no problem the Fed can always counter a market shock by throwing tons of liquidity. However, once inflation is here Bernanke's options are limited. The time for the Bernanke Put will be over!

US Dollar

Due to strengthening economy the dollar could move upwards in the short term. Long term the Dollar will trend downwards, especially against the Euro. However, asked about the crisi in Europe. He ducked the question by referring to his colleagues covering Europe. 

Gold

Fair value between $ 600 and 1100. Inflation has to be at 18% for 5 years to justify current gold price.

Gold shot up 2005, and is significantly above inflation (CPI)

Even when measured against real rates (TIPS yield, displayed on an inverted scale below), BCA thinks Gold is in dangerous territory, since bond yields could jump suddenly

But… I sat during the presentation next to a senior analyst of the Swiss National Bank, and he confessed that the bown up money supply of the worlds central banks is frightening (see chart above. We are in uncharted water and central banks have no exit plan for QE. This could mean that we have huge inflation at the end, and rocketing gold prices!!!

Returns of Investment of Passion

There has been an interesting article about investments of "Ultra High Net Worth Individuals" (i.e. the super rich  in the weekend edition of the FT. The graph below contrasts the returns of collectibles versus gold and  real estate.

Following trends are interesting to note:

• On the collection side, classic cars did much better than fine arts, although fine arts remains of course the most popular "investment of passion". Overall, collectibles enjoyed an outstanding performance over the last 10 years.
• Within each collectible segment there can be strong price swings, which can be caused by following development:
  Inexperienced investor tend to to inest in secure big names, but as they grow more confident they expand beyond the security of big names.
  At first, this leads to a strong increase in big names and then to a strong drop of those big names. 
• A big shift of wealth is occurring from the old world (Europe and the US) to the new world (Asia, BRIC) 
• Property prices exhibit this shift.
  While property prices in New York only increased 72% over the last 10 years, prices in Hong Kong tripled. 

An important detail to keep in mind is the fact, that collectibles make up only 4% of the super rich's asset.

Also, Bob Shiller stated that a home is not a good investment in general, since the value of a building is depreciating over time:

BCA Webcast: Geopolicy and asset allocation

This is a rather technical piece about geopolitics and asset allocation.
On February 19th, 2013, BCA has held a webcast about "Global Asset Allocation/Geopolitical Strategy Forecast":
USA
Less policy risk due to bipartisan collaboration (although politician still make a lot of noise with extreme positions, behind the scene they are compromising). Normalization of interest rates (i.e. rising interest rates from today's super low levels) is not anticipated by markets today, and could cause problems in the future. Rising yields are bad for bonds, equities and gold.
Europe
France's problem (low productivity) is hiding bhind Italy and Spain. The implementation of structural reforms in Italy in Spain is unsure as their governments are very weak (Monti is gone and Rajoy is weakened by accusation of corruption). But GDP  could grow as austerity policies cease and as exports to growing China and USA rise.

Asset Allocation
We are in a liquidity driven bull market, so don't be underweight equities, especially cyclical stocks (keep your beta high). But liquidity rallies tend to turn around quickly. Hedging with puts on equity indices is prudent. Moreover, we are priced for perfection.
Currencies: Every country is trying to strengthen economic growth by weaken their currency (beggar thy neighbour policy). EPS growth will be influenced as well as the value of respective bond positions.

Central banks are no longer independent

In an interview the  former chief economist of the ECB and monetary hawk, Jürgen Stark made some interesting remarks about global central bank policy:

Central banks (in the US, Europe, Switzerland and Japan) are flooding the financial system not to avert deflation but to support economic growth and decrease interest rates of over indebted government. Hence, there policy is no longer independent. The chart below show the explosion of money supply. Only the central bank of  Japan did not increase its balance sheet (yet), but this might happen soon, as the new PM Abe is demanding a weaker currency.

Today, central bankers are trouble shooters for non-monetary problems like weak economic growth, high unemployment and the burden of interest payments for over indebted governments, which is increasing the bankers power enormously.

The result of the monetary flood is financial repression (i.e. savers lose out due to interest rate not covering inflation anymore) and bubbles in various asset classes (e.g. bonds, swiss real estate etc.).

At the moment the increased money supply is not inflating consumer prices because the liquidity is not fueling the real economy (the liquidity is contained in the financial system fueling asset bubbles). But once the transmission works again and prices increase, it is doubtful whether central banks are willing and able to reduce this monetary sea in due time. In that case we will face substantial inflation!

To protect your investments you have to find real assets which are not yet in bubble theory. As indicated, real estate could be the wrong place to be!