Friday, January 13, 2017

The Beginning of The End?

On Friday morning, Zero Hedge published a comment, Guggenheim: "3% Is The Beginning Of The End":
The debate over what yield on the 10Y spells the end of the 30 year bond bull market, and would spillover into selling among other asset classes, is heating up.

Earlier this week, in his monthly annual letter Bill Gross wrote that 2.6% is the only level for the market that matters: "This is my only forecast for the 10-year in 2017. If 2.60% is broken on the upside – if yields move higher than 2.60% – a secular bear bond market has begun. Watch the 2.6% level. Much more important than Dow 20,000. Much more important than $60-a-barrel oil. Much more important that the Dollar/Euro parity at 1.00. It is the key to interest rate levels and perhaps stock price levels in 2017."

Later that day, during his webcast with investors, Doubleline's Jeff Gundlach slammed Gross as a "second tier bond manager" for his "forecast", and countered that 3.0% is the magic number: “the last line in the sand is 3 percent on the 10-year. That will define the end of the bond bull market from a classic-chart perspective, not 2.60%” as Gross suggested. He then added that “almost for sure we’re going to take a look at 3 percent on the 10-year during 2017, and if we take out 3 percent in 2017, it’s bye-bye bond bull market. Rest in peace.”

Today, a third bond manager joined the frey when Guggenheim's Scott Minerd sided with Gundlach and said that 10-year yields could end their long-term trend if they rise above 3%.

“It’s basically the beginning of the end,Minerd told Bloomberg Television. “Long-term trends like this don’t reverse quickly,” he added, saying yields might spend several building a new base before taking off."

Minerd also said the Federal Reserve risks falling “behind the curve” on the U.S. economy and needs to raise interest rates in March, a step that markets see as far from certain. Futures trading implies a roughly 30 percent chance, according to data compiled by Bloomberg. The fund manager also said that while stock markets may be volatile as President-elect Donald Trump takes office, his policies ultimately can provide a “potent mix” for economic growth. The S&P 500 Index, now at 2270, is likely to end the year in the 2450-2500 neighborhood, according to Minerd.

However, he cautioned that markets continue to disagree with the Fed's dot plot signaling where rates are headed, which makes “the market is vulnerable to a tantrum."

Also, he said that "as the business cycle ages, in 2019, 2020 when we could anticipate we might have another recession, that there will be another deflationary burst that will bring rates back down if we do get above 3%, but we haven't violated that trend yet."

We have little to add to this pissing contest about whose prediction about the number that marks the end of the bond bull market will be right, suffice it to say that it truly is a bizarro world when some of the smartest bond managers are arguing over some squiggles on a chart.
I just got off the phone with the president of a major Canadian pension fund who told me that they had another solid year last year. He said they sold US Treasuries in mid-year when the 10-year yield approached 1% "because we didn't see any more upside" and right before Christmas were itching to buy some 30-year Treasuries when yields popped back over 3.3%. He added: "If yields on the 10-year Treasuries rise back to 3%, we'll be buying."

What else did he share with me? Stocks are somewhat over-valued here by a factor of seven on their scale, with ten being significantly over-valued. "This silliness can last a little while longer but people forget the same thing happened back when Ronald Reagan won the elections. Stocks took off then too but after the inauguration, they sank 20% that year."

No kidding! As I've repeatedly stated, most recently in my Outlook 2017: The Reflation Chimera, the best risk-reward in these markets is US Treasuries. I don't care what Bill Gross, Ray Dalio, Paul Singer, Jeffrey Gundlach say in public, in a deflationary environment, I would be jumping on US long bonds (TLT) every time yields back up violently.

Also, take the time to read my comment on the 2017 US dollar crisis where I painstakingly go over the main macro trends and why all that is happening right now is the US is temporarily shouldering the world's deflation problems through a higher dollar. There is nothing structural going on in terms of solid long-term growth.

What else? The global pension crisis is alive and well which is why I don't see yields on the 10-year Treasuries rising anywhere near 3%. Most smart institutional fund managers took my advice and jumped on US long bonds when they yield on the 10-year hit 2.5%.

Below, Guggenheim Partners Global CIO Scott Minerd discusses the bond markets. Is it the beginning of the end for bonds? No, if yields rise, global pensions are going to be snapping up US long bonds like no tomorrow, capping any significant rise in yields. Ignore all the rubbish out there.

Thursday, January 12, 2017

Scandal at Korea’s Retirement Giant?

Bruce Einhorn and Heejin Kim of Bloomberg report, A Scandal at Korea’s Retirement Giant:
With 546 trillion won ($456.5 billion) in assets, South Korea’s public National Pension Service is the world’s third-largest pension fund, behind Japan’s and Norway’s. It’s also become a part of the widening scandal surrounding impeached President Park Geun-hye.

On Dec. 31, a Seoul court issued a warrant for the arrest of Moon Hyung-pyo, chairman of the NPS. He was suspected of having pressured the fund, when he was a government minister, to support the controversial merger of two Samsung Group-affiliated companies. Moon’s lawyer said the chairman denied the allegations, according to reports in Korean media. Authorities also want to know whether Samsung made donations to benefit a confidante of the president in exchange for help getting NPS support. Jay Y. Lee, Samsung’s heir apparent and de facto leader, was summoned to be questioned as a suspect on Jan. 12. Both Samsung and Lee have denied wrongdoing. The NPS has said it supported the deal based on investment considerations.

Established in 1988, the NPS is Korea’s main public retirement plan and a major investor in the country’s blue-chip companies, owning 9 percent of Samsung Electronics, 8 percent of Hyundai Motor, 10.3 percent of LG Display, and large stakes in other prominent companies. Its potential influence as a shareholder makes it a natural target for pressure from politicians seeking favors from the corporations in its portfolio. The scandal has “created huge risks to the integrity and legitimacy of the NPS,” says Katharine Moon, a political science professor at Wellesley College.

As the fallout from Park’s impeachment spreads, some lawmakers are looking into reforming the pension service. The alleged use of the fund’s investment clout to advance politicians’ agendas “can bring doubts on Korea’s capital markets overall,” says Chae Yibai, a National Assembly member from the opposition People’s Party. “We need to discuss the matter of the independence of the investment management unit from the control of the government, like overseas pension funds,” he says.

Despite its size, the NPS often takes a passive approach in its relations with the chaebol, the family-run conglomerates that dominate Korea’s economy and have close ties with local politicians, says Woojin Kim, an associate professor of finance at Seoul National University. The fund’s management structure contributes to its low-key approach. The NPS has three decision-making bodies to provide public input into investment decisions, but “none of them is formed of members with knowledge of asset management or pension funds,” says Kim Sang-Jo, a professor of international trade at Hansung University in Seoul. Instead, officials from business lobbies, labor unions, and civic groups dominate the committees, and “they have little power or interest in decision-making on important issues at NPS,” says Kim.

The NPS has occasionally taken a more active role, particularly when the government has the lead on an issue. In early 2016 the fund announced plans to blacklist companies that didn’t follow Park’s directive to raise their dividend payouts, part of her effort to get chaebol to reduce their cash hoards and return money to shareholders through dividends or to workers via wage increases.

The NPS has recently felt some pain from a government-dictated relocation of its headquarters to Jeonju, a sleepy provincial capital about 125 miles south of Seoul. During her campaign for president in 2012, Park pledged to help redevelop the southwestern city. More than 30 fund managers, including about 20 in charge of overseas investment, have left the fund rather than relocate, according to the NPS.

By focusing public attention on the tangled relationships among the government, the fund, and business, the turmoil may ultimately help the NPS achieve one stated goal: to invest more outside Korea. “The Korean stock market is going to be too small for them,” says Michael Na, a Korea strategist with Nomura. “More and more of the money will go overseas.” Foreign investments account for less than 150 trillion won, about 27 percent of its total assets, but the NPS wants to expand its foreign portfolio to more than 300 trillion won by 2021. This year it plans to increase international holdings by about 25 trillion won, of which 10 trillion will go to alternative investments such as private equity or bank loans. The NPS in July picked BlackRock and Grosvenor Capital Management to manage as much as $1 billion in hedge fund investments. As for local stocks, the fund “will cautiously approach investing in domestic markets for this year,” spokeswoman Chi Young Hye says.

Moving beyond Korean equities wouldn’t only reduce the risk of political meddling but would also potentially improve investment performance, says Moon of Wellesley. That will be essential as NPS fund managers face the task of supporting Korea’s aging population. “They know the math,” she says. “There will have to be a push to diversify and decrease the overinvesting in a small number of companies.”

The bottom line: Korea’s public retirement plan is a major shareholder in the country’s most important companies, and its chairman has been arrested.
So, what else is new, a scandal at a large national pension fund with paltry governance? How shocking!

Sorry, I'm still in a crabby mood and recovering from the flu with off and on low grade fever but I decided to write on this because it's just another example of a large pension fund -- in this case, the third largest in the world -- where lack of proper governance leads to political interference and corruption.

South Korea’s National Pension Service should first and foremost get its governance right. It should relocate its headquarters back to Seoul (nobody worth anything will want to live in Jeonju) and hire a top-notch consulting firm like McKinsey or Boston Consulting Group to make a series of recommendations on how it can bolster its governance, adopting Canadian pension governance standards.

In Canada, there is is a clear separation of pension investments and governments. Instead, most have an independent qualified board overseeing the operations at these pensions where decisions of where and how to invest are made solely by senior pension fund managers that are paid extremely well to run these organizations.

Is it perfect? No, it isn't and there is always room to improve on governance, but it's a lot better than having your national pension fund run by a bunch of corrupt cronies who are looking to line their pockets.

The thing that gets me is the part of Korea's NPS allocating a billion dollars to hedge funds and picking BlackRock and Grosvenor Capital Management.

On Wednesday, Bloomberg reported that BlackRock’s main quantitative hedge-fund strategies were on track to post big losses:
At least three of the quant strategies used by BlackRock’s global hedge fund platform have suffered losses greater than 10 percent in the year through November, according to the client update, a copy of which was seen by Bloomberg. That compares with an average return of 3.6 percent for quant funds, Hedge Fund Research Inc.’s directional quant index shows.
In September, Mark Wiseman, the former head of the Canada Pension Plan Investment Board, was brought in to run the group and no doubt use his huge Rolodex to garner new assets.

But things aren't going well for this group. I don't know what exactly is going on at Blackrock's SAE team but it's losing top talent and investors. Larry Fink, BlackRock’s CEO, is right to feel frustrated with the group's poor showing (not the end of the world as BlackRock is cleaning up house in its low-cost funds business).

[Note: Too many quants with PhDs all doing factor-based models are getting killed. BlackRock needs to really understand why these strategies are unable to perform and if it can't get to the bottom of it, shut these operations down until it has clear answers to explain their poor performance to investors.]

As far as Grosvenor Capital, it's a well known fund of funds which invests across hedge funds and other alternative funds. It has a solid reputation but again, why is NPS investing in any hedge funds before it gets its governance right? That just doesn't make sense to me.

I think Korea's NPS should be revamped and the first order of business is to drastically improve its governance. Forget hedge funds, private equity funds, infrastructure, real estate or foreign investments. Get the governance right first, implement fraud detection and whistleblower policies, use top-notch consultants and forensic accounting firms to beef up internal compliance and then worry about investing in hedge funds!

By the way, those of you looking to invest in a great macro hedge fund, Bloomberg reports Chris Rokos’s hedge fund rose about 20 percent in 2016, its first full year of trading, to become one of the world’s best-performing money pools betting on economic trends, according to people with knowledge of the matter.

In my opinion, Rokos is a superstar macro manager, one of the very best in the world. Brevan Howard has never been the same without him and he really performed exceptionally well last year which wasn't an easy year for most hedge funds in general and macro funds in particular (just ask Mr. Soros who lost a cool billion after Trump was elected; Rokos one-upped him last year).

Below, Bloomberg reports on the scandal engulfing Korea's national pension fund. I hope this is the wake-up call that prompts officals overseeing the NPS to revamp its governance once and for all.

Tuesday, January 10, 2017

Outlook 2017: The Reflation Chimera?

Julia La Roche of Yahoo Finance reports, Kyle Bass: 'Global markets are at the beginning of a tectonic shift':
Texan hedge fund manager J. Kyle Bass, the founder of Hayman Capital, says that global markets are at the “beginning of a tectonic shift.”

Today, global markets are at the beginning of a tectonic shift from deflationary expectations to reflationary expectations. What happens to economies at maximum leverage when interest rates begin to rise? Reconciling the potent strengths of the world’s largest economies with their inherent weaknesses has revealed various investable anomalies. The enormity of the apparent disequilibrium is breathtaking, making today a tremendous time to invest,” Bass wrote in a year-end letter to investors seen by Yahoo Finance.

He added: “One opportunity in particular has the greatest risk-reward profile we have ever encountered in our decade of being a fiduciary.”

He didn’t provide specifics about the opportunity in the letter.

On Tuesday, Hayman launched its third Asia-focused fund, which is “designed to provide investors with nuanced access to perhaps one of the largest imbalances in financial markets history.”

The first Asia-focused fund was the Japan Macro Opportunities Fund, which returned capital to investors after the Japanese yen depreciated 40% from 2012 to 2015. The second Asia-focused fund was the Hayman China Opportunities Fund, which launched in July.

Bass had a knockout 2016, with Hayman Capital’s Master Fund finishing the year with an estimated net-performance of 24.83%, according to the letter. This compares to the S&P 500, which was up a modest 9%.

Meanwhile, the average macro hedge fund returned 0.28% through the end of November, according to HFR. Since Hayman’s inception in 2006, the fund has returned 436.75% and an annualized return of 16.7%.

2016 got off to a rough start for many investors. At the time, Bass returned to his core competency — global macro investing. In the letter, he noted that he expects the next few years to be the best years for macro since the late 1990s.

“We reorganized our portfolio to invest in the macro themes that began to reveal themselves early in the year. Exploiting our reflationary view, we invested in global interest rate markets, currencies, and commodities across the world,” he wrote in the letter.

A number of macro fund managers have voiced concerns about central banks distorting markets with extraordinary monetary policy. This had made macro investing particularly challenging.

“Over the past several years, economic gravity has been pulling one way and central banks have been using aggressive monetary policy to pull the other. Investing in macro, while this phenomenon has existed, has been difficult to say the least,” Bass wrote, adding, “From here-on, we expect to encounter significant changes in global fiscal policies along with a continuation of the upward movement of general price levels for consumers and producers alike.”

Bass has been making a huge bet against China’s “recklessly built” banking system. Back in February, Bass unveiled his case in an investor letter entitled “The $34 Trillion Experiment: China’s Banking System and the World’s Largest Macro Imbalance.”

Bass, who gained notoriety for correctly betting against the US subprime crisis, wrote at the time that similar to the US banking system, China’s banking system has “increasingly pursued excess leverage, regulatory arbitrage, and irresponsible risk taking.” He believes that the Chinese banking system losses will be gargantuan.
Back in October, Bass warned that stagflation is coming in 2017:
"You have wages up, you have real estate rent moving up, now you have commodities bouncing. So 2017 is going to be a year of increasing inflation but economic growth lagging," Bass said during an interview on CNBC's "Power Lunch." "We're moving into a stagflationary environment in my view."

From an investment standpoint, the Hayman Capital Management founder and CIO said the main advice is for investors to stay away from long-duration bonds. Inflation usually causes bond yields to rise and prices to fall, creating capital losses for investors.
Bass's timing of that announcement was perfect as we all know what happened after the presidential election, US long bond yields surged, bond prices fell and all those gurus warning that the bond bubble will burst got some temporary vindication.

The rout in US long bonds after Trump was elected helped Bass's fund end the year with sizable gains of 25% after being down 10% at the midpoint of 2016 (a little leverage also helped). Other macro funds, including some backed by Soros, didn't fare as well (I would be investing with them, not Bass, at this point).

Now, notice I emphasized "temporary vindication" for all those bond bubble clowns and delivering alpha gurus that keep warning us that US long bonds are toast.

I don't buy this nonsense and went on record in my recent comment on trumping the bond market to state that from a risk-reward point of view, US long bonds offer the best potential in 2017, recommending institutions and retail investors load up on them after the latest backup in yields.

I know, all the talking heads on Wall Street are out full force talking about the "huge reversal" taking place as institutions dump bonds and get back into stocks. They've even given it a catchy name, "The Great Rotation" to propagate this myth that the bond bull market is dead and we should all rush into stocks for the long run.

Even well-known bulls that are now throwing in the towel on stocks are buying the global reflation story, stating that bond yields are headed higher as inflation expectations are recovering, reversing four years of disinflationary trends.

Every year I hear the same nonsense and ignore it knowing all too well the bond market has the last laugh and all these people are really out to lunch, erroneously proclaiming deflation is dead and inflation is coming.

Case in point, Bryan Rich's recent article in Forbes, Trumponomics Is Finally Reflating Europe And Japan. He shows you nice charts of how inflation is picking up in Europe, the UK, Japan and the US. Unfortunately, what he doesn't tell you is that the driving force behind the pickup in inflation is all due to huge currency depreciation and this isn't good or sustainable inflation.

It's this type of flimsy economic analysis that I can't stand reading but to the layperson out there, they read these articles and think, oh wow, global reflation is back, inflation is coming full force, especially now that Trump and his billionaire A-team are coming to power. Even Ray Dalio thinks Trump could reignite animal spirits and unleash something wonderful.

Total and utter nonsense! Forgive me, I'm in a very crabby mood, been sick like a dog over the past two weeks, first suffering from painful gastro, then the flu and now coughing and wheezing for air (the 1-2-3 knockout punch!). On the health front, I've had a terrible start to the new year and only slowly recovering as I'm very weak.

The flu season is getting worse but I still don't believe in the flu shot and I'm convinced this happened because I was too lazy to go pick up my Genestra D-Mulsion 1000 (Citrus) drops and load up on vitamin D (I still take 10,000 IUs a day and recommend everyone take a minimum of 2000 or 3000 IUs a day, especially in the winter months and wash your hands often!).

But my crabby mood aside, if I hear another person on CNBC warn me of how US long bond yields are headed "much higher" and the world has escaped deflation now that Trump is getting into power, I'm going to puke or throw something at my television set.

Oh wait, China is going to export inflation to the rest of the world even though it has a huge yuan problem. Who buys this nonsense? Who? I'm seriously dismayed and perplexed that any serious macro economist thinks deflation is dead and global reflation is coming back with a vengeance.

To all you delusional reflationistas, do you realize the world has huge structural imbalances that cannot be cured by currency depreciation alone? Sure, Trump will cut taxes and spend on infrastructure but it won't really make a dent in economic trends and it will be too little, too late as the US economy will stall in the second half of the year (his policies might even hinder long-term growth).

Then there is Greece, the debt boomerang story that keeps coming back every second or third year to haunt financial markets. That saga continues but as bad as Greece is, it's a walk in the park compared to Italy which saw annual deflation for first time since 1959 and is dealing with a looming banking crisis (and deflation happened despite the decline in the euro!).

The world is a structural mess and anyone who thinks otherwise should have their head examined and go back to school to understand the new macroeconomic reality.

What about stocks? Dow 20000? There are plenty of prognosticators out there warning us that the stock market could 'melt up' 10 percent right before a meltdown or that this year reminds them of 1987.

I ignore them too and if you followed my advice and loaded up on biotech before the elections, took profits and reloaded on biotech shares, you would have made great returns in the last two months alone.

In fact, have a look at the daily chart of the equally weighted SPDR S&P Biotech ETF (XBI) since the elections in early November (click on image):


You see how it popped, came back to its 200-day moving average (filling the gap) and then headed right back up? This is a classic bullish technical pattern.

The longer term weekly chart is equally bullish and I expect biotechs to have a great year and this is where I will be focusing my trading once again (click on image):


The biotech ETF however only tells you part of the story, when you dig deep to search for individual names, you will find plenty of biotech shares that can really move huge this year, like ARIAD Pharmaceuticals (ARIA) which surged 72% on Monday after it got bought out by Japan-based Takeda Pharmaceutical Company Limited for approximately $5.2 billion.

I'm in a crabby mood but will even give you Leo's biotech watch list (click on images below):


Among these stocks are some of my core holdings and I think there are real gems in this list that top funds have invested in.

What about Valeant Pharmaceuticals (VRX)? The stock jumped this morning after the company announced it is divesting $2 billion in assets to shore up its balance sheet. We'll see how it ends the day but the news was sold after the initial pop which tells me lots of short sellers are still shorting it and lots of bag holders are itching to dump their shares.

This could be the turnaround story of 2017 (Bill Ackman and Bill Miller sure hope so) but the weekly chart remains very ugly (click on image):


Apart from biotech, I like technology shares (XLK) in general, and note the Nasdaq hit a record today (click on image):


How long will the Trump rally last? I don't know but you can feel that 'panic is starting to set in' about missing the rally and lots of nervous portfolio managers praying for a pullback are getting very nervous about a melt-up in stocks.

Keep your eye on the US dollar index (DXY) because the higher it goes, the more trouble down the road. There could be a short term reversal here but if the longer term uptrend continues in the greenback, watch out, it will spell trouble for the US economy and stock market, especially for the high flying sectors of 2016 like Industrials (XLI), Metal & Mining (XME) and Energy (XLE) shares.

I continue to recommend taking profits or better yet, actively shorting all these sectors including emerging markets (EEM) and Chinese (FXI) shares on any strength in Q1. The same goes for financials (XLF), book your profits as they too will struggle once people realize the reflation chimera is just that, an illusion that will never be sustained.

Also, in a deflationary, ZIRP & NIRP world, I still maintain nominal bonds (TLT), not gold, will remain the ultimate diversifier and still think US long bonds (TLT) offer investors the best risk-reward going forward (click on image):


That pretty much sums up my outlook 2017. There will be tradeable opportunities in biotech and tech shares but investors who need income and safety should continue to invest in US long bonds, especially if yields go back up (I doubt it).

I'm still sick and in a crabby mood. I'm also not really in the mood to continue blogging and think there are a lot of people out there who can help me reach my real potential. Begging people for a donation is just a dead end (I hardly get any) and it's not worth my time and effort to continue blogging. I can be making a lot more money trading on my own or as part of a global macro or global stock team at a large Canadian pension fund (Hint, hint!!).

On that note, take very good care of yourself, this flu season is nasty, wash your hands often and thoroughly, do your flu shot if you can as it's not too late (some people hate it and I understand why but it might shorten the duration and severity of the flu), eat properly getting plenty of fruits and veggies and take your vitamin D (trust me on vitamin D, even my doctor friends are now true believers but it took some persuading on my part).

Below, once again, Wall Street’s number one ranked strategist, Cornerstone Macro’s François Trahan explains why he isn't bullish. François might be off by a month or two but his analysis is spot on and I highly recommend his research to any serious institutional investor (read his latest with Stephen Gregory, The Mother Of All Traps For Stock Pickers: Ex-TRAP-olating Into 2017).

He will be in Montreal at the end of the month delivering his outlook along with my former boss and colleague, Clément Gignac and Stéfane Marion. It should be a great luncheon.

By the way, I received no donations or subscriptions over the holidays. Not surprising as most people are spending on other things but if you appreciate my comments, the least you can do is support the work via your dollars. Like I said, I'm not in the mood to blog any longer and I am looking at working and getting paid properly for my analysis and recommendations, so if you know of anything in Montreal, please let me know about it.

Wednesday, December 21, 2016

2016's Biggest Hits and Misses?

Ted Carmichael recently posted a year-end review on his Global Macro blog, The Biggest Global Macro Misses of 2016 (added emphasis is mine):
As the year comes to a close, it is time to review how the macro consensus forecasts for 2016 that were made a year ago fared. Each December, I compile consensus economic and financial market forecasts for the year ahead. When the year comes to a close, I take a look back at the prognostications and compare them with what we know actually occurred. I do this because markets generally do a good job of pricing in consensus views, but then move -- sometimes dramatically -- when the consensus is surprised and a different outcome transpires. When we look back, with 20/20 hindsight, we can see what the surprises were and interpret the market movements the surprises generated.

Of course, the biggest forecast misses of 2016 were not in the economic indicators and financial markets, but in the political arena. The consensus views of political pollsters were that Brits would vote to remain in the European Union and that Hilary Clinton would win the US Presidential election. Instead, the actual outcomes were Brexit and President-elect Donald Trump. These political misses have had and will continue to have significant economic and financial market consequences. In the context of these political surprises, it's not only interesting to look back at the notable global macro misses and the biggest forecast errors of the past year, it also helps us to understand 2016 investment returns.

Real GDP

Since the Great Financial Crisis, forecasters have tended to be over-optimistic in their real GDP forecasts. That was true again in 2016. Average real GDP growth for the twelve countries we monitor is now expected to be 3.0% compared with a consensus forecast of 3.5%. In the twelve economies, real GDP growth fell short of forecasters' expectations in eleven and exceeded expectations in just one. The weighted mean absolute forecast error for 2016 was 0.51 percentage points, down a bit from the 2015 error, but still sizeable relative to the actual growth rate (click on image).



Based on current estimates, 2016 real GDP growth for the US fell short of the December 2015 consensus by 0.8 percentage points, a bigger downside miss than in 2015 (-0.5) or 2014 (-0.1). The biggest downside misses for 2016 were for Russia (-1.6 pct pts), Brazil (-1.4), India (-1.1) and Mexico (-0.8). China's real GDP beat forecasts by 0.1. Canadian forecasters missed by -0.5 pct pts, a little less than the average miss. On balance, it was a sixth consecutive year of global growth trailing expectations.

CPI Inflation

Inflation forecasts for 2016 were also, once again, too high. Average inflation for the twelve countries is now expected to be 2.2% compared with a consensus forecast of 2.6%. Nine of the twelve economies are on track for lower inflation than forecast, while inflation was higher than expected in three countries. The weighted mean absolute forecast error for 2016 for the 12 countries was 0.33 percentage points, a much lower average miss than in the previous two years.


The biggest downside misses on inflation were in Russia (-0.9 pct pts), India (-0.7), Australia (-0.7), and Korea (-0.6). The biggest upside miss on inflation was in China (+0.5). UK and US inflation were also slightly higher than forecast (click on image).

Policy Rates

Economists' forecasts of central bank policy rates for the end of 2016 once again anticipated too much tightening by developed market (DM) central banks, but for emerging market (EM) central banks, it was a more mixed picture (click on image).


In the DM, the Fed failed to tighten as much as forecasters expected. The biggest DM policy rate miss was in the UK, where the Bank of England had been expected to tighten, but instead cut the policy rate after the Brexit vote. The ECB, the Bank of Japan, the Reserve Bank of Australia and the Bank of Canada also unexpectedly cut their policy rates. In the EM, the picture was more mixed. In China, where inflation was higher than expected, the PBoC did not deliver expected easing. In Brazil and India, where inflation fell more than expected, the central banks eased more than expected. In Russia where inflation also fell, Russia's central bank eased less than expected. In Mexico, where the central bank was expected to tighten, the tightening was much greater than expected after the Trump election victory caused the Mexican Peso to fall sharply.

10-year Bond Yields

In nine of the twelve economies, 10-year bond yield forecasts made one year ago were too high. Weaker than expected growth and inflation combined with major central banks’ decisions to delay tightening or to ease further pulled 10-year yields down in most countries compared with forecasts of rising yields made a year ago (click on image).


In five of the six DM economies that we track, 10-year bond yields surprised strategists to the downside. The weighted average DM forecast error was -0.33 percentage points. The biggest misses were in the UK (-0.88 pct. pt.), Eurozone (proxied by Germany, -0.49), Japan (-0.39), and Canada (-0.34). In the EM, bond yields were lower than forecast where inflation fell more than expected, in India and Russia. The biggest miss in the bond market was in Brazil, where inflation fell much more than expected and reduced political uncertainty saw the 10-year bond yield almost 4 percentage points lower than forecast. Bond yields were higher than expected in China, where inflation was higher than expected, and much higher than expected in Mexico where political risk increased with Trump's election.

Exchange Rates

Currency moves against the US dollar were quite mixed in 2016. The weighted mean absolute forecast error for the 11 currencies versus the USD was 5.4% versus the forecast made a year ago, a smaller error than in the previous two years (click on image).


The USD was expected to strengthen because many forecasters believed the Fed would tighten two or three times in 2016. Once again the Fed found various reasons to delay, with only one tightening occurring on December 14. If everything else had been as expected, the Fed's delay would have tended to weaken the USD. But everything else was not as expected. Most other DM central banks eased policy by more than expected and the ECB and the BoJ implemented negative policy rates. In addition, oil and other commodity prices rallied causing commodity currencies like RUB, AUD, and CAD to strengthen more than forecast.

The biggest FX forecast misses were casualties of the big political consensus misses on Brexit and the US presidential election. The GBP was almost 18 percent weaker than forecast a year ago, while the MXN was 17% weaker than forecast after President-elect Trump promised to “tear up” NAFTA. The biggest miss on the upside was for BRL (+27%) where President Dilma Rousseff’s impeachment received a standing ovation from the currency market.

North American Stock Markets

A year ago, equity strategists were optimistic that North American stock markets would turn in a decent, if unspectacular, performance in 2016. However, despite a year characterized by weaker-than-expected real GDP growth and inflation and by political surprises that were widely-perceived as negative, North American equity performance exceeded expectations by a substantial margin. I could only compile consensus equity market forecasts for the US and Canada. News outlets gather such year-end forecasts from high profile US strategists and Canadian bank-owned dealers. As shown below, those forecasts called for 2016 gains of 5.5% for the S&P500 and 10.0% for the S&PTSX Composite (click on image).


As of December 14, 2016, the S&P500, was up 13.6% year-to-date (not including dividends) for an error of +8.1 percentage points. The S&PTSX300, rebounding from a sizeable decline in 2015, was up 17.1% for an error of +7.1 percentage points.

Globally, actual stock market performance was less impressive than that of North American markets, with two notable exceptions, Russia and Brazil (click on image).


Stocks performed poorly the Eurozone and Japan, where deflation worries caused central banks to adopt negative interest rates. China saw the biggest equity loss (-11.3%) of the markets we monitor as slowing growth and fears of currency devaluation fueled large capital outflows. In the US, where the Fed delayed monetary policy tightening, and in the UK, where the BoE unexpectedly eased, equities posted solid gains. In Canada, and Australia, where central banks eased more than expected, equities were also boosted by a recovery in commodity prices. Russia and Brazil posted huge equity market gains, rebounding from large currency and equity market declines in 2015.

Investment Implications

While the 2016 global macro forecast misses were similar in direction, they were generally smaller in magnitude relative to those of 2015 and the investment implications were different. Global nominal GDP growth was once again weaker than expected, reflecting downside forecast errors on both real GDP growth and inflation. In 2016, most central banks either tightened less than expected or eased more than expected, but continued political uncertainty, weaker than expected nominal GDP growth and the strong US dollar held the US equity market in check through early November prior to the US election.

Although many strategists argued that a Trump victory would be bad for US equities, because of uncertainty over his policies in general and his protectionist views in particular, the opposite reaction followed the election. US equities outperformed by a wide margin. US small caps and financials led the gains on Trump’s promise of reduced regulation, corporate tax reform and a steeper yield curve. UK equities rallied in the aftermath of Brexit, boosted by the increased competitiveness generated by the sharp depreciation of the GBP. In Japan and the Eurozone, where governments failed to enact structural reforms and where central banks experimented with negative policy interest rates, equities badly underperformed. In Canada, Australia, Brazil, Mexico and Russia, rebounding commodity prices supported equity markets. In China, one of the few countries where reported nominal GDP growth was stronger than expected (despite on-the-ground reports of economic slowdown), equity prices fell as capital fled the country.

Similar to the previous two years, downside misses on growth and inflation and central bank ease in most countries provided solid, positive returns on DM government bonds in the first 10 months of 2016. However, after the Trump election victory, as markets priced in stronger US growth and inflation and bigger US budget deficits, government bonds across the globe gave back much of their gains and significantly underperformed equities in all regions.

Smaller divergences in growth, inflation and central bank responses, along with firming crude oil and other commodity prices, led to smaller currency forecast errors. For Canadian investors, the stronger than expected 5% appreciation of CAD against the USD meant that returns on investments in both equities and government bonds denominated in US dollars were reduced if the USD currency exposure was left unhedged. The biggest losers for Canadian investors were Eurozone and Chinese equities, as well as most DM sovereign bonds, especially if unhedged.

As 2017 economic and financial market forecasts are rolled out, it is worth reflecting that such forecasts form a very uncertain basis for year-ahead investment strategies. The high hopes (and fears) that markets are currently pricing in for a Trump presidency will surely be recalibrated against actual policy changes and foreign governments’ policy reactions.

The lengthy period in recent years of outperformance by portfolios for Canadian investors that are globally diversified, risk-balanced and currency unhedged may have run its course. Global asset performance may be shifting toward a more US-centric growth profile that could also benefit Canada if Trump’s protectionist tendencies are implemented only against China, Mexico and any other countries a Trump-led America deems to unfair traders. While such an outcome is possible, 2017 will undoubtedly once again see some large consensus forecast misses, as new surprises arise. As an era of rising asset values supercharged by ever-easier unconventional monetary policies seems to be coming to an end, the scope for new surprises to cause dramatic market moves has perhaps never been higher.
First, let me thank Ted for posting this great global macro comment which covers the main macro themes of the year. He really did a wonderful job and I love reading his year-end review to understand the bigger picture.

I myself think back at the year as one where things got off to a very rocky start and then all of a sudden, as if someone turned off the deflation switch and  turned on the reflation switch, it was good times, global growth and inflation coming back, and all this even before Trump was elected into office in early November.

Still, there are critically important macro trends which will define markets going into 2017. I recently discussed the developing US dollar crisis which I think will have a profound effect on the global economy and financial markets next year. The crisis won't be in US dollars, of course, but in its effect on emerging markets dollar-denominated debt and importing global deflation into the United States.

I too am surprised the Trump rally wasn't sold earlier but his victory unleashed those animal spirits, prompting Ray Dalio to praise him and his administration as he worries we're headed back to the future.

All I know is the global pension storm rages on and we better all heed Denmark's dire warning as the Dow 20,000 won't save pensions.

What else? I'm pretty sure Trump won't trump the bond market and that US long bonds will rally like crazy in the new year, especially if another crisis hits Asia or Europe.

What are some of the biggest global macro misses I saw this year? Soros was wrong to warn of another 2008 crisis early in the year and he was wrong on China, for now. The great crash of 2016 never transpired but investors are feeling increasingly uneasy about risk assets levitating higher, quietly making record highs as the world economy still faces deep structural and deflationary headwinds.

The deflation tsunami I warned of in my 2016 outlook was averted, for now, but I have a feeling a much bigger financial crisis is brewing down the road and that expansionary fiscal policy in the US and elsewhere is too little, too late.

Another huge global macro miss was Morgan Stanley's call for the greenback to tumble in early August. Not only did the greenback not tumble, it soared and continues rising and could wreak havoc on the global economy next year.

As far as bonds, it looks like Jamie Dimon was right back in April to claim the Treasury rally will turn into a rout and the bond bubble clowns got some vindication in the last quarter of the year (still, backup in yields is just another big bond buying opportunity).

Dimon also made a killing this year, buying 500,000 shares of JP Morgan (JPM) at the bottom (the "Dimon bottom") and riding the wave up (my advice to him is to dump those shares in Q1 and retire before deflation strikes America). The Oracle of Omaha also did well buying Goldman shares (GS) at their bottom (I'd be dumping those too).

As far as stocks, beware of animal spirits. I continue to recommend to be long the greenback and would take profits or even short emerging market (EEM), Chinese (FXI),  Metal & Mining (XME) and Energy (XLE) shares on any strength in Q1.

In a deflationary, ZIRP & NIRP world, I still maintain nominal bonds (TLT), not gold, will remain the ultimate diversifier and Financials (XLF) will struggle for a long time if a debt deflation cycle hits the world (ultra low or negative rates for years aren't good for financials). The latest run-up in financials should be sold and I would ignore strategists telling you big banks are going to be the big winners next year.

As far as Ultilities (XLU), REITs (IYR), Consumer Staples (XLP), and other dividend plays (DVY), they got hit with the backup in yields but also because they ran up too much as everyone chased yield (might be a good buy in Q1 but be careful, high dividend doesn't mean less risk!).

It is worth noting, however, high yield credit (HYG) continues to perform well which bodes well for risk assets. As long as high yield bonds are rallying, it's hard to get very bearish on markets.

And despite huge volatility, I remain long biotech shares (IBB and equally weighted XBI) and keep finding gems in this sector by examining closely the holdings of top biotech funds. My call to go long biotech before the elections was also one of my best calls all year from a swing trading perspective and I still see more upside (and volatility) in biotech next year.

As far as individual stocks, you can easily look at what rallied this year by clicking here but this list only gives you part of the story as there were some huge moves from the bottom in stocks like Cliff Resources (CLF), Teck Resources (TECK) and US Steel (X). And the best stock of the year was Celator Pharmaceuticals (CPXX) which went from $1 to over $30 (a thirty bagger) before it got bought out by Jazz Pharmaceuticals (JAZZ).

The other great stock trades of the year were on the short side, like shorting Valeant Pharmaceuticals (VRX), something Jim Chanos did well, and more recently, shorting Dryships (DRYS) when it went from $5 to over $100 on a high frequency speculative orgy which lasted about a week before it died down again and shares plunged back down below $5.

There are a lot more big moves in stocks but I can't cover everything here. All I can tell you is 2017 will be different from 2016 and I'm looking forward to getting over window-dressing season so we can start the new year.

On that note, I'm off until Tuesday January 10th where I will reconvene and think about whether it's worth continuing this blog. I'm tired, really tired, and I think it's a lot of effort for too little money and I'm ready to move on and do something else. I have to think a lot of things through over the holidays.

But the number one thing I'm looking forward to now is spending time with my girlfriend, family and friends and just sleeping in and waking up late. I get the deepest sleep of the year this time of year and I love it, it's by far the most important thing for my health.

On that note, let me wish you all a Merry Christmas, Happy Hanukkah, Happy Holidays and a very Happy and Healthy New Year. Enjoy your holidays with your loved ones, eat well and get lots of sleep!

I would also like to thank the individuals who support my work and show their support through donations and subscriptions to my blog. I spend three, four or five to six hours a day every day writing these comments and thinking about interesting topics to cover and trust me, it's a lot of work and it's nice to see people who appreciate it and who take the time to contribute via PayPal under my picture.

Below, in an exclusive interview, Wall Street’s number one ranked strategist, Cornerstone Macro’s François Trahan makes a stunning call. The bull market is almost over and it’s time to get defensive.

I agree, this rally could continue in Q1 but it could also evaporate very quickly and reverse course. Be very careful with all the bulls out there touting their rosy scenarios. Very, very careful.

Tuesday, December 20, 2016

US Pensions Looking North For Inspiration?

Gillian Tan of Bloomberg View reports, Pension Funds Should Look North For Inspiration:
When it comes to at least one type of investing, U.S. pension funds should take a (maple) leaf out of their Canadian counterparts' playbook.

Despite being among the largest private equity investors, U.S. pension funds such as the California Public Employees' Retirement System and the California State Teachers' Retirement System have been slow to transition from a hands-off approach to one that involves actively participating in select deals, a feature known in the industry as direct investing.
A More Direct Approach

The benefits of direct investing are lower (or sometimes no) fees and the potential to enhance returns, and that makes it an attractive proposition. But so far, U.S. pension funds have been pretty content as passive investors for the most part, writing checks in exchange for indirect ownership of a roster of companies but without outsize exposure to any (click on image).

State of the States

State pension funds are comfortable writing checks to private equity firms but could bolster their returns by investing directly in some of those firms' deals (click on image).


Not so Canadian funds. A quick glance at the list of the private equity investors -- commonly referred to as limited partners -- that have been either participating in deals alongside funds managed by firms such as KKR & Co. or doing deals on their own since 2006 shows that these funds have had a resounding head start over those in the U.S.

Notably Absent

Large U.S. pension funds are nowhere to be seen among private equity fund investors that participate directly in deals, a strategy used to amplify their returns (click on image).


Canadian funds' willingness to pursue direct investing is driven in part by tax considerations: they can avoid most U.S. levies thanks to a tax treaty between the two North American nations, while they are exempt from taxes in their own homeland. But U.S. pensions would still benefit from better returns, so it's curious that they haven't been more active in this area.

There's plenty of opportunity for direct investing. Private equity firms are generally willing to let their most sophisticated investors bet on specific deals in order to solidify the relationship (which can hasten the raising of future funds). It also gives them access to additional capital.

Rattling the Can

Private equity firms recognize that offering fund investors the right to participate directly in their deals bolsters their general fundraising efforts (click on image),


The latter point has been a crucial ingredient that has enabled larger transactions and filled the gap caused by the death of the so-called "club" deals (those involving a team of private equity firms) since the crisis.

Seal the Deal

U.S. private equity deals which are partly funded by direct investments from so-called limited partners reached their highest combined total since 2007 (click on image).


There are some added complications. Because some of the deals involve heated auction processes, limited partners must do their own diligence and deliver a verdict fairly quickly. That could prove tricky for U.S. pension funds, which would need to hire a handful of qualified executives and may find it tough to match the compensation offered elsewhere in the industry. Still, the potential for greater investment gains may make it worth the effort -- even for funds like Calpers that are reportedly considering lowering their overall return targets.

With 2017 around the corner, one of the resolutions of chief investment officers at U.S. pension funds should be to evolve their approach to private equity investing. They've got retired teachers, public servants and other beneficiaries to think about.
This article basically talks about how Canada's large pensions leverage off their relationships with private equity general partners to co-invest alongside them on bigger deals.

It even cites one recent example in the footnotes where the  Caisse de dépôt et placement du Québec, or CDPQ, in September announced a $500 million investment in Sedgwick Claims Management Services Inc., joining existing shareholders KKR and Stone Point Capital LLC.

Let me cut to the chase and explain all this. An equity co-investment (or co-investment) is a minority investment, made directly into an operating company, alongside a financial sponsor or other private equity investor, in a leveraged buyout, recapitalization or growth capital transaction.

Unlike infrastructure where they invest almost exclusively directly, in private equity, Canada's top pensions invest in funds and co-invest alongside them to lower fees (typically pay no fees on large co-investments which they get access to once invested in funds where they do pay fees). In order to do this properly, they need to hire qualified people who can analyze a co-investment quickly and have minimum turnaround time.

Unlike US pensions, Canada's large pensions are able to attract, hire and retain very qualified candidates for positions that require a special skill set because they got the governance and compensation right. This is why they engage in a lot more co-investments than US pension funds which focus exclusively on fund investments, paying comparatively more in fees.

[Note: You can read an older (November 2015) Prequin Special Report on the Outlook For Private Equity Co-Investments here.]

On top of this, some of Canada's large pensions are increasingly going direct in private equity, foregoing any fees whatsoever to PE funds. The article above talks about Ontario Teachers. In a recent comment of mine looking at whether size matters for PE fund performance, I brought up what OMERS is doing:
In Canada, there is a big push by pensions to go direct in private equity, foregoing funds altogether. Dasha Afanasieva of Reuters reports, Canada’s OMERS private equity arm makes first European sale:
Ontario’s municipal workers pension fund has sold a majority stake in marine-services company V.Group to buyout firm Advent International in the first sale by the Canadian fund’s private equity arm in Europe.

Pension funds and other institutional investors are a growing force in direct private investment as they seek to bypass investing in traditional buyout funds and boost returns against a backdrop of low global interest rates.

As part of the shift to more direct investment, the Ontario Municipal Employees Retirement System (OMERS) set up a private equity team (OPE) and now has about $10-billion invested.

It started a London operation in 2009 and two years later it bought V.Group, which manages more than 1,000 vessels and employs more than 3,000 people, from Exponent Private Equity for an enterprise value of $520-million (U.S.).

Mark Redman, global head of private equity at OMERS Private Markets, said the V.Group sale was its fourth successful exit worldwide this year and vindicated the fund’s strategy. He said no more private equity sales were in the works for now.

“I am delighted that we have demonstrated ultimate proof of concept with this exit and am confident the global team shall continue to generate the long-term, stable returns necessary to meet the OMERS pension promise,” he said.

OMERS, which has about $80-billion (Canadian) of assets under management, still allocates some $2-billion Canadian dollars through private equity funds, but OPE expects this to decline further as it focuses more on direct investments.

OPE declined to disclose how much Advent paid for 51 per cent of V.Group. OPE will remain a minority investor.

OPE targets investments in companies with enterprise values of $200-million to $1.5-billion with a geographical focus is on Canada, the United States and Europe, with a particular emphasis on Britain.

As pension funds increasingly focus on direct private investments, traditional private equity houses are in turn setting up funds which hold onto companies for longer and target potentially lower returns.

Bankers say this broad trend in the private equity industry has led to higher valuations as the fundraising pool has grown bigger than ever.

Advent has a $13-billion (U.S.) fund for equity investments outside Latin America of between $100-million and $1-billion.

The sale announced on Monday followed bolt on acquisitions of Bibby Ship Management and Selandia Ship Management Group by V.Group.

Goldman Sachs acted as financial advisers to the shipping services company; Weil acted as legal counsel and EY as financial diligence advisers.
Now, a couple of comments. While I welcome OPE's success in going direct, OMERS still needs to invest in private equity funds. And some of Canada's largest pensions, like CPPIB, will never go direct in private equity because they don't feel like they can compete with top funds in this space (they will invest and co-invest with top PE funds but never go purely direct on their own).

[Note: It might help if OPE reports the IRR of their direct operations, net of all expenses relative to the IRR of their fund investments, net of all fees so their stakeholders can understand the pros and cons of going direct in private equity. Here you need to look at a long period.]

There is a lot of misinformation when it comes to Canadian pensions 'going direct' in private equity. Yes, they have a much longer investment horizon than traditional funds which is a competitive advantage, but PE funds are adapting and going longer too and in the end, it will be very hard, if not impossible, for any Canadian pension to compete with top PE funds.

I am not saying there aren't qualified people doing wonderful work investing directly in PE at Canada's large pensions, but the fact is it will be hard for them to match the performance of top PE funds, even after fees and expenses are taken into account.

Who knows, maybe OPE will prove me wrong, but this is a tough environment for private equity and I'm not sure going direct in this asset class is a wise long-term strategy (unlike infrastructure, where most of Canada's large pensions are investing directly).
When it comes to private equity, Mark Wiseman once uttered this to me in a private meeting: "Unlike infrastructure where we invest directly, in private equity it will always be a mixture of fund investments and co-investments." When I asked him why, he bluntly stated: "Because I can't afford to hire David Bonderman. If I could afford to, I would, but I can't."

Keep in mind these are treacherous times for private equity and investors are increasingly scrutinizing any misalignment of interests, but when it comes to the king deal makers, there is no way Canada's top ten pensions are going to compete with the Blackstones, Carlyles and KKRs of this world who will get the first phone call when a nice juicy private deal becomes available.

Again, this is not to say that Canada's large pensions don't have experienced and very qualified private equity professionals working for them but let's be honest, Jane Rowe of Ontario Teachers won't get a call before Steve Schwarzman of Blackstone on a major deal (it just won't happen).

Still, despite this, Canada's large pensions are engaging in more direct private equity deals, sourcing them on their own, and using their competitive advantages (like much longer investment horizon) to make money on these direct deals. They don't always turn out right but when they do, they give even the big PE funds a run for their money.

And yes, US pensions need to do a lot more co-investments to lower fees but to do this properly, they need to hire qualified PE professionals and their compensation system doesn't allow them to do so.

Below, Julie Riewe, Co-Chief of the Asset Management Unit in the Securities and Exchange Commission’s Enforcement Division, sits down with Bloomberg BNA’s Rob Tricchinelli to talk SEC priorities in the private equity industry. You can watch this interview here.

Also, CNBC's David Faber speaks with Scott Sperling, Thomas H. Lee Partners co-president, at the No Labels conference about how President-elect Donald Trump's policies could affect private equity and jobs.

Lastly, regulation has been a "drag on the economy" and the "system needs to be debugged," Blackstone's Stephen Schwarzman recently said on CNBC's "Closing Bell."

Like I stated in my last comment on Ray Dalio's Back to the Future, inequality will skyrocket under a Trump administration and private equity and hedge fund kingpins will profit the most as they look to decrease regulations and increase their profits.