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DAVE JANNY JANUARY TWO 2017 INVESTMENT LETTER 2017 VOLUME 2 “GEORGE COSTANZA, FAKE NEWS AND HOW TO BE A CONTRARIAN” George Costanza: “Why did it all turn out like this for me? I had so much promise. I was personable, I was bright. Oh, maybe not academically speaking, but... I was perceptive. I always know when someone's uncomfortable at a party. It became very clear to me sitting out there today, that every decision I've ever made, in my entire life, has been wrong. My life is the opposite of everything I want it to be. Every instinct I have, in every of life, be it something to wear, something to eat... It's all been wrong.” Jerry Seinfeld:” If every instinct you have is wrong, then the opposite would have to be right.” George Costanza: “Yes, I will do the opposite. I used to sit here and do nothing, and regret it for the rest of the day, so now I will do the opposite, and I will do something!” I know many among you, as I am, are fans of all-time classic TV show “Seinfeld”. If you are, you’ll certainly recognize the above lines from one of the most popular” Seinfeld” episodes known as “The Opposite”. George decides to turn his life around by doing everything exactly “opposite” to what his normal instinct and reaction would be. After all as Jerry so aptly said “If every instinct you have is wrong, then the opposite would have to be right.” From an investing standpoint, what George and Jerry were really talking about was “contrarian” investing. Investing can be emotional and as a result prone to “chasing” investments too late after they’ve had a big run or “panicking” out at the wrong time in a decline. In my last two Investment Letters I spoke about how “conventional wisdom” in 2016 was proven wrong many times. 1 2016 was a tricky investing year marked by essentially 4 market periods. I’ll illustrate for you using data from Thomson. “Period One” was just under an approximately 10% S&P 500 market correction that lasted 6 weeks till the middle of February. Remember that “conventional wisdom” as communicated by the Fed was that we were going to see a revived economy and 4 Fed interest rate hikes in 2016. The market corrected, U.S. treasury yields went lower and the U.S., economy was in continued underperformance mode. Just when the “consensus” felt like the market pressure would continue and intensify, “Period Two” was the recovery back from the February lows that lasted till the summer and included the 3 day head fake posed by the Brexit. “Conventional wisdom’ suggested that the Brits would not exit the EU and of course they did. The “conventional wisdom” suggested that the Brexit would create market chaos. That chaos lasted only 3 days and the market recovery continued. Just when it looked like the U.S. stock market was really breaking out in the summer, “Period Three” was marked by a low volatility drift that brought the markets back down just a little bit. It was historically low volatility marked by continued earnings and economic disappointment. U.S interest rates had started to move up a bit despite the “negative interest rate” environment global bonds markets were dealing with. “Period Four” of course started in the very early hours of the morning on the day after the Trump victory in the U. S. presidential election. “‘Conventional wisdom” was proven wrong again as not only did Trump win but the market chaos that his victory would produce only lasted 3 hours. The U.S. stock market rallied, U.S. interest rates sharply shot up and the U.S. dollar was incredibly strong through the end of the year. In December an Italian referendum knocked out incumbent Italian president Renzi and the global move towards “populism” was picking up steam. 2017 now picks up where 2016 “Period Four” left off. There are a lot of very “consensus” views in the investing world that were emboldened in the sharp “end of 2016” market moves. The relative calm of the last couple of years has reinforced bigger “consensus” views that have been forming since the 2 market bottom after the financial crisis. I’ll try to take a look at some of these “consensus” views and offer a “George Costanza” “opposite” or contrarian position on some of those views. FAKE NEWS AND THINKING OPPOSITE One of the big stories of the year was a new phenomenon that we now know as “fake news”. I would say that today’s news media has become incredibly biased. Reporting of news feels more like opinion than fact. There even seems to be no such thing as fact checkers any more since the fact checkers have their own point of view. It seems like, most if not all, major news outlets as well as more obscure internet outlets report with an “agenda”. The prevalence of social media adds fuel to the fire and creates more ire and division. In my June 2016 Investment Letter tiled “Happy Talk, Who You Gonna Listen To?” http://www.morganstanleyfa.com/david.janny/viewpoint.htm I warned about how central bankers and incumbent politicians were telling us that everything was good. Their motivation was of course to retain power and influence. There’s no disputing that the politically motivated mainstream media jumped on board in a big way to try to aide Hillary Clinton in the election. The electorate here in the U.S. decided that things weren’t that good and voted for change. Since the election, it only seems like the “fake news” and biased reporting trend has worsened. Unfortunately for our country, it appears that partisan political battles will continue and the media will not shy away from the fight. I don’t think it will be far-fetched to think that the mainstream media will now probably start to tell us that things are not so good. The ironic or “opposite” part of the trend is that this time they may actually be accurate. I felt that no matter who won the election, that person was inheriting a flawed “late cycle” economy and stock market that was poised and overdue for a serious correction. The stock market has thus far viewed Trump’s “different “approach favorably, but I wonder if between any potential implementation delays and raised expectations there could be room for disappointment. Even worse, the debt burdened economy may be more weak and broken than most people think and the stock market may have been more over-valued than many market participants realized. Really thinking “opposite” for a moment, if last year’s story was the populists winning versus the elitists and globalists, the revenge of the elitists and globalists may be to expose the weaknesses of the global economy particularly in the U.S. and U.K. where the populists scored their biggest victories. VIEWS OPPOSITE TO THE CONSENSUS Since my last Investment Letter (“New Year’s Advice From Three Wise Men”), we have seen some of the “normalization” of some of the sharp sector moves since the election that I’ve been speaking about . As I pointed out in that Investment Letter as well as in the previous one (“Somewhere Over The Rainbow, The New Wizard of Oz”), the potential range of investment outcomes in 2017 seems to be as dispersed as ever, but there are some big “consensus” views. I’ll go through a list of currently crowded “consensus’ views and provide some rationale for the “opposite” view. THERE WON”T BE A RECESSION IN THE U.S. IN THE NEXT FOUR YEARS – We already have a very weak and very long economic recovery. A huge surge in economic activity this late in the cycle with all the debt that’s been already piled on in the consumer, corporate, municipal and federal sectors seems to me to be a very tall task. Four more years without a recession would probably represent a historical 3 record length of economic recovery. From strictly a political perspective, wouldn’t it be better to get the recession you “inherited” out of the way early and then “fix” the problem with your policies? According to Raoul Pal of the Global Macro Investor there are many historical examples of the first year of a new presidency, after a previous eight year presidency, being particularly tough and recessionary. I think that is something to definitely ponder. Here is his article: http://www.zerohedge.com/news/2016-11-17/raoul-pal-warns-trump-will-see-recession-2017 DEBT DOESN”T MATTER – It doesn’t matter till it does. We’ve been in a massive global debt cycle where debt growth around the world has handily outpaced economic growth. That can’t continue forever. Debt is just the “pulling forward” of economic activity. We’ve been “pulling forward” now in a big way for around 30 or 40 years. Besides our well documented $20 trillion of government debt here in the U.S., Japan and the developed world’s debt position stand at extremely high debt/GDP ratios. According to Carmen Reinhart and Ken Rogoff paper titled “Growth in a Time of Debt” these debt/GDP ratios are at levels that have historically been associated with difficult economic circumstances. Oh by the way, China has seen the fastest debt buildup in economic history. There is such a thing as a debt limit, at some point maybe sooner rather than later we’ll find out what it is. The world has become very complacent about the dangers of excessive debt. INTEREST RATES CAN ONLY GO HIGHER - It would seem to me that any further rise in rates could quickly become self-defeating. The U.S. as well as the rest of the indebted world can’t really afford higher rates. Also, larger U.S. rates increases compared to Japan and Germany have increased spreads and actually made U.S. treasuries more attractive. THE U.S. DOLLAR CAN ONLY GET STRONGER –How about if just like last year, the U.S. economy is not as strong as the forecast (the bar seems to be set even higher) and we don’t get the anticipated Fed interest rate hikes? The dollar strength actually presents some short term issues. There’s a good chance that a strong dollar will eventually weigh on U.S. multinational corporate earnings. Also, many emerging market economies that have tacked on much U.S. dollar denominated debt could experience some serious economic issues on continued dollar strength. Desmond Lachman of the American Enterprise Institute does a good job explaining the emerging market issue in this article: https://www.aei.org/publication/rising-us-dollar-taking-its-toll-on-emerging-economies/ MUCH ANTICIPATED FISCAL STIMULUS WILL PROVE SUCCESSFUL – After years of monetary steroids thru unprecedented central bank intervention, global economies are still relatively weak. The handoff to fiscal stimulus could easily prove to be problematic. Additionally the timing of benefits from fiscal stimulus could take longer than anticipated to achieve. Also remember that before the election, Trump’s trade policies were viewed as potentially protectionist. This is still an area where negotiating rhetoric may cause some concerns that the market has so far looked past. This CNBC article discusses some of those trade challenges: http://www.cnbc.com/2017/01/04/donald-trump-is-serious-about-trade-wars-commentary.html 4 TRUMP AND THE REPUBLICANS SUPPORT A DEFICIT SPENDING BASED STIMULUS PLAN – Talk about “opposite”? That doesn’t sound like a fiscal conservative policy, yet the market believes that is what we will see. It may be a little more complicated than that. THE U.S. CONSUMER IS IN GREAT SHAPE AND WE HAVE RECORD HIGH CONSUMER SENTIMENT – I have repeatedly pointed out the student loan debt, auto loan debt and credit card debt are now all at record levels. By the way, the rates on all of that debt are not low interest rate debt. Wages have been stagnant for a very long time. Despite a job recovery, many of the jobs have not been of the best quality. Also, we still have many people not participating in the work force. For those people pointing to record consumer confidence, according to The Daily Shot Brief; January 3 – Global Macro Current , we just got to about the same record highs as we not coincidentally got to in 2001 and 2007. Here’s the chart going to 2004. (2001 not pictured) HIGHER OIL PRICES ARE A GOOD SIGN FOR THE GLOBAL ECONOMY – Not for consumers. Oil prices, according to Thomson bottomed in Q1 2016 after a big tumble but have now just about doubled off of those lows. Add that to the above list of consumer financial health concerns. As GasBuddy warns in its 2017 Fuel Price Outlook, motorists are about get some sticker shock in 2017 and will shell out $52 billion more over the course of the year compared to 2016 as the national yearly average rises to $2.49 per gallon.” OBAMACARE WILL BE REPEALED AND REPLACED WITH A GOOD ALTERNATIVE – Yes it probably will be repealed and eventually replaced, but rapidly rising premiums will probably continue for quite a while. Fixing our costly healthcare system is complicated. Insuring more people at less cost while retaining quality care is a difficult assignment. Also add this to my list of consumer concerns. Here’s a good discussion from AEI that discusses the “repeal and delay” policy: https://www.aei.org/publication/the-problems-with-repeal-and-delay/ EVERYONE SHOULD GO TO COLLEGE – This sounds like what we heard at the peak of the housing crisis, which was that everyone should own a home. When access to debt gets too easy as is the case for student loans right now, the college institutions continue to aggressively raise prices to meet the enhanced demand. The economic value of a college education, that can now easily be at $60,000 per 5 year, has to be questioned. There is an education bubble. Delinquencies on payments are already large and a generation of our population has become financially burdened as a result of this debt. College student Cole Feldman posted a very good LinkedIn article on the “college bubble”: https://www.linkedin.com/pulse/college-bubble-what-true-value-higher-education-cole-feldman EVERYBODY HAS BENEFITED FROM THE LAST EIGHT YEARS – The real beneficiaries are coincidentally just meeting in Davos at the World Economic Forum. The “Davos Men and Women” may be to blame for some of the unresolved problems that have been accumulating. The move towards populism is a reflection of the failure to address income equality. Global central bank policies have benefited investors rather than the overall economy. From a 1/16/17 Zero Hedge article titled “A New Problem Emerges for the Davos Elite” “As such, one major problem facing Davos, is one of loss of credibility, as the majority of people now believe the economic and political system is failing them, according to the annual Edelman Trust Barometer, released on Monday ahead of the Jan. 17-20 World Economic Forum.” “Making matters worse, according to a PwC survey released at Davos, even the global business elite is starting to lose confidence in the benefits of globalization, i.e. the very bread and butter of the people present at the world's biggest echo chamber symposium”. “As Bloomberg puts it, while "the top executives, financiers, academics and politicians making their way up the mountain to the World Economic Forum will be talking a lot about such non-establishment leaders as President-elect Donald Trump, France’s National Front chief Marine Le Pen and Italian populist Beppe Grillo of the Five Star Movement, they won’t be meeting them. Not one of the leaders bent on overturning the world order as Davos has designed it will be present." GLOBAL MARKETS DON’T CARE ABOUT GEOPOLITICS– Well they haven’t, but that doesn’t mean that they won’t. How about European elections, Russia, China, North Korea, Syria, Iran, and Turkey? Ian Bremmer of Eurasia Group is one of the most followed geopolitical analysts on Wall Street. He called “2017 the ”most volatile” year for political risk since World War II”. Despite all the uncertainty , there has been minimal if any reaction from the markets. That could change. Here’s an article on that Bremmer report: https://www.aei.org/publication/rising-us-dollar-taking-its-toll-on-emerging-economies/ To add to that, despite the market calm, “economic policy uncertainty” indices are at record high levels like this one from Datastream: 6 OUR PENSIONS ARE SAFE – Pensions are certainly an area that have been hurt by low and negative interest rates environment of the last couple of years. . Underfunded pensions (we know a little bit about that in CT) are another issue that the markets haven’t fretted about. Have you read about the Dallas Police Pension? Maybe you should. Here’s a good account of the problem by Jonathan Rochford of Narrow Road Capital: http://www.zerohedge.com/news/2017-01-17/dallas-pension-fiasco-just-beginning CONTRARIAN SIGNPOSTS Some of the most typical classic contrarian indicators have recently surfaced. These are signposts for some short term “extreme optimism” that usually occur at market inflection points. Time to think “opposite”. Record ETF Purchases “Case in point: last week, TrimTabs Investment Research reported that U.S. equity exchange-traded funds issued a record $59.9 billion in December, easily surpassing the previous record of $50.7 billion in November.” “Investor appetite for U.S. equities is seemingly insatiable,” said David Santschi, chief executive officer of TrimTabs. “U.S. equity ETFs have had inflows on all but six trading days since the U.S. presidential election, and the buying volume has been by far the strongest we’ve ever seen.” “In its note, TrimTabs explained that the inflow of $110.6 billion into U.S. equity ETFs in November and December combined is equal to a stunning 7.2% of these funds’ assets.” High and Increasing Margin Debt As reported by Advisor Perspectives on 12/30/16: 7 “The latest debt level is up 3.4% month-over-month. The current level is 1.3% below its record high set in April of last year. The November data gives us an additional sense of investor behavior during the election rally.” http://www.advisorperspectives.com/dshort/updates/2016/12/30/a-new-look-at-nyse-margin-debtand-the-market Other things like significant reductions in short interest as well as high bullish investor sentiment readings in surveys like Investors Intelligence have also recently occurred. CONCLUSION Just like George Costanza it could be a good time to think “opposite”. Hopefully I’ve given you some food for thought for doing so. Also, be alert for ”fake news” or at least understand the source and the “agenda” that the media outlet and author may have. Despite what at least to me seems like some obvious warning signs, markets are still relatively complacent. 2017 will be a year, as much as ever, to not get too drawn into the complacency but be very aware of the “opposite” side of every story. David Janny Senior Vice President Financial Advisor NMLS# 1279369 Morgan Stanley Wealth Management 200 Nyala Farms Rd. Westport, CT 06880 203 221-6093 Visit my website www.morganstanleyfa.com/david.janny/ Connect with me on LinkedIn: https://www.linkedin.com/in/david-janny-ba2734115 The views expressed herein are those of the author and do not necessarily reflect the views of Morgan Stanley Wealth Management or its affiliates. All opinions are subject to change without notice. Neither the information provided nor any opinion expressed constitutes a solicitation for the purchase or sale of any security. Past performance is no guarantee of future results. Please be advised by clicking on a third party URL or hyperlink, you will leave morganstanley.com. Morgan Stanley Smith Barney LLC is not implying an affiliation, sponsorship, endorsement with/of the third party or that any monitoring is being done by Morgan Stanley of any information contained within the web site. 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