Download The Point - Fieldpoint Private

THE POINT
May 17, 2013
Bill Kennedy, CFA
Chief Investment Officer
What’s the Point?
• We expect this rally to continue, but hate the market longer term
• For now, don’t fight the Fed, BoJ, or the ECB
• Companies are going to be forced to invest – good for equities
• If you own Treasurys, you own an over-priced asset
• Buy a little insurance for fixed income and equity exposures
• Focus List recommendations on page four
Short-term gain, long-term pain
Last week I had the opportunity to hear Stanley Druckenmiller speak at a conference in New York.
Druckenmiller is from Duquesne Family Office (previously of hedge funds Duquesne Capital and Soros Fund)
and, in my opinion, one of greatest investors/traders of our time. In his opening remarks he expressed mild
annoyance with the constant drone of pundits on CNBC who state “how much they love the market longterm, but expect a near-term correction.” Druckenmiller said he believes just the opposite – he loves the
market short-term, but hates it long-term.
This pretty much sums up your CIO’s own views.
We believe the global economy is in the throes of a massive, multi-year deleveraging cycle. Deleveraging is a
story with three chapters:
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•
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Chapter One: transfer of debt from the private sector to the public sector (2008-2010).
Chapter Two: implementation of policies to help transition the government from debt accumulation to
debt reduction. These include some combination of (a) growth, (b) currency debasement and (c)
inflation (2011-2014).
Chapter Three: structural and systemic changes required to repair the fallout from “Chapter Two”
(2014-2020).
THE POINT
An understanding of history is very important in investing. For instance, the U.S. has experienced a number of
fiscal crises, including one in 1995 when the U.S. debt-to-GDP ratio reached a high of 65% and the budget
deficit was roughly 3% of GDP. Bob Rubin was then Treasury Secretary, working closely with a gentleman
named Jack Lew, then a Presidential appointee at the Office of Management and Budget. A tonic of economic
growth policies, coupled with a slowdown in entitlement spending, was introduced, allowing the U.S. economy
to grow. Five years later, the country entered the new millennium with debt-to-GDP stabilized (~60%) and a
budget surplus of roughly 2%.
One might ask if it is possible, twenty years later, to repeat this kind of fiscal engineering. While it is possible, it
seems improbable when you consider that today’s starting point is materially worse than previous fiscal crises.
For example:
•
•
•
•
As of 4Q12, debt-to-GDP was 104% and the deficit -7% of GDP.
Since 1995, the U.S. economy (real) has grown at a compounded rate of 2.6% compared to the growth
in federal outlays of 5.0% and federal transfer payments of 6%. In 2013, transfer payments will
represent nearly 70% of total government outlays, compared to 50% in 1995. Medical, income
maintenance and state unemployment benefits account for two-thirds of the growth in benefits.
Federal transfer payments have grown because of powerful lobbies in Washington, not because of an
aging population. Today the number of workers per retiree is 4.5:1, the same ratio as in 1995. The real
demographic storm is just beginning. By 2020 (seven years from now) the ratio is projected to be 3.5:1,
and by the year 2030 it will be 2.5:1.
The political landscape today is much more contentious than 1995. The nation, indeed the world, lacks
statesmanship and the true political leadership required to push through rational policies to achieve
economic growth and fiscal responsibility.
Against this backdrop, central banks around the world have unleashed a wave of liquidity - monetary policies
hell-bent on facilitating the second chapter of the deleveraging story.
For avoidance of doubt, I think central bank behavior is somewhere between irresponsible and criminal. The
Fed is pulling a fast one on the American public with a masterful shell game.
Like a street hustler in the commercial districts of lower Manhattan, Dr. Bernanke directs market participants
to his table where he shuffles three red plastic cups while rhetorically asking the question, “Where’s the ball?”
In this case, the ball hidden under the cup represents 6.5% unemployment and 2% inflation, two artificial
anchors.
With his audience (and the media) completely focused on trying to guess under which cup the ball is hiding,
Professor Bernanke and his cohorts quickly and quietly go about picking the pockets of the audience members
by penalizing savings and curtailing investment through artificially low interest rates and volatility, thus
allowing Dr. Ben to pull off his true objective: monetizing $17 trillion of federal debt in order to buy time until
responsible fiscal policy can be introduced into the economy.
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THE POINT
The Fed is manipulating the price of money and these policies create real economic dislocations. First, they
cause the misallocation of capital as investment decisions are based on artificially low interest rates. Second, for
savers - including endowments, foundations and individuals - the stretch for yield leads to unintended (and
loss-making) consequences. Finally, they prevent the banking and financial system from operating normally,
since policy uncertainty prevents consumers of capital and suppliers of capital from acting rationally.
These are just a few of the reasons I am negative on the markets longer-term. Our asset allocation work takes
these long-term risks into account by assuming future capital market returns will be very different than those
of the last twenty years. Fieldpoint Private’s annualized return expectations for the next seven years are: stocks
+7%, U.S. Treasurys -2%, and cash 0% (all before taxes).
SHORT-TERM GAIN
So why do we like the near term? One reason is we think the Fed has no intention of raising rates, even if
unemployment achieves 6.5% or Professor Bernanke himself avoids unemployment by retiring from his post.
Again, the Fed’s ultimate goal is to buy time to allow fiscal policy to drive debt-to-GDP back to reasonable
levels (say, below 90% of GDP).
Another reason we like the market near-term is that we think corporate savings need to find a higher return.
Corporate cash flows are at an all-time high and balance sheets are pristine. As sluggish economic growth
causes top-line revenue growth to stagnate, CEO and CFO behavior will have to change. Cost cutting and
rationalizing expenses have reached a natural conclusion. With interest rates at these stupid levels, company
managements will be forced to take action, which we think will come in the form of increased debt issuance,
with the proceeds to be used for (a) boosting dividends, (b) investing in new plant and equipment, and (c)
M&A to grow revenue and earnings. If corporate America is on the verge of leveraging up, then equity
investors should benefit from:
(1) Higher returns on equity (ROE)
(2) Higher dividend payouts and dividend yields
(3) Higher price-earnings (PE) multiples
In short, today’s monetary policy is laying the foundation for another bubble in risk assets, including global
equities. Chapter Two and the liquidity-fueled bull market will eventually end very badly. However, we think
central banks’ policies will remain accommodative for longer than most believe possible. Knowing stocks are
highly correlated (88%) to the Fed’s balance sheet, we believe there’s further room for this rally to run.
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THE POINT
Fieldpoint Private Focus List Recommendations:
In global fixed income, we believe anyone who owns U.S. Treasury bonds owns a mis-priced asset. Treasurys
play an important diversification role, but the downside risk is too great. We prefer high-yield bonds, municipal
bonds and mortgage-backed securities. We strongly encourage Members to take out a little insurance on their
fixed-income portfolios by lowering portfolio duration and increasing allocations to skilled managers seeking
absolute, risk-adjusted returns. Recommended Focus List managers include:
FP Focus List Recommendation
iShares Floating Rate Note Fund (ETF)
Ivy High Income fund (Mutual Fund)
Breckinridge Inter Tax Exempt Municipals (SMA)
KLS Diversified (hedge fund)
Good Hill (hedged fund)
Sandalwood Bodleian Partners B (fund of funds)
Description
Floating rate instruments
High-yield corporates
Municipals bonds
Hedged rates, credit, structured product
Hedged rates and mortgage backed securities
Fund of hedge funds
In global equities we prefer growth over value, cyclicals over defensives, mid-cap over large-cap, and
international stocks over U.S stocks. We favor equity investments in Japan, the U.K. and emerging markets.
We would avoid equity investments in Canada and Australia. Like fixed income, we strongly encourage
Members to buy insurance on their global equity exposures by reducing overall equity volatility. This can be
achieved through passive options like volatility-minimizing ETFs as well as increasing allocations to skilled
managers with a record of good risk-adjusted returns and attractive downside capture. Recommended Focus
List managers include:
FP Focus List Recommendation
iShares MSCI Minimum Volatility Funds (ETFs)
Apex Capital SMID Growth (SMA)
Scout Mid-Cap Fund (Mutual Fund)
WCM Focused Int’l Growth
Matthews Asian Growth and Income (Mutual Fund)
Aston/Lake Partners LASSO (Mutual Fund)
Description
Liquid alternatives
Small and mid-cap growth (US)
Invests 80% in stocks with mkt cap of $1.5-$17bn
Invests 75% in non-US equities
Top 3 exposures HK, Singapore, Japan
Liquid alternatives
Please contact your Fieldpoint Private advisor for more information about these and other Focus List manager
recommendations.
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THE POINT
FIELDPOINT PRIVATE’S INVESTMENT VIEW (2Q13):
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The global economy is in the throes of a massive, multi-year debt deflation cycle. Against this backdrop,
2013 is expected to be a year of re-leveraging as governments and consumers see debt-to-income rise.
•
Central bank policy actions have eliminated deflationary tail risks. Inflation risks will remain subdued
until slack economic capacity is eliminated.
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For the next several years productive capital will be re-allocated to non-productive uses (debt
repayment). As a result, economic growth, corporate earnings and investor returns should remain below
their historical averages.
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We expect equities to return 7%, bonds 0% and cash 0% over the next seven years.
•
Traditional asset allocation is ill-suited for the current environment of negative real interest rates,
investors’ thirst for yield, and below-average returns. Fieldpoint Private’s risk budgeting approach
utilizes return and risk assumptions using our proprietary research, determines appropriate risk
exposures, and allocates Members’ capital to match risk budgets and deliver true diversification.
•
Fieldpoint Private’s asset allocation models shifted from “turbulent” to “normal” positioning in 1Q13,
reflecting expectations for marginally better economic growth in the second half of this year and into
2014.
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THE POINT
About Fieldpoint Private
Headquartered in Greenwich, Connecticut, Fieldpoint Private (www.fieldpointprivate.com) is a boutique
financial firm providing the highest degree of personalized, confidential wealth planning and private banking
services. Catering to highly successful individuals, families, businesses and institutions, Fieldpoint Private
offers a powerful combination of wealth management and strategy, family office, private banking and
business banking services addressing every financial need for each of our Members including: wealth transfer
advice, tax planning, aggregation and performance reporting, risk management, goals-based investing
strategies, sophisticated investment selection, discreet and personalized banking, highly customized credit
solutions, custom custody and trust solutions, highly attentive/responsive service and concierge services.
Fieldpoint Private was established in 2008 by 31 Founders with a specific vision and purpose. These
extraordinary leaders of industry and community recognized the opportunity to create a financial firm totally
attuned to people’s individual circumstances. Our firm is built on a philosophy of exclusive Membership and
client-centricity. Working with a limited number of relationships gives every person the experience of
belonging to an extremely selective group. The result is a new breed of institution established on the basis of
personalization, responsiveness, and exclusivity, and an ensured commitment to impeccable service and
consistently flawless execution. Our Member-oriented service approach offers a unique client experience
custom crafted to each Member’s financial needs.
© 2013 Fieldpoint Private. All rights reserved.
Banking Services: Fieldpoint Private Bank & Trust
Registered Investment Advisor: Fieldpoint Private Advisors, Inc.
Securities: Fieldpoint Private Securities, LLC, Member FINRA, SIPC
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THE POINT
Compliance Disclosure
This material is for informational purposes only and is not intended to be an offer or solicitation to purchase or sell any security or to
employ a specific investment strategy. It is intended solely for the information of those to whom it is distributed by Fieldpoint Private.
No part of this material may be reproduced or retransmitted in any manner without prior written permission of Fieldpoint Private.
Fieldpoint Private does not represent, warrant or guarantee that this material is accurate, complete or suitable for any purpose and it
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obtained from public sources. Fieldpoint Private assumes no responsibility for independent verification of such information and has
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otherwise revise these materials. This material does not purport to contain all of the information that a prospective investor may wish
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judgments of such sources or represent reasonable estimates. Any pricing or valuation of securities or other assets contained in this
material is as of the date provided as prices fluctuate on a daily basis. Past performance is not a guarantee of future results.
Asset allocation models are based on capital market expectations for each classification and segment using a thirty (30) year timeseries of historical returns and standard deviations. Returns and risk assumptions may vary from historical averages based on
prevailing market conditions, Fieldpoint Private's macro economic assumptions, and changes to assumptions including state and
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Asset allocation models represent the views of Fieldpoint Private's investment professionals and are based on their broad investment
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Public and market data sources may include Fieldpoint Private, Windham Global Solutions, Bloomberg and FactSet.
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