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By Maureen Farrell @CNNMoneyInvest May 24, 2013: 7:14 AM ET
NEW YORK (CNNMoney) Stocks have had a stellar year so far. In fact, the rally has gotten so heated that some investors are making bets on a big crash. Universa Investments, which spends hundreds of millions of dollars a year buying crash protection, has attracted a record amount of money into its fund this quarter. "People are starting to recognize that these market moves are unnatural and distorted," said Universa president and chief investment officer Mark Spitznagel, who declined to say how much is spent on crash protection, citing SEC rules. Universa's view that a crash is coming is not widely held, making crash protection cheap, he said. Universa buys this protection in the form of options that generate huge returns when the stock market falls by more than 20%. Universa's adviser, economist and former derivative trader Nassim Taleb calls it 'black swan' hedging. That's apropos considering Taleb coined the phrase 'black swan,' described as an unforeseen event that has an extreme impact, such as the 2008 financial crisis or Japan's 2011 nuclear disaster. Spitznagel says he's pretty confident that the market will crash, or fall by more than 20%, in the next six months -- a year max. The sell-off in Asian stocks Thursday, he says, is a "hint at what's going to happen." "I think there will be a lot of false starts before it does, and this may be one of them," said Spitznagel. Universa investors, mainly banks and pension funds, use the fund as an insurance policy to protect against a stock market crash. In 2008, when the S&P 500 dropped nearly 40%, Universa generated returns of more than 115% for investors, according to a source familiar with the fund's performance. Universa expects returns of at least 60% when the market is down 20%. Claude Bovet, who runs Lionscrest Capital, has been investing with Universa since it was founded six years ago. He says he has significantly increased his allocation in the past few months. "It allows me to be bullish. You can participate in all the upside of the stock market but without being complacent," said Bovet. Tail risk funds like Universa generally suggest that investors put 1% of what they put into stocks into these hedges. A fund that spends $100 million on equities would put about $1 million to $1.5 million into a tail-risk strategy. When the market is up, Spitznagel and his team try to limit losses. For example, in 2009, when the market gained 30%, Universa investors saw a bleed of only 4%. The Federal Reserve, with its massive bond buying program, is seeing its actions become less effective, said Spitznagel. The Fed, he says, can continue to forestall a crash but only for so long. "There are plenty of crazy things Bernanke can do," he said, referring to the Fed chairman. "But it will end badly." For Universa, a bad market is a good one.  Complacency is high as tail-protection is either sold or completely ignored. This can be seen in the chart which shows 3 month skew on S&P500 options, a measure of demand for tail-protection, going back to the pre-crisis lows of 2007.
Source: CS Equity Derivatives Strategy Lionscrest, through its relationship with Universa Investments, provides investors with tail-protection strategies that seek to hedge against crashes in asset prices whilst simultaneously participating in upside gains. Over the long-term, asset prices have tended to increase in value yet there have been periods of extreme, sharp losses that have had catastrophic consequences on investor portfolios. The possibility to hedge against these extreme losses can provide investors with the ability to compound positive returns over the long-term. Although extreme events of the Black Swan category are impossible to predict, it is nonetheless possible to measure when risk has increased and the investment environment is less stable.
----- Forbes: David Tepper Dramatically Altered Market Sentiment May 14, 2013 David Tepper has the magic touch. The hedge fund billionaire has contributed to a dramatic change in market sentiment, becoming one of the first major proponents of the Federal Reserve tapering its asset purchase program, or QE, to spark a rally. Tuesday’s Tepper rally is an act of rebelliousness to the sentiment that has prevailed over the past several months, when jittery markets sold off in the face of any indication the Bernanke Fed could be close to reducing its unprecedented monetary stimulus, marking an important paradigm shift. Yet, Tepper’s bullishness also came with an important warning: markets are close to overheating, and if expectations aren’t themselves tapered, we could be back to the pre-dotcom crisis days of late 1999, when investors set themselves up for one of the largest meltdowns in financial history. Back in late 2010, Tepper, founder and chief investment officer of Appaloosa Management, went on television and said he was “balls to the wall” bullish equitiess, as either the economy would improve or the Fed would force it to. On Tuesday, Tepper doubled down: “sure, I’m definitely bullish,” he said. And when Tepper speaks, markets listen. The equity rally began to materialize before the opening bell and by the end of the day, the Dow and the S&P 500 had reached new historic highs, while the Nasdaq closed at its highest levels since late 2000 (when the tech-heavy index was imploding). “There better be a true taper, or else you’re back to the second half of ’99,” Tepper told Andrew Ross-Sorkin at CNBC’s Squawk Box before the market open. Under the leadership of Ben Bernanke, the Fed has delivered unprecedented monetary support to the economy, keeping interest rates at the zero bound, and pledging to continue to do so, for a long time, while pumping billion after billion into the market through quantitative easing. The latest iteration of the Fed’s bond buying program, which started last September, is an open-ended $85 billion purchase of Treasuries and residential mortgage-backed securities a month. It has become commonplace to attribute the incredible strength seen in stock markets to Bernanke’s QE. And, by the same token, any sign the Fed could be close to scaling back its monetary support was met by fearful selling of risk assets. Tepper, who’s delivered net annual returns of about 30% since 1993 and was 2012’s highest earning hedge fund manager raking in $2.2 billion, sparked a market rally talking of tapering on Tuesday because he backed his words with numbers. The Fed’s open-ended asset purchases add up to more than $500 million over six months, yet the deficit over the next six month will be under $100 billion (Tepper pointed to an improved economy, tax income, and Fannie and Freddie returning money to the government). With net issuance by the Treasury just over $100 billion, a remaining $400 billion has to be “made up,” Appaloosa’s chief said. That’s $400 billion in investors’ hands, who now face a choice and have few options: put money into the economy, into the short and long-ends of the curve, or into stocks. Calling the current state of Fed capital injection unprecedented, Tepper issued a dire warning, albeit one that contradicts most of what’s been said over the past few months: “if we don’t taper back, we’re gonna get into this hyper-drive market,” so to keep markets going up at a steady pace, rather than an unsustainable one, the Fed needs to scale back its purchases. “The guys that are short, they better have a shovel to get themselves out of the grave that they’re in,” he added after Sorkin asked him about the possibility that fear of unwinding could drive down stocks. Tepper noted the improved economic environment and cited specific sectors. Housing is better and so is the auto sector, he said. If stocks reflect the underlying strength of a company, the charts of KB Home, Lennar, General Motors, and Ford Motor all support Tepper’s argument. Tepper picked up the baton where Jon Hilsenrath, Fed mouthpiece and WSJ reporter left it after the weekend. Hilsenrath said Fed officials had already drawn out a map as to how they would unwind QE when the timing was right. According to Tepper, the time is now, or the June FOMC meeting. Until Tuesday, market participants seemed to still fear a slowdown in Fed asset purchases. After Tepper Tuesday’s record highs, though, those fears seem long gone. ----- David Tepper is a legendary hedge fund manager and the founder ofAppaloosa Management which oversees $18 billion in assets. His investment specialty is distressed companies. While most hedge funds underperformed the U.S. stock market in 2012, Tepper trounced it. His flagship fund posted net returns of about 30%. Appaloosa has generated average annualized returns of approximately 30% net since inception in 1993. Tepper continues to focus his philanthropic efforts on education-- from the elementary school level to university--and feeding the hungry in his home state of New Jersey. Lionscrest, through its relationship with Universa Investments, provides investors with tail-protection strategies that seek to hedge against crashes in asset prices whilst simultaneously participating in upside gains. Over the long-term, asset prices have tended to increase in value yet there have been periods of extreme, sharp losses that have had catastrophic consequences on investor portfolios. The possibility to hedge against these extreme losses can provide investors with the ability to compound positive returns over the long-term. Although extreme events of the Black Swan category are impossible to predict, it is nonetheless possible to measure when risk has increased and the investment environment is less stable.
----- Jeremey Grantham, GMO Charlie Rose - March 2013 Jeremy Grantham speaks with Charlie Rose for a most informative hour where he starts by elaborating on his views on global warming, the environment, population growth and commodities. At 29:00 Grantham provides a compelling historical viewpoint on the markets and, more specifically, at 43:50 he speaks to the current envirnonment. ----- Jeremy Grantham is a British investor and co-founder and chief investment strategist of Grantham Mayo van Otterloo (GMO), a Boston-based asset management firm. GMO is one of the largest managers of such funds in the world, having more than US $97 billion in assets under management as of December 2011. Grantham is regarded as a highly knowledgeable investor in various stock, bond, and commodity markets, and is particularly noted for his prediction of various bubbles. He has been a vocal critic of various governmental responses to the Global Financial Crisis. Grantham started one of the world's first index funds in the early 1970s. Lionscrest, through its relationship with Universa Investments, provides investors with tail-protection strategies that seek to hedge against crashes in asset prices whilst simultaneously participating in upside gains. Over the long-term, asset prices have tended to increase in value yet there have been periods of extreme, sharp losses that have had catastrophic consequences on investor portfolios. The possibility to hedge against these extreme losses can provide investors with the ability to compound positive returns over the long-term. Although extreme events of the Black Swan category are impossible to predict, it is nonetheless possible to measure when risk has increased and the investment environment is less stable.
----- Paul Singer, Elliott Management Corporation "The Fed, Lost In The Wilderness The financial system (including the institutions themselves, products traded, and risks taken) has “gotten away from” the Fed’s ability to comprehend. The Fed is primarily responsible for that state of affairs, and it is out of its depth. Former Chairman Greenspan created – and reveled in – a cult of personality centered on himself, and in the process created a tremendous and growing moral hazard. By successive bailouts and purporting to understand (to a higher and higher level of expressed confidence) a quickly changing financial system of growing complexity and leverage, he cultivated an ever-increasing (but unjustified) faith in the Fed’s apparent ability to fine-tune the American (and, by extension, the world’s) economy. Ironically, this development was occurring at the very time that financial innovations and leverage were making the system more brittle and less safe. He extolled the virtues of derivatives and minimized the danger of leverage and risky securities and dot-com stocks, all while he should have been putting on the brakes. It was not just the disappearance of vast swaths of the American financial system into unregulated subsidiaries of financial institutions, nor was it just government policies that encouraged the creation and syndication of “no-documentation” mortgages to people who could not afford them. It was also the low interest rates from 2002 to 2005, the failure to see the expanding real estate bubble caused by an unprecedented increase in leverage and risk, and the general failure to understand the financial conditions of the world’s major institutions. Under Chairman Bernanke, the combination of ZIRP and QE completed the passage of the Fed from sober protector of a fiat currency to ineffective collection of frantically-flailing, over-educated, posturing bureaucrats engaged in ever more-astounding experiments in monetary extremism. If you look at the history of Fed policy from Greenspan to Bernanke, you see two broad and destructive paths quite clearly. One path is the cult of central banking, in which the central bank gradually acquired the mantle of all-knowing guru and maestro, capable of fine-tuning the global economy and financial system, despite their infinite complexity. On this path traveled arrogance, carelessness and a rigid and narrow orthodoxy substituting for an open-minded quest to understand exactly what the modern financial system actually is and how it really works. The second path is one of lower and lower discipline, less and less conservative stewardship of the precious confidence that is all that stands between fiat currency and monetary ruin. Monetary debasement in its chronic form erodes people’s savings. In its acute and later stages, it can destroy the social cohesion of a society as wealth is stolen and/or created not by ideas, effort and leadership, but rather by the wild swings of asset prices engendered by the loss of any anchor to enduring value. In that phase, wealth and credit assets (debt) are confiscated or devalued by various means, including inflation and taxation, or by changes to laws relating to the rights of asset holders. Speculators win, savers are destroyed, and the ties that bind either fray or rip. We see no signs that our leaders possess the understanding, courage or discipline to avoid this. It is true that the CEOs of the world’s major financial institutions lost their bearings and were mostly oblivious to their own risks in the years leading up to the crash. However, as the 2007 minutes make clear, the Fed was clueless about how vulnerable, interconnected and subject to contagion the system was. It is not the case that the Fed completely ignored risk; indeed, several Fed folks made “fig leaf” statements about the risks of the mortgage securitization markets, as well as other indications that they appreciated the possibility of multiple outcomes. But nobody at the Fed understood the big picture or had the courage to shift into emergency mode and make hard decisions. In the run-up to the crisis the Fed was a group of highly educated folks who lacked an understanding of modern finance. After convincing the nation for decades of their exquisite grasp of complexities and their wise stewardship of the financial system, they didn’t understand what was actually going on when it really counted. Ultimately, of course, as the system was collapsing and on the verge of freezing up completely, the Fed shifted into the (more comfortable and much less difficult) role of emergency provider of liquidity and guarantees. All this background presents an interesting framework in which to think about what the Fed is doing now. QE is a very high-risk policy, seemingly devoid of immediate negative consequences but ripe with real chances of causing severe inflation, sharp drops in stock and bond prices, the collapse of financial institutions and/or abrupt changes in currency rates and economic conditions at some point in the unpredictable future. However, the lack of large increases in consumer price inflation so far, plus the demonstrable “benefits” of rising stock and bond markets, have reinforced the merits of money-printing, which is now in full swing across the world. In the absence of meaningful reforms to tax, labor, regulatory, trade, educational and other policies that could generate sustainable growth, “money-printing growth” is unsound. We believe that the global central bankers, led by the Fed as “thought leader,” have no idea how much pain the world’s economy may endure when they begin the still-undetermined and never-before attempted process of ending this gigantic experimental policy. If they follow the paths of the worst central banks in history, they will adopt the “tiger by the tail” approach (keep printing even as inflation accelerates) and ultimately destroy the value of money and savings while uprooting the basic stability of their societies. Read the 2007 Fed minutes and you will understand how disquieting is the possibility of such outcomes and how prosaic and limited are the people in whom we have all put our trust regarding the management of the financial system and the plumbing of the world’s economy. Printing money by the trillions of dollars has had the predictable effect of raising the prices of stocks and bonds and thus reducing the cost of servicing government debt. It also has produced second-order effects, such as inflating the prices of commodities, art and other high-end assets purchased by financiers and investors. But it is like an addictive drug, and we have a hard time imagining the slowing or stopping of QE without large adverse impacts on the prices of stocks and bonds and the performance of the economy. If the economy does not shift into sustainable high-growth mode as a result of QE, then the exit from QE is somewhere on the continuum between problematic and impossible. Central banks facing high inflation and/or sluggish growth after sustained money-printing frequently are paralyzed by the enormity of their mistake, or they are deranged by the thought that the difficult and complicated conditions in a more advanced stage of a period of monetary debasement are due to just not printing enough. At some stage, central banks inevitably realize, regardless of whether they admit the catastrophic nature of their own failings, that the cessation of money-printing will cause an instant depression. Even though at that point the cessation of money-printing may be the only action capable of saving society, that becomes a secondary consideration compared to the desire to avoid immediate pain and blame. The world’s central banks are in very deep with QE at present, and the risks continue to build with every new purchase of stocks and bonds with newly-printed money." ----- Paul Singer founded the hedge fund Elliott Associates L.P. in 1977 with $1.3 million from various friends and family members. Elliott Management Corporation oversees Elliott Associates and Elliott International Limited, which together have more than $21 billion in assets under management. According to The Guardian, "Elliott's principal investment strategy is buying distressed debt cheaply and selling it at a profit or suing for full payment." Lionscrest, through its relationship with Universa Investments, provides investors with tail-protection strategies that seek to hedge against crashes in asset prices whilst simultaneously participating in upside gains. Over the long-term, asset prices have tended to increase in value yet there have been periods of extreme, sharp losses that have had catastrophic consequences on investor portfolios. The possibility to hedge against these extreme losses can provide investors with the ability to compound positive returns over the long-term. Although extreme events of the Black Swan category are impossible to predict, it is nonetheless possible to measure when risk has increased and the investment environment is less stable.
----- Niall Ferguson, Harvard University 10th Annual Strategic Investment Conference presented by Altegris Investments and John Mauldin "What is it that ails us? Has there been enough stimulus or is the current economic malaise a symptom of something else? Adam Smith – brought forth the idea of the “stationary state” where economies transition from growth to stability. However, it is the rule of law that allows countries to grow. Historically, what makes nations strong is the guarantee that justice will be done. This is what separated Europe from China during the 1800’s. Today, the west is now approaching the “stationary state.” So, the central question of the “great degeneration” is whether our institutions, corporations and governments, are degenerating. There are four symptoms of degeneration: Breakdown of the contract between generations. Excess regulation Rule of lawyers Decline of civil society Generational Contract Each generation has a responsibility to the next. Currently, we have violated the contract between our generation and the next. In order to restore the generational balance we could currently have to do one of two things: Immediately cut, and make permanent, all government outlays by 30% Immediately, and make permanent, increase in all federal taxes by 60% The problem is that if these measures are not implemented immediately the percentages required to restore the generational balance rise each and every year. While this is what is required to achieve generational balances – the individuals responsible for such decisions, however, are pursuing the opposite path – spend more and tax less. Regulatory Excess One of the major constraints to economic growth and the second pillar of the degeneration of our institutions is excessive regulation. “Unlike my arch enemy Paul Krugman”….who believes that the financial crisis was not caused by deregulation – the reality that there was plenty of regulation over the financial institutions. (Enforcement of those regulations is another issue entirely) that ultimately were at the epicenter of the crisis. The financial crisis was really a result of an increasingly complex financial system. However, in response to the financial crisis, the immediate course of action was to complicate the system further by adding layers of new regulation (Dodd-Frank, Consumer Protection, etc.). However, the problem is that by making a complex system more complex – the outcome is not stability but rather instability. Instability leads to inevitably bad outcomes. The Rule Of Law Dodd-Frank demonstrates the primary problem with the rule of law. Statutes that cover thousands of pages are ineffective, cumbersome and impedes growth. The complexity of recent laws such as Dodd-Frank, Affordable Care and others, along with our current tax code, would have our founding fathers and those of the Gilded Age reeling from disbelief. However, here is the real problem. The world is no longer under a rule of law - but rather a rule of lawyers. The U.S. has the highest cost of law of any other country in the world. The rule of law is supposed to be speedy, efficient and effective. However, the rule of law has been corrupted by the legal system for self-serving needs. There are three key indicators of the health of the “rule of law.” Legal System and Property Rights Regulation Summary of Economic Freedom Unfortunately, all of these measures have declined dramatically since the turn of this century. The outcome of this decline over the last 13 years is that it is more difficult than ever to do business in the U.S. Compliance and regulatory costs are on the rise which reduces profitability. The decline in the rule of law has led to daunting decline in the view of American Institutions. America was once the envy of the entire world - that is no longer the case. Of the 22 measures of institutional quality, covering everything from property rights to bribery, the U.S. is not at the top of the list in ANY category. More disturbing is that today – the U.S. is soundly beaten by Hong Kong on every measure. The Decline of Civil Society Lastly, the decline of civil society is most disturbing. One way to look at this is by looking at the active membership is voluntary associations which has plummeted in recent years. Americans are no longer actively involved in civil society and now depend on the government to “solve problems". The problem with this, of course, is that the decline of the civil society also leads to a decline in economic output. Dependency on government to solve social issues has very little economic benefit. While the rest of the world is getting better in term of building better institutions – the U.S. is getting progressively worse. Bright Spots However, the good news is, as compared to others, is that the U.S. is ageing less rapidly. China, as an example, will be harshly impacted by an aging population in the next two decades. For the U.S., despite have a completely flawed and non-existent energy policy, the country is undergoing and energy revolution that is just now becoming apparent. Natural gas is the new gold rush. While a large portion of the U.S. will continue to languish due to regulatory and fiscal policy – there are four growth corridors: Great Plains Third Coast Region Intermountain Region Gulf Coast However, the boom in these areas is not due to just the location of natural gas but rather pro-business regulatory and tax policies. If the current Administration was paying attention they would take the time to emulate the state governments that are growing versus declining. There is no question that institutions matter. It explains why the developed economies are struggling versus emerging markets. The problem is that, despite mainstream media commentary and Keynesian economists, the decline of institutions cannot be saved by monetary policy. In other words…Washington is killing economic prosperity. “The U.S. has the right to be stupid…and has been exercising that right for years.” We have allowed our government to whittle away at the rule of law and replace a vibrant economic system with a European style welfare state. If you want to be stupid…keep doing what you are doing. Q.A. Worried about the U.S. – What of Japan? The main lesson to be learned this year is the limit of monetary policy. The story last year was that the Central Banks are the only game in town. The story this year, is that despite stimulus spending which is simply an anti-volatility policy, the economy will not achieve “escape velocity.” I predict that the limits of monetary policy will be witnessed by the end of this year. We have a structural economic policy problem – not a monetary one. Question by Paul McCulley: “The long run is a misleading guide to current affairs…in the long run we are all dead.” Are we in a liquidity trap, are we at a zero bound of interest rates and stuck at 8% unemployment? Keynes was a homosexual and had no intention of having children. We are NOT dead in the long run…our children are our progeny. It is the economic ideals of Keynes that have gotten us into the problems of today. Short term fixes, with a neglect of the long run, leads to the continuous cycles of booms and busts. Economies that pursue such short term solutions have always suffered not only decline, but destruction, in the long run. Have Corporations Usurped Government? “It is corruption when corporations can buy regulation. It is corruption when laws are sponsored by Wall Street.” It is a sad state when the current level of corruption of the U.S. government is what was once only associated with third world countries ruled by dictators. The problem is that crony capitalism is a profound predicament in the U.S. and we now suffer from a third world disease. What Is The Solution To Restore Growth? The fiscal problems are a function of structural problems. Without addressing the structural problems that plague the economy from production to employment – stimulus will fail. The reality is that the “punch bowl” won’t fix employment growth, economic growth or the rule of law. The party of the last 20 years is now over and the longer we fail to address the real issues the bigger the hangover will be in the future." ----- Niall Ferguson is the Laurence A. Tisch Professor of History at Harvard University, a Senior Fellow of the Hoover Institution at Stanford University and a Senior Research Fellow at Jesus College at Oxford. He is also the author of 14 books including the must read “The Ascent Of Money: A Financial History Of The World.” Lionscrest, through its relationship with Universa Investments, provides investors with tail-protection strategies that seek to hedge against crashes in asset prices whilst simultaneously participating in upside gains. Over the long-term, asset prices have tended to increase in value yet there have been periods of extreme, sharp losses that have had catastrophic consequences on investor portfolios. The possibility to hedge against these extreme losses can provide investors with the ability to compound positive returns over the long-term. Although extreme events of the Black Swan category are impossible to predict, it is nonetheless possible to measure when risk has increased and the investment environment is less stable.
----- A. Gary Shilling, A. Gary Shilling & Co. 10th Annual Strategic Investment Conference presented by Altegris Investments and John Mauldin "Six Fundamental Realities: Private Sector Deleveraging And Government Policy Responses Household deleveraging is far from over. There is most likely at least 5 more years to go. However, it could be longer given the magnitude of the debt bubble. The offset of the household deleveraging has been the leveraging up of the Federal government. The flip side of household leverage is the personal saving rates. The decline in the savings rate from the 1980’s to 2000 was a major boost to economic growth. That has now changed as savings rate are now slowly increasing and acting as a drag on growth. However, American’s are not saving voluntarily. American’s have been trained to spend as long as credit is readily available. However, credit is no longer available. Furthermore, there is an implicit mistrust of stocks which is a huge change from the 90’s when stocks were believed to be a source of wealth creation limiting the need to save. My forecast for GDP growth going forward is that it will remain mired around 2%. The response to the stalled economic environment and deleveraging cycle has been massive government interventions. The Fed’s original program of zero interest rates have failed to promote borrowing. The next step was unprecedented Quantitative Easing. The Fed’s dual mandate is full employment, currently targeted at 6.5%, and price stability (inflation) around 2%. The Fed has been very clear that the current QE programs are directly tied to these targets. However, monetary policy is a very blunt instrument, but the Fed believes that it will work within a 5 step process. The Fed buys treasuries and mortgage bonds out of the market. The increase in liquidity is then reinvested into the equity market. The rise in asset prices creates a wealth effect for consumers. With stronger confidence consumers spend more which creates demand on businesses. The increase in demand leads to job creation. The problem is that there is little evidence that Q.E. programs are fulfilling their intended role. History is not a controlled experiment. There is no way to tell what would have really happened had the Fed not intervened after the financial crisis. However, what we can absolutely measure, is the impact of the Fed’s activities on the economy. If we measure the increase in real GDP for each dollar of increase in debt we find that it has been close to nil. From 2001 through the end of Q2-2012 – we find that there has been only a 0.08% increase in real GDP per dollar of increase in debt. While the economy has failed to ignite - there has been a sharp surge in market capitalization as a percentage of nominal GDP. Currently at levels well above the long term average it is unlikely that this is the beginning of the next great secular bull market. The bottom line is that despite trillions of dollars of Federal Reserve interventions there has been very little impact on the real economy. This is because there has been very little follow on effect from the massive increases in excess reserves. Historically required reserves have remained fairly close to the level of excess reserves. However, today, excess reserves are running roughly $1.7 trillion above the level of required reserves. Liquidity remains trapped which is why there is no velocity of money in the economy. Growing Protectionism The problem today is that everybody wants to increase exports to boost their respective economies - but no one wants to, or is able to, buy. This has pushed countries into the need to take more drastic actions to stabilize and boost their economies. This has led to currency devaluation schemes. Japan is the poster child to currency devaluation. They have gone “all in” to debase their currency in hopes that they will create some inflation. For Japan it is “go big or go home.” It is important to note that NO ONE ever initiates currency devaluation – they are just trying to get back to even. Currently, the head of the central bank in Japan, has the backing of the country. This will allow him to operate and continue his stimulative actions. The tipping point will be when he loses this approval. However, while Japan is currently happy with their direction, other countries are not. Eventually there will be a reprisal. The Great Disconnect “Don’t worry about a thing as long as the Fed is inflating assets and the economy is in the tank.” Nobody wants to end the current Q.E. programs. What it will take is an economic shock of some magnitude. What type of shock it will be, and when it will occur, are the only questions? Here is the simple truth: Stocks will eventually revert to the fundamentals of the economy. Such a reversion will devastate most investors that are unhedged for that eventuality. Zeal For Yield The chase for yield has reached excessive levels. Despite the rising risks individuals continue to ignore the fundamentals and reach for ever increasing levels of yield. Junk bonds, emerging market debt and bank loans are at record low levels in yield. The yield on stocks and bonds are equal for the first time decades. This is an indication of a late stage bull market. It is also one that has historically ended badly for investors. End of Export Driven Growth In Developing Countries. The demand for exports is slowing as the major developed countries are weak and demand slackens. As Jeff Gundlach discussed earlier – China’s growth rate is slowing. However, no run really trusts the data coming out of China. It takes China 18 days from the end of the quarter to report GDP. It takes the U.S. 28 days. China never revises their data subsequent to that first report while the U.S. revises its data two more times over a 90 day period. The data is extremely unreliable. For instance, how do you have a flat manufacturing report coming out of China, as measured by Markit PMI, when they supposedly have a 7.7% GDP growth? That simply does not add up. Going forward emerging economies are focused on creating internal growth to offset the drag from slowing export growth. This will likely lead to problems. Equities Are Vulnerable We are still within a secular BEAR market that begin in 2000 with P/E ratios still contained within a declining trend. Despite media commentary to the contrary - this time is likely not different. In order for valuations just to return to the long term average they would have to decline by 27.5% from current levels. However, the reality is that valuation reversions always exceed the long term mean. Furthermore, corporate profits have only soared due to declining labor costs and increased productivity. The problem now is that there is an inability to slash costs and increase productivity at levels that can offset the decline in operating earnings and revenue. This makes equities susceptible to a large reversion at some point in the future. Q&A: Austerity Or Stimulus – What Should We Be Doing? If you don’t get austerity when things are tough you will never get it. This is the problem in Germany. In the U.S. – Congress has it completely backwards. They should be working on structural deficits rather than fiscal deficits. Change retirement ages, etc. rather than trying to inflate assets. GDP less inventories is much weaker. Inventories are a residual of activity and small changes on either end have a big impact on the economic figure. What Happens? The great disconnect will reconnect over the next couple of years which will negatively impact long only investors. Does The Fed Have To Exit? That is an interesting point. With slow growth, which will continue due to the ongoing deleveraging cycle for another 5 years, it is likely that the Fed will not try and exit. However, when the economy begins to reach higher levels of growth in the future the excess reserves will begin to flow into the system. If the Fed doesn’t exit from their policies when that occurs the impact of inflation could be severe." ----- A. Gary Shilling is the President of A. Gary Shilling & Co. and is an American financial analyst and commentator who appears on a regular basis in publications such as Forbes Magazine, The New York Times and The Wall Street Journal. He is also editor of A. Gary Shilling's Insight, and member of The Nihon Keizai Shimbun Board of Economists. He is featured frequently on business shows on radio and television, and as a recognised orator, addresses conventions of global business groups like the Young Presidents' Organization. In the spring of 1969, he was one of only a few analysts who correctly envisioned the recession at year's end, and was almost a lone voice in 1973, when he forecast a monolithic international inventory-building fling, followed by the first significant recession since the Great Depression. In the late 1970s, while most analysts presumed that waxing inflation would go on unabated, Shilling was the first to predict that America's infirm political climate would impede it. He also foresaw various dangerous economic readjustment problems and a shift in investment strategy from a preference for tangible assets to an increased emphasis on stocks and bonds. In June 2011, he predicted a 20% drop in housing in 2012 with a resulting global recession. In October 2012 he predicted a global recession in 2013 . Lionscrest, through its relationship with Universa Investments, provides investors with tail-protection strategies that seek to hedge against crashes in asset prices whilst simultaneously participating in upside gains. Over the long-term, asset prices have tended to increase in value yet there have been periods of extreme, sharp losses that have had catastrophic consequences on investor portfolios. The possibility to hedge against these extreme losses can provide investors with the ability to compound positive returns over the long-term. Although extreme events of the Black Swan category are impossible to predict, it is nonetheless possible to measure when risk has increased and the investment environment is less stable.
----- Mohamed El-Erian, Pimco 10th Annual Strategic Investment Conference presented by Altegris Investments and John Mauldin "I want to try and build on what you have heard so far. I want to focus, in particular, on two statements that have been made so far at this conference. The need to put the pieces together To make sure we give ourselves a chance to win So, how do we put the pieces together to give us the best chance to win? I will try and give you an answer. If you knew nothing of the markets, and just showed up at this conference, you would be very confused. The world is awash in contradiction with stocks rising to new highs as interest rates reflect a slowing economy. It is an upside down world. Individuals are both excited and anxious. They are excited by the rally in the markets as they see their portfolios increase in values but at the same timed overwhelmingly concerned about the economic future. It is a world with an enormous contrast between the markets and the real economy. That is the world we are navigating and it is incredibly unusual. This is why it is an unloved rally. Therefore, I want to provide a simple framework to reconcile these issues. The long term view matters greatly - but the short term matters also. First, acknowledge that we are here, in terms of current policy, for a good reason. Most countries are shifting from a growth model based on leverage and credit creation to trying to find a new growth model based on new realities. Emerging markets are shifting from exports to internal growth. Developed economies are shifting to a lower growth economic cycle due to ongoing deleveraging. These shifts require assistance from the Central Banks. However, this assistance leads to disconnects. The question, however, is what the “hand off” from assisted support to organic growth will look like and when will it come? The hand off is the 'destination.' The 'journey' is getting there. Investors must invest for both the journey AND the destination. Investing for only one part will lead to unhappiness during the journey or pain at the destination. At Pimco this reality is what we call the “stable disequilibrium.” The world will not reset in cyclical manner and a “new normal” has arrived. The look of the “new normal” is that the West will be stuck in a low growth and high unemployment cycle for quite some time to come. Conversely, the emerging world will continue to bounce back and begin to close the gap between wealth and incomes. There are three speeds to the “new normal.” Slow: Europe and Japan will continue to live through lost decades. Medium: Countries like the US are healing - but not fast enough to obtain “escape velocity.” Fast: Emerging countries with strong balance sheets and favorable business economies. This is the reality of the world that we live in today. If this three speed theory is correct then there are three questions that must be answered: Can it persist and for how long? Will it add up? What do you do about it? Yes, it can persist but not forever. The timing, which is tricky, differs on where you look. For example, in Europe, Cyprus tells you much about the entire European structure. The Troika is no longer operating in an efficient manner. The creditors are also tired of supporting the Eurozone as they see no end to the checks they are writing. Likewise, the debtors are tired from adjustment fatigue. The problem is that the majority of Eurozone countries not only lack growth but, much more importantly, they lack a growth model. The financial markets don’t care because there is the ECB. Whatever happens - the ECB, as Mario Draghi promised last June, is willing and able to support them. However, the ECB only supports the journey – not the destination. The Eurozone is nearing the end of its journey and they will soon be forced to make tough choices. They will be forced to either opt for a stronger, and smaller, Eurozone which will begin to grow again, or, fragmentation which will end miserably. In the U.S. - the Fed is fully engaged in artificial support to give the system time to heal. There is no question that the economy is healing. Corporations, banks, and housing are all healing. If this continues it will allow for a handoff from supported growth to real growth. If the structural problems don’t improve then we will slip back into a slow growth economy. Emerging markets will either continue to surge or slip back to moderate growth. So, the reality is that when you live in an interdependent world your competitors are your friends. In an independent world your competitors can bring you down. The world, today, is unlike what we have ever seen before. Unfortunately, global policy coordination is really non-existent. Historically, when the core has been weak there has been someone to step in to support it. After WWII the U.S. stepped in to support Europe. Today, with the entire world weak – there is no one large enough to support the core. When it comes to investing the majority of recommendations to investors is not based on fundamentals but rather stocks are cheaper than something else. This is potentially very dangerous. What Should Investors Be Doing? Ride the central bank wave. The more intervention done by one Central Bank forces other countries to do more. The Fed forced Japan into its policy shift. Japan has now forced the ECB to move further. The Central Banks have little choice other than to continue on their current trajectory. They cannot get to their objective unless they make you feel better by boosting confidence. However, it is also important to understand that all waves eventually break. The question is whether you crash or “walk off” the surf board. This wave will crash. When it does it will depend on how you are positioned that will determine whether you suffer or not. Secondly, there are other waves out there. There are too few people looking for other waves where central banks cannot reach. In these areas there is genuine growth potential. These include selected currencies, bonds and other types of assets. Third, understand that past models are broken. The world today is far different than it has been historically and therefore new models must be built. Fourth, you cannot disconnect the markets from the fundamentals forever. There is a limit and when the reversion of markets to the fundamentals occur the devastation to capital will likely be severe. Fifth, do not give up liquidity cheaply. In the world today it is very binary. It will either end well, or very badly, with no middle ground. Optionality and liquidity is the key to surviving and profiting from a binary world. Finally, realize that risk mitigation is going to have to evolve. Cost effective tail hedging is going to be critically important. This is a choice that all investors must make: Do you leave some capital on the table as markets rise or suffer large capital losses later. The choice is critical. Conclusion Why is it that the Pimco’s of this world are not disciplining a system that is becoming more and more artificial? Why do we allow the manipulation? In a classroom you can discipline a single a person. However, if the whole class misbehaves it is an entirely different issue. Currently the whole class is misbehaving and that is a very different paradigm than what we have seen in the past which has led to unprecedented, unproven and untried interventions that are likely to have far reaching outcomes. Investors that are overly invested in stocks will eventually pay a very high price for taking on excessive risk. We are approaching the end of the journey for this experiment and it will either result in a return to organic growth or economic disaster. The problem is that we really don't know which it will be. What we do know is that eventually, regardless of the outcome of these monetary experiments, the disconnect between the fundamentals and the markets will revert which will prove painful for unhedged investors." ----- Mohamed El-Erian is the CEO and Co-CIO for Pimco, the global investment company with over $2 Trillion in assets under management. Lionscrest, through its relationship with Universa Investments, provides investors with tail-protection strategies that seek to hedge against crashes in asset prices whilst simultaneously participating in upside gains. Over the long-term, asset prices have tended to increase in value yet there have been periods of extreme, sharp losses that have had catastrophic consequences on investor portfolios. The possibility to hedge against these extreme losses can provide investors with the ability to compound positive returns over the long-term. Although extreme events of the Black Swan category are impossible to predict, it is nonetheless possible to measure when risk has increased and the investment environment is less stable.
In the next few posts, we will be highlighting the views of leading investment managers on the current market environment as it seems many of them are concerned about the exceptional policies of central bankers and governments. Let's start with Seth Klarman. ----- Seth Klarman, Baupost Group Excerpts from April 30, 2013, letter to investors: "Most U.S. investors today have a clear opinion about what everyone else has no choice but to do. Which is to say, with bonds yielding next to nothing, the only way investors have a chance of earning a return is to buy stocks. Everyone knows this, and is counting on it to remain the case. While economist David Rosenberg at Gluskin Sheff believes government actions could be directly or indirectly responsible for as many as 500 points in the S&P 500, or 30% of its current valuation, traders have confidence in Ben Bemanke because betting that his policies will drive equities higher bas been a profitable wager. Bernanke, likewise, is undoubtedly pleased with these speculators for abetting his goal of asset price inflation, though we all know that he will not call them first when he decides to reverse direction on QE. Then, the rush for the exits will be madness, as today' s "clarity" will have dissolved, leaving only great uncertainty and probably significant losses. "Investing, when it looks the easiest, is at its hardest. When just about everyone heavily invested is doing well, it is hard for others to resist jumping in. But a market relentlessly rising in the face of challenging fundamentals--recession in Europe and Japan, slowdown in China, fiscal stalemate and high unemployment in the U.S.-- isthe riskiest environment of all. "Only a small number of investors maintain the fortitude and client confidence to pursue long-term investment success even at the price of short-term underperformance. Most investors feel the hefty weight of short-term performance expectations, forcing them to take up marginal or highly speculative investments that we shun. When markets are rising, such investments may perform well, which means that our unwavering patience and discipline sometimes impairs our results and makes us appear overly cautious. The payoff from a risk-averse, long-term orientation is--just that--long term. It is measurable only over the span of many years, over one or more market cycles. "Our willingness to invest amidst failing markets is the best way we know to build positions at great prices, but this strategy, too, can cause short-term underperformance. Buying as prices are falling can look stupid until sellers are exhausted and buyers who held back cannot effectively deploy capital except at much higher prices. Our resolve in holding cash balances--sometimes very large ones--absent compelling opportunity is another potential performance drag. "Is it possible that the average citizen understands our country's fiscal situation better than many of our politicians or prominent economists? "Most people seem to viscerally recognize that the absence of an immediate crisis does not mean we will not eventually face one. They are wary of believing promises by those who failed to predict previous crises in housing and in highly leveraged financial institutions. "They regard with skepticism those who don't accept that we have a debt problem, or insist that inflation will remain under control. (Indeed, they know inflation is not well under control, for they know how far the purchasing power of a dollar has dropped when they go to the supermarket or service station.) "They are pretty sure they are not getting reasonable value from the taxes they pay. "When an economist tells them that growing the nation's debt over the past 12 years from $6 trillion to $16 trillion is not a problem, and that doubling it again will still not be a problem, this simply does not compute. They know the trajectory we are on. "When politicians claim that this tax increase or that spending cut will generate trillions over the next decade, they are properly skeptical over whether anyone can truly know what will happen next year, let alone a decade or more from now. "They are wary of grand bargains that kick in years down the road, knowing that the failure to make hard decisions is how we got into today's mess. They remember that one of the basic principles of economics is scarcity, which is a powerful force in their own lives. "They know that a society's wealth is not unlimited, and that if the economy is so fragile that the government cannot allow failure, then we are indeed close to collapse. For if you must rescue everything, then ultimately you will be able to rescue nothing. "They also know that the only reason paper money, backed not by anything tangible but only a promise, has any value at all is because it is scarce. With all the printing, the credibility of our entire trust-based monetary system will be increasingly called into question. "And when you tell the populace that we can all enjoy a free lunch of extremely low interest rates, massive Fed purchases of mounting treasury issuance, trillions of dollars of expansion in the Fed's balance sheet, and huge deficits far into the future, they are highly skeptical not because they know precisely what will happen but because they are sure that no one else--even, or perhaps especially, the policymakers—does either." ----- Who is Seth Klarman? The Economist had this to say in 2012: "Hedge fund bosses rarely double as cult authors. But an out-of-print book by Seth Klarman, the boss of the Baupost Group, sells for as much as $2,499 on Amazon. A scanned version of “Margin of Safety: Risk-Averse Value Investing Strategies for the Thoughtful Investor” has been circulating around trading floors. One hedgie likens Mr Klarman's book to the movie “Casablanca”: it has become a classic. "Why are Wall Street traders such avid readers of Mr Klarman? Baupost, which manages $25 billion, is the ninth-largest hedge fund in the world. Since 2007 its assets have more than tripled, as other funds have wobbled. Baupost has had only two negative years (in 1998 and 2008) since it launched in 1982, and is among the five most successful funds in terms of lifetime returns (see chart), a particularly striking record given its risk aversion. Long closed to new investors, Baupost counts elite endowments like those of Yale, Harvard and Stanford among its clients." Nick Colas - ConvergEX
April 30, 3012 Remember the bright red convertible driven by John Travolta’s character in the movie Pulp Fiction? It’s the one he used for his date with the boss’s wife, which started with dinner and dancing but ended with syringe to the heart. Well, that car was actually Quentin Tarantino’s personal daily driver, and it was stolen during the making of the movie. After 19 years on the run, police finally found it two weeks ago. And Quentin will get it back. “And you will know my name is the Lord when I lay my vengeance upon thee.” I can’t but feel a little jealous that even Quentin’s cars – let alone the writer/director/producer himself – lead a more exciting life than I do. Who knows what has happened to that red Chevelle, or in it, or around it, over the last 2 decades? Let alone that Uma and John created their own little bit of movie magic riding around LA in the car. And let’s not even discuss how Tarantino will celebrate its return. At the other end of the excitement spectrum, we have the sleepwalking U.S. equity markets and an equally somnambulant CBOE VIX index plodding along in its footsteps. The drip-drip-drip move higher for domestic stocks certainly fits the bill for a low volatility environment. The old saw that markets take the stairs up and the elevator down has never been truer than now. And this market feels like it is an old man walking up those stairs, arthritic knees and all. Since the VIX is a short-term measure of expected volatility – 30 days - it should be no surprise that it hews closely to the actual volatility of stocks over the last month. At the same time, a 13.X VIX reading is unusually low for this indicator. The long run average is 20, and it strains credulity to think that current macro conditions are less volatile than the last three decades. Just consider that the VIX hasn’t closed above 20 at any point in 2013. The common wisdom for this seemingly anomalous reading is as follows, albeit in fairly broad strokes:
Yes, these are ultimately unsatisfying answers, I grant you. Offsetting those points is one simple fact: global economic growth is slow and listless, meaning that recession stalks the ongoing rally like a wolf around the flock. Investors may be moving into stocks for their potentially higher returns, but the uncertain outlook means they are electing to put money to work at the low-volatility end of the equity risk-return continuum. If there is less demand for the options-based “Protection” which the CBOE VIX Index ultimately tracks, it may well be because low-vol investors already feel hedged by virtue of their allocations. Thinking outside the box for a moment, there may well be larger forces at work than just central banks or asset allocation dynamics. Perhaps the historical comparisons the VIX of old don’t properly account for how the world has changed. A few thoughts here:
In summary, there may well be other valid reasons for the low levels of market volatility at the moment. And perhaps some explanations for why it may remain so. In the end, however, the phrase “This time is different” is a useful warning. It never ever is “Different”. Until it is. |
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