The Investor August 2017

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Could this be a Game Changer for the world?
 by Richard Cluver
In the July issue I wrote of the dramatic issues that face your and my grandchildren, the Post Millennials of whom it is believed that half of the children born since 1994 will live to the age of 150 which in turn implies that on their shoulders will fall the burden of solving the immense problems of exponential global population expansion and the reality that a diminishing band of wealthy people will no longer be able to guarantee social services for the unemployed masses.

Surprisingly then, few people know about the great game changer that scientists have been working on for over half a century and which is now becoming a reality. In the French countryside near the village of Saint-Paul-Les-Durance engineers are hard at work on the construction of Tokamak, the International Thermonuclear Experimental Reactor (and pronounced EAT-er), which is being built to test a long-held dream: that nuclear fusion, the atomic reaction that takes place in the sun and in hydrogen bombs, can be controlled to generate power.

The artists impression below, courtesy of the New York Times, pictures what the reactor will look like when it is finally completed. In the ITER tokamak, deuterium and tritium nuclei will fuse to form helium, losing a small amount of mass that is converted into a huge amount of energy. Most of the energy will be carried away by neutrons, which will escape the plasma and strike the walls of the Tokamak, producing heat. In a fusion power plant, that heat would be used to make steam to turn a turbine to generate electricity, much as existing power plants do using other sources of heat, like burning coal. ITER’s heat will be dissipated through cooling towers.

There is no risk of a runaway reaction and meltdown as with nuclear fission and, while radioactive waste is produced, it is not nearly as long-lived as the spent fuel rods and irradiated components of a fission reactor.

To fuse, atomic nuclei must move very fast — they must be extremely hot — to overcome natural repulsive forces and collide. In the sun, the extreme gravitational field does much of the work. Nuclei need to be at a temperature of about 15 million degrees Celsius.

In a Tokamak, without such a strong gravitational pull, the atoms need to be about 10 times hotter. So enormous amounts of energy are required to heat the plasma, using pulsating magnetic fields and other sources like microwaves. Just a few metres away, on the other hand, the windings of the superconducting electromagnets need to be cooled to a few degrees above absolute zero. Needless to say, the material and technical challenges are extreme.

Although all fusion reactors to date have produced less energy than they use, physicists are expecting that ITER will benefit from its larger size, and will produce about 10 times more power than it consumes.

The ITER project is more than a pipe dream.Some 3,300 cubic metres of concrete have already gone into the ITER bioshield; pouring is underway now on the L3 level and the first rebar has been set in place for L4. The other structures of the Tokamak complex—the Tritium, Tokamak and Diagnostics buildings—are advancing each at its own rhythm. By the time assembly activities get underway late next year, the Complex will have a roof .



The site is a cathedral to the fusion dream: it spans the equivalent of 60 football fields and the reactor building will weigh 320,000 tonnes, all resting on rubber bearings in case of an unlikely, but not impossible, earthquake. The reactor itself will weigh 23,000 tonnes, three times more than the Eiffel Tower. It is the most complex engineering project in history. More than 2,800 tonnes of superconducting magnets, some heavier than a jumbo jet, will be connected by 200km of superconducting cables, all kept at -269C by the world’s largest cryogenic plant, which will pump 12,000 litres per hour of liquid helium.

Millions of precision components will be shipped in from the seven partners to be assembled by thousands of workers. This is all aimed at keeping just two grammes of plasma hot enough and stable enough in the 30m-diameter Tokamak for fusion to take place.

Iter’s schedule is to create the first plasma in 2025, then start firing tiny 5mm frozen pellets of heavy hydrogen – deuterium and tritium – into the plasma and generating energy. Deuterium is easily refined from seawater and fuses with tritium, which is harvested from fission reactors but could be self-generated in Iter in future. The aim is to reach its maximum power output by 2035 and, if so, Iter will be the foundation of the first fusion power plants.

The ultimate prize is unlimited electric power at extremely low cost which would allow mankind to overcome problems like climate change by ending our dependance upon internal combustion engines, solve our dwindling fresh water issues by making abundant desalination possible. We will need it if the global population reaches more than ten-billion which is the current estimate that our grandchildren, the so-called Generation Z, will have to deal with.

For Johannes Schwemmer, the director of Fusion for Energy, the EU partner in the international Iter collaboration.there is only one long-term option. “You would have to cover whole continents with wind turbines to produce the energy needed for 10 billion people,” he says. “And if our children’s children are not to sit on piles of nuclear waste, we have to make fusion work. Even if it takes till 2100, we should still do it.” Nuclear fission is also limited by uranium supplies, perhaps to a few decades if it were to play a large role.


How to build a share portfolio that will keep for the future

  And why you should really worry if you expect to live to a ripe old age and do not have GOOD growth investments


by Richard Cluver

When I was young people would joke about unachievable things by promising that if you could meet their challenge they would “Buy you a farm in Durban’s West Street.”

The idea, of course, was that it would at that time be unimaginably expensive to buy such a property but one would be financially set up for ever if one owned it. And indeed there are many examples worldwide of such impressive property fortunes though few are as impressive as the estate of Gerald Grosvenor, the Duke of Westminster who at his death last year owned property in Edinburgh, Liverpool, Oxford, Cambridge, Southampton and Cheshire, including the family’s country seat of Eaton Hall, as well as 300 acres of Mayfair and Belgravia in Central London with further interests in other parts of Europe. According to the Sunday Times Rich List 2016, the Duke was worth £9.35 billion placing him sixth in the list and making him the third-richest British citizen.

The everyday reality, of course, is that property ownership is fraught with problems as most people have learned who have bought a “flat in town” as a retirement income exercise only to find that the tenant reneged on paying the rent while you, the owner, remained saddled with rates, levies and utility bills and impossibly expensive recourse to law proved that eviction was nearly impossible. In fact, unless you are, like the late Duke, wealthy enough to own numerous properties and thus spread your risk and also afford the services of professional property managers to handle the day to day issues, property ownership beyond the home you live in and possibly a holiday cottage that you and your family regularly use, is not for ordinary folk.

And thinking about it, with the centre of Durban subject to urban decay who, but an intrepid few who are not averse to being tenement landlords with a preparedness to muscle out recalcitrant tenants, would want a farm in West Street even if it came as a gift.

If you are determined to invest in property, in fact, you would be best off buying shares in a listed property-owning company like Hyprop which has delivered its shareholders an annual increase in share value of compound 18.7 percent together with annual dividends averaging 5.8 percent making for a “Total Return” of 24.5 percent as my graph below illustrates:

Now admittedly that is one of the better performers on the JSE but the the JSE Property Index, which lists the top 20 liquid companies by full market cap in the Real Estate Investment & Services Sector, has done nearly as well, delivering a compound annual average share price growth rate of 11.1 percent plus an average annual dividend of 6.1 percent representing a total return of 17.2 percent.

So you can see that over the past decade the property sector has delivered a somewhat better return than the ten year average return of the JSE All Share Index which has delivered 11,1 percent compound annual growth over the past decade with an average dividend yield of 2.8 percent making a Total Return of 13.9 percent. My graph below shows what the All Share Index has done since 2007. Note also the volatility which saw prices declining every few years as the index snaked about its long-term trend line giving anxious moments to its shareholders.

There is, of course, one class of shares that has done better than everything else. I refer of course to the Blue Chips, a category that I have defined as the shares of companies that have delivered consistently rising dividends over no less that a decade. This group is extracted in my ShareFinder 5 Quality List database and ranked in descending order of quality on the basis of their long term balance sheet fundamental statistics. The list is too long to show in its entirety, but I have reproduced below the top 20 as extracted by my ShareFinder software:

The shares are sorted in terms of their ten-year dividend growth rate because long-term dividend growth over time inevitably translates into share price growth. So, if you care to work out the averages, you will determine that were you to buy a share portfolio consisting of equal value purchases of every share in this list, you would own an investment that has grown annually in value by 18.74 percent over the past decade and, over the past 30 years as illustrated by my graph below, at an annual average rate of 22.4 percent delivering throughout an average dividend of 3.4 percent representing thus a Total Return of 25.8 percent. Note, furthermore, how little price volatility there has been; how little the portfolio has snaked around its trend line!

  So how do you get to own such a portfolio?

Regular readers will be very familiar with my constant urging to save a tenth of your pre-tax income from the day you start work; an argument that I have offered to everyone who would listen throughout my career. Then, armed with a list like the one I have illustrated above, all you need do is buy the shares whenever their price takes them well below the trend line I have drawn onto the graphs. Thus, for example, the share with the highest dividend growth average in the list above is AVI Limited which was very cheap in mid 2008 and it remained so until 2012. Then it was cheap again in early 2014 and again in early 2016 and again in recent months.

Such a graph is drawn by most share market computer programmes by the least squares fit method which links the greatest number of price direction changes in any given period; in this case over the past decade. So if you accumulate a tenth of your income and simultaneously watch the price graphs of a list like the one generated by my ShareFinder programme, you will constantly find buying opportunities and the money with which to buy….and of course a steadily-increasing income stream from rapidly-growing dividends.

Furthermore, since even the Blue Chips go through periodic phases of underperformance, spreading your money over 20 shares like this will effectively insulate yourself against capital risk.

So this is all you need to guarantee yourself a very wealthy retirement….and if you really want it, the ability to go and buy a farm in West Street which, taking a very long-term view, must be quite cheap right now.

How wealthy would you be? It is too difficult to create a virtual portfolio assuming quarterly purchases of such shares over a working lifetime, but let us take the example of a young working professional taking home around R50 000 a month today and assume that he was able to save a tenth of R600 000 in one year which he then proceeded to buy the Blue Chip list I have listed here which, as I have already shown, would deliver an annual “Total Return” of 25.8 percent and that each successive year he invested the same sum.

In the table below I have detailed what would happen to the money if the portfolio continued growing at 25.8 percent and he kept up his R60 000 a year instalments:

  As you can see, after a 30-year working life he would be worth nearly quarter of a-billlion Rands. Now imagine if his income were growing steadily over the period by not less than ten percent a year and if he maintained his 10 percent savings rate:


  So here we note that the accumulated capital at the end of 30 years would be a seriously impressive R459-million. But you should simultaneously note that a salary of R600 000 a year today incrementing at ten percent a year would have grown to R9.5-million a year in 30 years. Can this be realistic? Well note that over the past 50 years South Africa’s inflation rate averaged has averaged 9.17 percent and so in this assumption I have assumed that our employee would have enjoyed a very modest increase in value to his employers and a very modest REAL increase in his salary.

Now you need to recognise that there are many people retiring now who could live for another 30 years and so, if you are one of them and your current pension is R600 000 a year you should be very afraid of living too long if you do not have growth investments to compensate you for inflation in the coming years. Chances are that if you need R50 000 a month to live on now you will need around R800 000 a month to live on in 30 years time. Note that R459-million at a dividend yield of 3.4 percent would provide you with a monthly income of R1.3 million. It sounds like a lot but it is just twice what your retirement salary would have been.

The obvious conclusion is that saving a tenth of your income and equalling the growth rate of this blue chip portfolio should be a MINIMUM requirement for a secure retirement. Noting that the average South African unit trust has delivered 5.06 percent annual growth over the past 30 years, you would need to save considerably more than a tenth of your income if you chose that route. The best of the unit trusts, the Coronation Industrial Fund has delivered an average of only 15.02 percent compound.



Wall Street Banks Warn Downturn Is Coming


By Sid Verma and Cecile Gutscher


HSBC Holdings Plc, Citigroup Inc. and Morgan Stanley see mounting evidence that global markets are in the last stage of their rallies before a downturn in the business cycle.

Analysts at the Wall Street behemoths cite signals including the breakdown of long-standing relationships between stocks, bonds and commodities as well as investors ignoring valuation fundamentals and data. It all means stock and credit markets are at risk of a painful drop.

“Equities have become less correlated with FX, FX has become less correlated with rates, and everything has become less sensitive to oil,” wrote Andrew Sheets, Morgan Stanley’s chief cross-asset strategist. His bank’s model shows assets across the world are the least correlated in almost a decade, even after U.S. stocks joined high-yield credit in a selloff triggered this month by President Donald Trump’s political standoff with North Korea and racial violence in Virginia.

Morgan Stanley

Just like they did in the run-up to the 2007 crisis, investors are pricing assets based on the risks specific to an individual security and industry, and shrugging off broader drivers, such as the latest release of manufacturing data, the model shows. As traders look for excuses to stay bullish, traditional relationships within and between asset classes tend to break down.

“These low macro and micro correlations confirm the idea that we’re in a late-cycle environment, and it’s no accident that the last time we saw readings this low was 2005-07,” Sheets wrote. He recommends boosting allocations to U.S. stocks while reducing holdings of corporate debt, where consumer consumption and energy is more heavily represented.

That dynamic is also helping to keep volatility in stocks, bonds and currencies at bay, feeding risk appetite globally, according to Morgan Stanley. Despite the turbulent past two weeks, the CBOE Volatility Index remains on track to post a third year of declines.

Morgan Stanley

For Savita Subramanian, Bank of America Merrill Lynch’s head of U.S. equity and quantitative strategy, signals that investors aren’t paying much attention to earnings is another sign that the global rally may soon run out of steam. For the first time since the mid-2000s, companies that outperformed analysts’ profit and sales estimates across 11 sectors saw no reward from investors, according to her research.

“This lack of a reaction could be another late-cycle signal, suggesting expectations and positioning already more than reflect good results/guidance,” Subramanian wrote in a note earlier this month.

Zero Alpha Beats – Bank of America Corp

Oxford Economics Ltd. macro strategist Gaurav Saroliya points to another red flag for U.S. equity bulls. The gross value-added of non-financial companies after inflation — a measure of the value of goods after adjusting for the costs of production — is now negative on a year-on-year basis.

“The cycle of real corporate profits has turned enough to be a potential source of concern in the next four quarters,” he said in an interview. “That, along with the most expensive equity valuations among major markets, should worry investors in U.S. stocks.”

The thinking goes that a classic late-cycle expansion — an economy with full employment and slowing momentum — tends to see a decline in corporate profit margins. The U.S. is in the mature stage of the cycle — 80 percent of completion since the last trough — based on margin patterns going back to the 1950s, according to Societe Generale SA.

Societe Generale SA

After concluding credit markets are overheated, HSBC’s global head of fixed-income research, Steven Major, told clients to cut holdings of European corporate bonds earlier this month. Premiums fail to compensate investors for the prospect of capital losses, liquidity risks and an increase in volatility, according to Major.

HSBC Holdings Plc

Citigroup analysts also say markets are on the cusp of entering a late-cycle peak before a recession that pushes stocks and bonds into a bear market.

Spreads may widen in the coming months thanks to declining central-bank stimulus and as investors fret over elevated corporate leverage, they write. But, equities are likely to rally further partly due to buybacks, the strategists conclude.

“Bubbles are common in these aging equity bull markets,” Citigroup analysts led by Robert Buckland said in a note Friday.

— With assistance by Cecile Vannucci


  What I Learned at (Economics) Summer Camp

By John Mauldin

All over America, kids who were fortunate enough to go to summer camp are busy telling mom and dad what they did. Their stories will be suspiciously incomplete, but that’s OK. We know they learned something.

Well, I went to camp this summer, too. I go every year, and I always learn more than I can manage to remember. Camp Kotok is an invitation-only gathering of economists, market analysts, fund managers, and a few journalists. It takes place at the historic Leen’s Lodge in Grand Lake Stream, Maine. We fish, talk, eat, drink, and talk some more. It’s a three-day economic thought-fest (and more rich food and wine than is good for me or anyone else at the camp). For me, that’s about as good as life gets.

Come along with me as I share some of my main takeaways from the camp and then, in a “lightning round,” touch on on a few various shorter topics.

David Kotok of Cumberland Advisors started the event after narrowly escaping death in the World Trade Center on 9/11. It was a way for him and a few friends to get away from the city, appreciate life, and talk about things that matter. Now the gathering has grown to about 50 of us. We meet under the Chatham House Rule, which means we can’t quote each other directly without permission. That helps promote an open exchange of ideas. And it’s definitely open. It is interesting to see the difference in the level of communication in an environment where people are not worried about being quoted when they trot out a new idea they have recently started thinking about. Testing those ideas against one’s peers, who might have different views about the same topic, is a valuable process.

David relaxes the rule for certain parts of the event, and that’s part of what I’ll share with you today. The Saturday night dinner always includes a debate on some contentious issue, with participants who are known to disagree. Martin Barnes from Bank Credit Analyst always moderates. He is one of the few who can quiet that room, with his imposing height, his booming Scottish brogue, and his offbeat sense of biting humour.

This year’s debate topic was the Federal Reserve. Specifically, we discussed the Fed’s future leadership and policies. Both are very much in question right now, and much depends on the answers. Time will tell what happens, but here is what some experts think.

Will Yellen Stay or Go?

The first debate question was deceptively simple. Who will be running the Fed next year, and will it matter? How will new leadership change anything? Janet Yellen’s current turn at the chair expires in February. Trump could re-nominate her but hasn’t yet announced a decision or even given a hint.

This is speculation, but President Trump had some kind words for Yellen in a recent Wall Street Journal interview. Anonymous sources quoted in the media say Trump economic advisor and former Goldman Sachs executive Gary Cohn is also in the running. Other names come up, but those two are leading for now.

I am not sure what to make of President Trump’s generous remarks, especially after his less than laudatory remarks about the Yellen Fed on the campaign trail last summer. It may just be that wiser heads got to him and pointed out that she is going to be Fed chair through February. No matter what he plans to do, there is really no point in a sitting president antagonizing a Fed chair when he would like her to not turn off the easy-money spigot too soon – in spite of what he said during the campaign.

Camp Kotok attendees had mixed views. Even most of those with a preference doubted the choice would matter very much. The Fed’s policy course under Yellen will be hard for Cohn or anyone else to change. One person made a very interesting point, though. We know President Trump admires successful business leaders. That might give Cohn an edge, since he was COO at Goldman Sachs. But then again, installing a Goldman Sachs alum at the head of the Fed really doesn’t square with his campaign speeches.

It wouldn’t surprise me to see a “dark horse” emerge as the nominee. Let’s hope we get for Fed chair – and then also for the Fed governors – individuals as qualified as Trump’s Supreme Court nominee. Trump will get to fill at least six of the seven potential open seats by this time next year. No other president has been able to put his stamp this firmly on the Fed since Woodrow Wilson appointed the original Federal Reserve Board of Governors in 1913: Trump’s nominees will control the Fed. The Fed chair and vice chair plus three board governors were appointed by Obama, but as part of the normal process of governors’ terms expiring. Fed governors are appointed for 14 years in an effort to keep any one president from being able to appoint all the governors. But in recent years, because of resignations, the situation has shifted; and now Trump has a remarkable opportunity – and will own the outcome. Good, bad, or indifferent, it will be the Trump Fed.

For the record, Yellen has also left open the possibility of staying on the Board of Governors after her term as chair is over. Those are separate appointments. She can technically remain on the board until January 31, 2024. She’s 70 now, and I doubt she’ll hang around till 2024, but it’s possible. But going from being Fed chair to just another governor would be unusual, especially considering the rather large speaking fees and book royalties that ex-Fed chairs can command. Then again, we know Supreme Court justices delay retirement so that a president they like can appoint their successors. I think Yellen is reminding Trump that she still has that option.

The same is true for Vice Chair Stanley Fischer. His board term lasts until January 31, 2020; so if he chooses to stay, he could be around until either Trump’s second term or someone else’s first.

The other two serving Board of Governors members are Jerome Powell, whose term isn’t over until January 31, 2028, and Lael Brainard, whose term ends on January 31, 2026. They can both elect to stay, but the expectation is that Brainard will also resign after Yellen departs. There is really no speculation as to what Jerome Powell will do. If he likes doing what he does – and he does run some very interesting committees – he may wait until he sees who else is on the reconfigured board and figures out whether he can get along with them.

Now, with regard to the importance of these appointments, businesspeople think differently from economists. They pay attention to market signals rather than political criteria. One person said Cohn at the Fed might “clean house,” as Rex Tillerson is doing at the State Department. The Fed has over a thousand PhD economists on staff, and it’s not at all clear that the combined weight of their expertise leads to better policy decisions. (When that point was made at the camp, the discussion got heated, more so than I recall seeing in past years, but with good reason. There were any number of economists in the room, and they had a lot of PhD-holding friends who were still at the Fed. So they squawked loudly; and, as you might imagine, Martin Barnes had to restore order.)

The bottom-line consensus on Yellen vs. Cohn: Both are tolerable. Markets might like Yellen better simply because she is at least a known quantity. Cohn might bring a different attitude and make personnel changes, but his impact wouldn’t show up in monetary policy for some time. But there were more than a few campers who preferred to see someone else appointed. Including your humble analyst.

However, when I discussed Trump’s next two probable nominees to the board (Randal Quarles, a Treasury Department official in the George W. Bush administration, and Marvin Goodfriend, a former Fed official who is now a professor of economics at Carnegie Mellon University), there was general agreement with me that those two names suggested there would not be a serious change in direction at the Federal Reserve Board next year. So when the next crisis hits, you can expect more QE and perhaps even negative rates, if you take Goodfriend’s speeches and research seriously, which I would.

Quantitative Tightening

The next question we dealt with was, should we be concerned about quantitative tightening? Is the market too complacent?

Here I’ll use my edited version of my associate Patrick Watson’s notes on the debate:

Jim Bianco (bond market maven/guru and analyst): Assume QT begins in September. Will not be immediate problem in 4Q, but may be in 2018. What really matters isn’t the Fed but the collective balance sheets of all central banks, which are still growing worldwide for now. Problems more likely when we see net global QT. In other words, bigger market impact will come when ECB decides to start QT. This will likely raise interest rates, could get 150 bps on long end by 2019. Problematic for risk markets. [We will touch on the issue of reserve-bank balance sheets in a moment.]

Bob Eisenbeis (Atlanta Fed chief economist, who attended FOMC meetings for ten years): Thinks market can easily digest the suggested tightening levels over five quarters. Amounts are trivial to Treasury market. But part of impact will depend on Treasury choices over re-funding what Fed doesn’t buy. Agrees with Bianco that international is bigger issue than Fed.

Danielle DiMartino (former assistant to Richard Fisher at the Dallas Fed and author of recent bestseller Fed Up) thinks none of this matters because QT won’t happen. We will get to recession first. Global bond markets assume the same, so Fed is performing a risky experiment if it does QT.

Megan Greene (chief economist at Manufacturers Life): Everyone worried about inflation when QE started. It showed up only in asset prices. QT might have opposite effect, which would mean a potential reversal of asset prices – but impact mitigated if Fed keeps making its plans clear. Maybe we will see a slight steepening. It depends on how much and on how long they keep going.

From the floor, Harvey Rosenblum (chief economist at the Dallas Fed for many years until he resigned a few years ago): Will we become Zimbabwe, or Japan? So far Japan winning. Is inflation being mismeasured, and is it really much lower than the Fed believes? If so, and the Fed realizes it, QT could come back off the table. If they don’t realize it, they could make a major policy error. (Many recessions can be laid at the foot of the Federal Reserve and its policy errors. Only in hindsight, of course. For the record, I believe QT is a policy error. Just saying…)

(Sidebar: You scoff at the idea that inflation is lower than anticipated? If you take out food, energy, and the oddly figured “owner’s equivalent rent,” inflation is about 0.6%. Yes, I know, if you assume away the real world, you can make your model do anything you want. But for the bulk of the economy, inflation is not a worry and is actually falling. When we get to “peak rents,” we could easily see inflation drop below 1%. And during a recession? Can you say deflation? The Fed panicking and massive QE? Get ready for an interesting ride.

Consensus Forecasts

Each year, most camp participants fill out a survey (and some of us place small side bets, typically five dollars a choice) on a number of different economic indicators. Let me just give you the average predictions as to where things will be one year from now.

• Three-month LIBOR: 1.64% from 1.30% today and 0.82% a year ago – that’s a doubling in the rate in two years.

• Ten-year Treasury note: 2.57%

• WTI crude oil: $50.20 (but the range was all over the place, from $30 to $76)

• S&P 500: 1,340, with surprisingly few really bearish views

• Gold: $1,340, and while there were a few outliers in both directions, people were generally looking for a strong movement upward.

• Dollars per euro: $1.14

• Dollars per UK pound: $1.23

• Yen per Dollar: 115 (and surprisingly, my suggested number was not the highest prediction)

• Unemployment rate: 4.4%

• Core CPI: 1.9%

• US GDP: 2.12%, again with a very wide range, but interestingly, nobody was predicting a negative GDP or an outright recession.

In short, the average predictions pretty much repeated the current consensus of the market, which is to say, they are averages that reflect a complacent outlook. But I can tell you, there was a wide range on most of the predictions, and that disparity in views certainly came out in the discussions.

Lightning Round

Takeaway 1: Almost everyone expects a serious market correction before the end of the year. Most of the people I talked to were concerned about market complacency; and even if they were bullish, which many of them were, they were surprised that we’ve gone this long without a correction. Could one be starting this week? We’ll see…

Takeaway 2: In talks with people I seriously respect, I found more concern about valuations and spreads in the bond market than about valuations in the stock market. As I sat with a few people and “war-gamed” what the next recession will look like, a general agreement emerged that the credit markets will be far more volatile than they were last time, even though banks are better capitalized today than they were 10 years ago. The problem is simply that credit markets have no liquidity and valuations are extraordinarily stretched. And not just in the US.

One of the participants told me to look at this chart:

Dear gods, when European junk bonds pay the same as US Treasuries do, there is really something out of whack in the world. Look at that spike in European junk in 2009 and the one back in 2002. European junk bond investors have never been more complacent. The reach for yield is staggering. The participants in that market think that Draghi and the European Central Bank have their backs. If the situation starts to get volatile, they expect the ECB to step in. But the ECB would have to change its mandate in order to buy junk bonds, and that means getting the more conservative members of the Eurozone to agree. I hesitate to bet on that. This could be the European equivalent of the Big Short in the next global recession.

Takeaway 3: Much of the private discussion centred around how much the Fed will tighten this year. Some thought the Fed wouldn’t raise any further, and some thought we would get at least one or two more rate hikes. The consensus seemed to be that a December rate hike is on the table unless we get some really unsettling data between now and then. It certainly doesn’t look as though we’ll see a hike in September, though. If there is one, it will be a surprise to everyone I talked to.

Takeaway 4: There was a conversation between a very serious Fed watcher and a former Fed economist. The question was, what would happen if the Fed’s balance sheet went negative, i.e., if they were selling their bonds back into the market at a loss? The answer was that the Fed is not required to record losses on asset sales against capital. There is an agreement with the US Treasury that says the Fed can create a negative asset account, but at that point it withholds remittances until the balance sheet is positive again. The Fed would be technically insolvent, but that wouldn’t matter because it’s backed by the US Treasury.

Takeaway 5: One gentleman who has been coming to the camp for several years runs a fund and is an expert on frontier markets. Because I have been to 62 countries – many of them on the very frontier of the frontier markets, I’m always interested in talking with him. And now that I’m managing my own portfolio of managers, I’ve noticed that we have several different frontier-country ETFs in our portfolios. This piques my interest even more. So I always ask him what his favourite frontier market is, and what he sees happening in that space. For the last three or four years he has been consistently big on Vietnam.

This year he surprised me by answering “Serbia.” I probably shouldn’t have been surprised, as almost the entire Central and Eastern European sector is hot, hot, hot. When I asked why, he pointed out the country has really made itself investor-friendly but that plus is not all that easy to trade, so there’s a lot of undervalued potential in what is essentially a well-educated and growing economy. And he still loves Vietnam and also mentioned Myanmar and a few countries in East Africa.

As you might expect, he has to travel more these days and to places that really aren’t vacation spots in order to do proper due diligence. He has to do things that you and I might not want to do, which says that if you ever want to invest in those markets, you need to find someone like him to do your traveling and decision-making for you

So how secure is Bitcoin really?

by Jared Dillian

Right before I sat down to write this, I read a New York Times article about how people are getting their identities stolen via their phone number.

The one thing all these people had in common? They were vocal on social media about investing in bitcoin. They got hacked—and their bitcoins disappeared. In some cases, seven figures’ worth.

That seems less secure than having gold or cash in your safe at home, buried in your backyard, or in a safe deposit box. It seems less secure than buying an expensive watch and insuring it.

I thought the whole point of bitcoin was security, right?

There are a lot of facets to bitcoin.

Capital Controls

I tweeted out The New York Times article, and then somebody quote-tweeted me:

Yes, if you are living in Venezuela and you have all your money in bolivars, you are pretty unhappy. And if you were living in Cyprus and had your money in banks during the bail-in, you are pretty unhappy.

Would bitcoin have solved your problems? Possibly.

Certainly in Cyprus’ case, other things would have solved your problems, too—like gold!

Admittedly, gold may be no help in Venezuela because the rule of law has broken down and there is no way to defend it. So yes, in Venezuela, bitcoin may have helped.

You know what else would have helped? Getting out of the country! If you are sitting in Venezuela with all your bitcoin, you are still pretty unhappy. It sucks there.

People spend a lot of time trying to figure out how to protect their wealth from inflation, expropriation, and so on. There are a million ways to skin this cat… piles of cash, gold, diamonds, jewelry, other hard assets, and now bitcoin.

Each of these ways has advantages and disadvantages. (But never tell a bitcoin promoter that bitcoin has disadvantages.)

The main advantage of bitcoin is that you can easily move money across national borders. Try doing that with cash. Bitcoin just sits in your digital wallet, and when you settle in your new country, you sell it and convert it into currency. Theoretically, you could move your entire liquid net worth in this fashion.

It’s an open secret that Chinese people have been busy smurfing as much wealth as they can out of the country with bitcoin. I bet that if China could figure out a way to stop it, they would.

But let’s talk about the disadvantages.

Uber Shady

I am not a technophobe, but I am not a technophile, either. Bitcoin seems hard. I certainly don’t claim to know enough about technology to guarantee the security of my bitcoin.

So far in bitcoin’s short history, we’ve had an exchange get hacked, and widespread hacking of digital wallets. You could protect your bitcoin by having a “hardware wallet,” an external hard drive that’s not connected to the web, but that kind of defeats the purpose. You’re then no better off than you were with gold.

Not to mention the fact that bitcoin is used for a lot of shady stuff, like trafficking of all manner of contraband on the dark web. Hey, I’m all for personal liberty and anonymous financial transactions, but as my grandmother used to say, “you lay down with dogs, you get fleas.”

You might remember discussions from a year or two ago about how Larry Summers (and others) want to eliminate cash, because cash facilitates criminal activity. Yes, it does—but nowhere near to the extent of bitcoin!

If I were to guess, I’d say that the volume of criminal activity facilitated by bitcoin could be orders of magnitude bigger than the criminal activity facilitated by cash.

Which is why, one day, bitcoin will be made illegal.

A bitcoin enthusiast will say making it illegal doesn’t really do anything. The government can’t stop bitcoin.

This is true with lots of things, like drugs. Drugs are everywhere, but they are still illegal. Once you make something illegal, you drive it underground, and you delegitimize it.

So while it would be exceedingly rare for anyone to be caught and prosecuted for using illegal bitcoin, dreams of it becoming an “alternate currency” would be shattered. Then it really would only be for criminals.

None of this sounds like anything I want to be a part of. The government can ban gold, but I can’t see the federal government going door-to-door and searching for gold like they did in the 1930s.

And besides… before it even got to that point, you should have left the country!


The foolproof way to protect your wealth is to leave for a jurisdiction that will treat it with more respect. There were reports that the number of people renouncing their citizenship increased under Obama. It will be interesting to see what happens under Trump.

The point is to get out before the walls go up. That’s unlikely to happen in the United States, with its stable democracy and strong institutions. But it never hurts to be a little paranoid—Venezuela only took a couple of decades to go from stable democracy to communist basket case.

It’s good to have a plan. It’s no fun coming up with a plan when everyone else is trying to come up with a plan at the same time.

Back in the 2000s, I had a thing for Greece. I watched The Bourne Identity, and at the end of the movie, Matt Damon finds Franka Potente renting bicycles on some remote Greek island, completely off the grid.

That sounded pretty attractive to me. I even remember looking up some Greek real estate at my desk at Lehman Brothers. It was 2003. Bear markets make you think of some crazy stuff.


  Serious US trade sanctions are coming

By Patrick Watson

What do freight trains, oil supertankers, and the Trump administration’s trade plans have in common? Once they get going, they’re pretty much unstoppable. President Trump wants to punish nations he thinks treat US companies unfairly, and China is first on his list. The North Korean missile situation is complicating matters. Trump openly says his position on trade depends on China’s willingness to help rein in North Korea.

It’s taking longer than he’s planned, but rest assured, serious trade actions are coming—and they will have a major economic and market impact. Now is the time to fasten your seat belt.

Recently  I explained how “Trade and National Defence Are Now the Same Thing.” At that point, the Trump administration was threatening to impose steel tariffs and import quotas, using a 1962 law that lets the president do this to protect US national security. The Commerce Department report that would have justified this action was originally due at the end of June. They missed that deadline, for unknown reasons.

Did the Trump administration back down because other countries threatened retaliation? Maybe. At the recent Camp Kotok economics retreat, I spoke with someone involved with US trade policy, especially as it affects China. I asked what happened to this “Section 232” action that had seemed so imminent. My source said the White House ran into a veritable buzz saw of opposition, mainly steel-using businesses and their supporters in Congress. The opponents appear to have succeeded, for now, but they haven’t killed the idea.

US law clearly gives the president this authority, and he doesn’t need permission from Congress. He can always change his mind. This is a strategic adjustment, not a policy change.

And that’s not the only loophole the new White House strategy tries to exploit…

Now President Trump has signed an executive memorandum asking US Trade Representative Robert Lighthizer to investigate Chinese IP infringements under Section 301 of the Trade Act of 1974. This section might allow the president to retaliate against Chinese intellectual property or “IP” infringements. Presently, China forces foreign businesses to share private business information—like software source code—with Chinese joint venture partners. That confidential information often finds its way into the wrong hands, subsequently appearing in counterfeit products. This is a serious problem, so it’s good that the president wants to stop it. But how he stops it makes a difference.

There’s no doubt about the outcome of this “investigation.” This sword of Damocles will hang over Chinese heads as US negotiators demand stricter IP protections. If they comply, the sword will magically disappear. If not, it may drop onto their heads. Whether it happens under Section 232 or 301 or some other law, the Trump administration clearly intends to crack down on trade practices it considers unfair. For the moment, nothing too serious is happening. North Korea is a higher priority, and the White House has plenty of other distractions.

That’s good news for investors because it means we have more time to modify our portfolios so they align with this new landscape.

Recently I told readers to get ready for “Globalization 2.0.” The present international flow of goods and services will soon hit a barrier at the US border. While President Trump may be the one who pulls the trigger, this has been building for a long time. Many countries are unhappy with current trade arrangements. They want something else—and I think they’ll get it.

Two Trading Blocs

Globalization 2.0 has some important investment implications. Instead of one big, worldwide “sort of free”-trade zone, I think we will have two trading blocs. They will be:

  • The United States, and
  • Everyone else.

Trade will be relatively free within the US and outside of it. Getting goods across the US border, though, will be difficult and expensive. Right now, the most successful US corporations are exporters that earn most of their revenue overseas. The weaker dollar gives them a tailwind. This will change, for both export- and import-dependent US businesses. Foreign companies with US customers will face a similar problem. As trade barriers rise, US government policies will increasingly put them at a disadvantage to US-based firms.

So how do you succeed on that new world map? Here are the two kinds of businesses that should thrive:

  • US companies whose customers and supply chains are mostly within the US.
  • Non-US companies whose customers and supply chains are mostly outside the US.

Any business that depends on goods or services crossing the US border will face real trouble in the coming years, so keep holdings of those stocks to a minimum.

The good news: many outstanding businesses are already in position to ride out this storm—and Washington’s political gridlock is giving us more time to find them.

Even better news: Companies fitting that profile can outperform even if we avoid a serious trade war. Owning them is an inexpensive hedge.

A few glimmers of hope ahead for South Africa

by Brian Kantor


The SA economy has begun to offer a few glimmers of cyclical light. Of most importance is that industrial metal prices have continued to recover from their depressed levels of mid-2016, as we show below in figures 1 and 2. The London Metal Exchange Index, in US dollars, is up 20% on its levels of January 2017 – a helpful trend for SA exports and manufacturing and mining activity. Less helpful to the SA economy is that the oil price has also sustained a muted recovery, influenced no doubt by the same pick up in global growth.

Further encouragement for the economy has come from a stronger rand: it has more or less maintained its US dollar value when compared to its emerging market (EM) peers. The US dollar exchange value of the rand has moreover remained consistently ahead of its values of a year ago, as is shown in figure 3.

The stronger rand has helped to reverse the headline rate of inflation, which is now well down on its peak levels of mid-2016 and could easily fall further, as we show in figure 4, where currently favourable trends are extrapolated. Over the past quarter, the consumer price index has risen at less than a 3% annual rate.

The prospect of significantly lower short-term interest rates, which would be essential to any cyclical recovery, has therefore now greatly improved, given prospects of lower inflation. The demand for and supply of cash, a very useful coinciding business cycle indicator, has been growing ever more slowly in recent months and, when adjusted for inflation, has turned significantly negative. Somewhat encouraging therefore is that the cash cycle appears to have reached a cyclical trough (see figure 4). A reversal of the cash cycle is an essential requirement for any cyclical recovery.

Two other activity indicators, retail sales volumes and new vehicle sales, provide somewhat mixed signals about the state of the economy. Retail volumes, as can be seen in figure 5, have continued to increase, albeit at a slow rate, while new vehicles sold in SA have declined sharply since early 2016. However the latest vehicle sales trends as well as retail volumes suggest that the worst of these sales cycles may be behind the economy. The sales trend however remains very subdued and will need all the help it can get from lower interest rates over the next 12 months.

We combine two recent data releases, new vehicle sales and the cash in circulation in July 2017, to establish our Hard Number Index (HNI) of the immediate state of the SA economy. As we show in figure 7, the HNI of economic activity turned decidedly down in mid- 2016 but now appears to have levelled off. The HNI can be compared to the coinciding business cycle measured by the Reserve Bank as we do in Figure 7. Extrapolating this Reserve Bank business cycle indicator also indicates that the worst of the current business cycle may be behind us.

The economic news therefore is not all negative. However essential for an economic recovery is further rand stability and the lower inflation and interest rates that would accompany a stable rand. A combination of better global growth and so higher metal prices would help. So, presumably, would any confirmation of the end of the Zuma regime – a view seemingly already incorporated into the current strength of the rand as well as by the reduction in SA risk premiums. Both the strength of the rand, relative to other EM exchange rates, and the spread between RSA Yankee (US dollar) bond yields and US Treasuries indicate that the market expects the Zuma influence over economic policy to be over soon. For the sake of the rand, the economy and its prospects, one must hope the market is well informed. 25 August 2017


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