Click to view as PDF. “We can’t solve problems by using the same kind of thinking we used when we created them.” -ALBERT EINSTEIN INTRODUCTION In this month’s edition of our Gavekal-authored EVA, we are giving readers a sample of three different views from our partner firm. It’s fair to say that Gavekal’s deep team of analysts provides some of the most comprehensive insights on global economic, financial, and political trends. It’s also not an exaggeration to say that their global footprint is extraordinary. In today’s first section, Tan Kai Xain and Simon Pritchard discuss the growing likelihood of some type of fiscal splurge in the US—probably heavily focused on infrastructure build-outs and upgrades—as well as the road-blocks such a program would need to overcome. As EVA readers may recall, Evergreen has long believed a well-designed “domestic Marshall Plan” would almost assuredly produce a significant boost to the US economy. The key, of course, is “well-designed”, which, given our current cast of political actors, may well prove extremely challenging. In the second part of this Gavekal EVA, Rosealea Yao takes us half way around the world to China, arguably the planet’s other most critically important economy. No doubt most EVA recipients have been following reports out of that nation on its remarkable housing bubble, at least in major cities. But relevant to the point of her brief essay, the fundamentals of the Chinese commercial property market are even more ominous. This appears to be particulary true in retail development where, as in the US, e-commerce is putting severe pressure on bricks and mortar stores. Thus far, China has been able to avoid a day of reckoning for its massive bubbles in residential and commercial real estate. Perhaps the modern-day mandarins over there will be able to continue delaying any kind of Thelma and Louise (i.e., off the cliff) moment. Yet, there are clearly some points of serious stress accumulating in the Middle Kingdom that might defy its command and control model. It’s just another one of those “fingers of instability”, as my friend John Mauldin calls them, that have the potential to destabilize exceedingly complacent financial markets, particularly in the US. Speaking of the United States, Charles Gave, one of my most important intellectual influences, confesses his confusion on the current status of the US economy in this EVA’s final short installment. In doing so, he makes an admission that most of you have often have read from yours truly, such as when I’ve referenced Edward R. Murrow’s famous quote: “Anyone who isn’t confused clearly doesn’t understand the situation.” As even Fed vice-chairman Stan Fischer conceded recently in Jackson Hole, there is enough conflicting information on the US economy that one can come to nearly any conclusion about its present condition. Yet, both Charles and I are becoming increasingly alarmed about the erosion in a wide array of “real economy” datapoints. In his piece, he gives a concise overview of these even while conceding the dramatic improvement seen since early February in almost all financially-driven indicators, especially our favorite stress measure—credit spreads. But as Louis Gave and I discussed over Labor Day weekend, up at Louis’ beautiful home in Whistler, B.C., it’s possible that with the European Central Bank buying so much US corporate debt, spreads aren’t as meaningful a heads-up factor as they once were. But that’s a topic for an upcoming Random Thoughts edition of this newsletter. For now, it’s Gavekal time. Read More

Click here to view as PDF. “One way to make sure crime doesn’t pay would be to let the government run it.” -RONALD REAGAN SUMMARY -This Labor Day is bringing back haunting memories of the same holiday weekend eight years ago. -Back then, former Treasury Secretary Hank Paulson made the decision to place Fannie Mae and Freddie Mac in “conservatorship”. In other words, they were bust and shareholders—including those owning preferred stock—were wiped out. -A panic started almost instantly. Shortly thereafter, Lehman collapsed, Washington Mutual failed, AIG needed a bail-out, and the Primary Reserve money market fund “broke the buck”. -New mark-to-market accounting rules forced banks and insurance companies to value their portfolios at prevailing panic-driven prices. This created a self-fulfilling “doom loop”. Even the strongest banks and insurance companies might have been technically insolvent as markets continued to crumble. -AAA-rated mortgage pools were trading at 30% of face value. High-grade corporate bonds dove to 60 to 70 cents on the dollar. Credit spreads (the yield gap between government and corporate bonds) erupted to the highest since the Great Depression. -In response to the escalating disaster, the Treasury Dept pushed through the $700 billion financial system bail-out known as TARP and the Fed guaranteed all money-market fund assets. Despite these measures, the panic continued. -At the time, my view was the ultimate problem was collapsing asset prices. This caused me to write a letter imploring the Fed/Treasury to do a “shock and awe” purchase of high-grade corporate bonds and preferred stocks, as well as non-government-backed mortgages at bombed-out prices. Eventually, this proposal made it to the desk of the San Francisco Fed president. -The government could have borrowed at 1% and reinvested at high-single to low-double digit yields, creating a taxpayer windfall and tremendously boosting confidence. Instead, the Fed “printed” $1 trillion and bought the most overpriced asset in the world, US treasuries. This began the now notorious Quantitative Easing (QE) process. -QE 1.0 still didn’t turn the tide as it stoked fears of rampant inflation, paralyzing investors. Asset prices continued to fall. The global economy careened into the worst downturn since the Great Depression. It wasn’t until a proposal was floated in March of 2009 to suspend the mark-to-market rule that the 60% decline in the S&P 500 ended and the bull market began its long run. -Now, eight years later, central banks have resorted to ever more extreme and exotic ploys to keep asset prices high and, supposedly, restore normal economic growth. However, the US continues to experience the weakest expansion in modern history and most other “rich” economies are even more sluggish. -A media frenzy surrounds every Fed meeting as it agonizes over the smallest of rate increases. Yet there is almost no consideration given to shrinking its bloated balance sheet. Consequently, the Fed, with its key interest rate near zero, has limited stimulus options during the next market panic and/or recession. Read More

Click here to view as PDF. “He who lives by the crystal ball will eat shattered glass.” -Hedge-fund titan, Ray Dalio “The central principle of investment is to go contrary to the general opinion, on the grounds that if everyone agreed about its merit, the investment is invariably too dear and therefore unattractive.” -JOHN MAYNARD KEYNES INTRODUCTION A slick call on oil. Pretty much any EVA reader who has been tracking our outlook over the last few years realizes—as I painfully do—that we’ve been calling for a serious market shakeout since 2012. For sure, we’ve had a few corrections along the was—even a couple that were border-line scary—especially last August and at the start of this year. But nothing really serious has happened…or has it? While the overall US stock market has been able to hover close to its highs, notwithstanding the aforementioned fleeting pull-backs, there have been some true bear markets in certain important sectors. Gold miners and biotech stocks are a couple of graphic cases in point. The former plunged an appalling 80% peak-to-trough, while the latter were tattooed nearly 40% from last summer through early February this year. Even after rousing rallies in 2016, they remain down 55% and 25% from their high points in 2011 and 2015, respectively. Even more significant from a market standpoint was the mid-2014 to February, 2016, poleaxing in the oil complex. Crude itself crashed by 70% and, even though oil-related stocks held up better, the energy ETF (XLE) was essentially cut in half. The oil carnage became so severe that at one point it was spilling over into the stock market itself, with every downtick in crude pushing stocks lower at the outset of this year. Consequently, what we’ve seen in recent years are a series of rolling bear markets (small- and mid-cap stocks also fell enough over the past twelve months to qualify for bear status, as well). This has allowed the purging of speculative excesses without bringing down the S&P 500. Perhaps, that’s what we will continue to see with the market in general zigging and zagging without making much headway. If so, it will be essential to allocate funds to those areas that are severely over-sold and out-of-favor in order to produce superior returns in a world where central banks have left very little juice to be squeezed out of markets. Which brings me to this month’s Guest EVA, courtesy of our friends at Ned Davis Research (NDR). Read More

Click here to view as PDF. INTRODUCTION This week’s edition of the Evergreen Virtual Advisor (EVA) is a return to one of our most popular formats, the Evergreen Exchange. This structure gives three of our team members the chance to agree, disagree, or simply comment on a topic of interest (with the constant hope that our readers care about these, too). The theme of this issue revolves around how Wall Street often focuses more on its own best interests, frequently at the expense of its clients. Lately, “The Street” has been such a punching bag for politicians that perhaps “Everlast” should be chiseled in stone above the grand entrance to the New York Stock Exchange. Therefore, to avoid accusations of beating a dead horse, we will endeavor to be fair in our criticisms—however difficult that may be. Also, some of our complaints are actually directed against our corner of the investment world, the so-called “buy side”, otherwise known as the money management industry. In this Evergreen Exchange, I take a look at the long-term results of hedge funds, contrasting their modest realized returns with the utterly immodest fee structure still utilized by most of them (though we do note some positive changes underway). Then, Jeff Dicks shines his spotlight on IPOs (initial public offerings) which generate so much hype and excitement, yet, in the long run, such disappointing returns. To finish up, Tyler Hay is focusing on the rip-off known as closet indexing, basically paying high fees to receive an index fund in drag. As we often do with our Exchange issue, we are asking readers to select which case was made most persuasively. We would greatly appreciate it if you’d take the time to submit your vote. Thank you! Read More

Click to view as PDF. “Just because a reversal of something unsustainable hasn’t happened yet doesn’t mean it won’t.”    -Seth Klarman, one of the most successful investors of the last 30 years. “There is too little economic risk-taking and too much financial risk-taking.” -Christine Lagarde, head of the International Monetary Fund (IMF) INTRODUCTION One of my regrets from the ill-fated summer of ’07 is when I edited out a quote that was destined to become infamous in the fullness of time. It was uttered by Citigroup’s then CEO, Chuck Prince, and it basically said as long as the music was still playing (meaning the liquidity spigots were still wide open), Citi would keep dancing. A little over a year later, the global financial system was on life-support and Citigroup stock was break-dancing its way to $1 per share from over $50. At the time, my gut told me that Mr. Prince’s quip would come back to haunt him. It also occurred to me that it was one of the most succinct examples of the devil-may-care attitude prevailing back then among most of the leaders of the financial community, not to mention regulators and the Fed. But, alas, for some long-forgotten reason, I left it out. In this week’s EVA, Gavekal’s Joyce Poon resurrects Mr. Prince’s exceedingly ill-advised sound-bite and discusses the similarities with today. Nobody likes a kill-joy, though, and Evergreen is certainly enjoying riding the market wave right now. This is especially the case since some of the most battered asset classes from last year—which we were consistent buyers of—are in the vanguard of the current market rally. However, it’s only realistic to realize that the central banks are at the controls of the wave-making apparatus. In other words, it’s not the usual bull market drivers—such as strong earnings, rising productivity, an improving regulatory environment, swelling societal confidence, et al—that are at work these days. In fact, all of the above have been heading in the wrong direction over the past couple of years. Read More

Click here to view as PDF. “In economics, things take longer to happen than you think they will, and then they happen faster than you thought they could.” -Famed German economist, RUDIGER DORNBUSCH “Risk is most dangerous when it is least apparent, and least dangerous when it is most apparent.” -JIM GRANT, Grant’s Interest Rate Observer INTRODUCTION This week marks the maiden voyage for our webinar version of the Evergreen Virtual Adviser. As you will soon see, this issue expands on some of the themes covered in last week’s “Random Thoughts” EVA. However, it also discusses several prevailing memes (basically, currently popular beliefs that circulate among investors) influencing the financial markets. In some cases, Evergreen believes these memes are more like dreams that may soon experience a rude awakening. A couple of the charts in this slide deck are repeats from last week’s EVA but most are new. They focus on topics investors tend to care about the most: the stock market, bonds/credit spreads, the economy, and energy/master limited partnerships (MLPs). Last week’s extremely disappointing GDP release perhaps makes some of the economic comments in this EVA more timely. If you missed it, the second quarter growth rate was essentially half of what was originally expected. Moreover, the first quarter was revised from an already underwhelming 1.1% to a totally limp 0.8%. Therefore, it’s worth considering the views of those who are increasingly on-guard about the next recession. Read More

Click here to view as PDF. “I never give them hell.  I just tell them the truth and they think it’s hell.” -Harry S. Truman, aka, “Give ‘em hell, Harry” SUMMARY -One of Wall Street’s most strongly held beliefs is “Don’t Fight the Fed”. This means to be a buyer of stocks when it is cutting rates, or is on hold, and to sell stocks when it is tightening. However, the terrible performance of the stock market in the early 1930s, at the start of the 2000s, and from mid-2008 to early 2009—all times when the Fed was aggressively easing—calls this conviction into question. -“Don’t Fight the Spread” might be a better mantra. The episodes cited above were all times when credit spreads (the difference between government and corporate borrowing rates) were rapidly expanding. -The good news currently is that the impressive break-out to new highs by the S&P 500 has been accompanied by a further decline in credit spreads. These have been contracting since early February. As usual, this narrowing has coincided with a powerful rally in almost all markets. -The US stock market clearly has upside momentum right now and may be entering a “blow-off top” phase. However, not all indicators are supportive, particularly those of a fundamental nature, such as earnings. S&P 500 profits are back to where they were in 2006, when this index was trading at 1300, some 40% lower than today. -While Brexit turned out to be a non-event, at least from a lasting stock market standpoint, there is another risk emerging in Europe. Italy has a crucial vote coming up in October. Due to how severely the Italian economy has suffered since the euro was introduced in 1999, there is a distinct chance of the anti-European Union (EU) party winning this fall. This would likely threaten the entire EU project. -A long-running EVA prediction has been the increasing “Japanization” of the developed world. This means very slow growth combined with interest rates falling to previously unimaginable levels. 30% of global bonds, amounting to around $12 trillion, now have negative yields. The US is actually one of the last bastions of decent cash flow. Corporate America represents just 12% of total worldwide investment grade debt but is producing 33% of aggregate income. The world continues to be exceedingly growth-challenged despite (or because of) these miniscule rates. -In the US economy, some recent data has been surprisingly positive. Most notable in this regard was the June jobs number reported in early July showing an extremely healthy employment increase. However, the Household Survey (not as well known as the official Payroll Survey) showed job losses and now shows over 500,000 net terminations this year. Historically, the Household Survey has been better at picking up pivot points in the economy. -Economic releases tend to be contradictory when the economy is in transition such as from expansion to recession and vice versa. We are seeing considerable amounts of “dueling data” currently. However, when Evergreen weighs the positives and negatives, the scales seem to be leaning more toward an economy that is very late cycle. Read More

Click here to view as PDF. “Money won’t create success. The freedom to make it will.” -NELSON MANDELA INTRODUCTION The Point of (Almost) No Return. Long, long ago, back when the earth was cooling and I began writing this newsletter, John Mauldin was my role model. His Thoughts From the Frontline weekly missive had already gone semi-viral and, shortly thereafter, the “semi” was no longer applicable as his recipient list surged into the millions. Around that time, circa 2006, I also began attending his now acclaimed Strategic Investment Conference. As I’ve admitted several times in the past, it was at those events that I became convinced the then-prevailing housing boom was soon to go bust, a conclusion that saved Evergreen clients a considerable sum in subsequent years. Since those early days, I’ve gone from being a Mauldin acolyte to the honor of being a FOJ—Friend of John. In fact, at my partner Louis Gave’s 40th birthday party up at Whistler two years ago, John even graciously tolerated my American bulldog sampling some of the food he had left on his plate by Louis’ outdoor fire pit. It’s been quite awhile since we’ve run one of John’s newsletters as a Guest EVA. But his recent piece, “The Age of No Returns”, focuses on several issues that Evergreen believes are of utmost importance. We plan to expand on these and several others in next week’s full-length EVA but, in the meantime, John provides a concise overview of some of the realities bullish investors might be overlooking currently. Read More

Click to view as PDF. “When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done.” -JOHN MAYNARD KEYNES referring to market bubbles. INTRODUCTION Vertigo isn’t just a Hitchcock movie. Is your head spinning? Wasn’t it just a few weeks ago when the UK said “see ya, wouldn’t want to be (with) ya” to Europe and global markets were in free-fall? I’ll be the first to admit I’m feeling decidedly disoriented these days. When I am in “what-the-hell?” mode (I’d use another similar phrase, but this is a PG-rated publication), I try to steady myself by reflecting on thoughts from my partners Charles and Louis Gave. But before discussing their current views, I want to give a hearty hat-tip to Ned Davis Research’s Vincent Deluard whom I’ve quoted in recent weeks. Vincent absolutely nailed it when he was among the very few to view Brexit as a bullish development and for exactly the right reason: Central banks gone even more wild. For the raging bulls out there, I’ve got some good news: Vincent believes there is much more upside to come as the market has broken out to a new all-time high. Based on today’s facts, I think he’s right—despite extreme overvaluation. The reality is, valuations matter almost not a whit on a short-term basis. The not-so-good news is that he also feels this blow-off surge will ultimately lead to the next market disaster. This is despite his suspicion the S&P may surprise most pundits with how high it goes before the cliff-dive moment. Vincent’s longer-term concerns are a good segue to the musings from Charles and Louis. As I’ve noted before, both father and son Gave are genetically pre-disposed to being bullish so it’s not reasonable to ignore their rising concerns on grounds of being perma-bears. Also, while Charles has been worried about stocks for the last year or so, he’s been pounding the proverbial table on long-term treasury bonds. And just this year alone, the rocket ship known as the 30-year T-bond has screamed 22%, leaving the US stock market choking on its contrails. Read More

Click here to view as PDF. “This is a supernova that will explode one day” -BILL GROSS on global government bond markets. Pull it together, Dave! One of my EVA goals for the summer has been to do an overview issue summarizing a number of Evergreen’s dominant views. It dawned on me over the 4th of July weekend that, thanks to my close friend Grant Williams, I’d already attempted to do so, at least orally, while we were both attending the Mauldin Strategic Investment Conference (SIC) in late May. At the time, Grant and I did a wide-ranging interview where he skillfully guided me through the maze that passes for my overarching mindset on current financial and economic conditions. It’s only been a bit over a month since he and I chatted but, obviously, there has been a major development—the Brexit—in the meantime. Yet, despite the risks posed by that event, US stocks remain back up at all-time highs. On the other hand, the message from the bond market isn’t as positive.  Longer-term Treasury bond yields have recently hit their lowest point ever, indicating both risk-aversion and concerns about the global economy (and, perhaps, worries about a critical vote in Italy come October). Moreover, credit spreads*, which Grant and I spend a fair amount of “air time” discussing, have moved up (though, as yet, not alarmingly). Read More