Click here to view as PDF. “The areas of consensus shift unbelievably fast; the bubbles of certainty are constantly exploding.” - REM KOOLHAS, RENOWNED DUTCH ARCHITECT AND HARVARD UNIVERSITY PROFESSOR SUMMARY - While conventional wisdom suggests that US government bond yields have nowhere to go but up, we believe the economic fundamentals will continue to weigh on interest rates for the foreseeable future. - Given their ability to appreciate during periods of market stress, US Treasury bonds (1) continue to play a critical role in any diversified portfolio, and (2) represent an actionable opportunity as the threat of risk aversion rises around the world. - US Treasury bonds are one of our largest portfolio positions at Evergreen GaveKal based on the conviction that they can generate attractive capital gains in the event that the US economy slides toward recession and the global equity bear market intensifies. - Should investors rush toward the safe haven of US Treasuries in the middle of a bear market, as we have consistently seen in times of panic, our plan would be to start rotating into other asset classes like equities and high yield bonds as falling prices lead to more attractive valuations. Read More

Click here to view as PDF. “It is better to be three hours too early than a minute too late.” -Falstaff, in Shakespeare’s The Merry Widows of Windsor. “Put simply, the Fed has created the third speculative bubble in 15 years in return for real economic improvements that amount to literally a fraction of 1%.” - John Hussman, referring to a recent influential research paper by the University of Chicago’s Cynthia Wu and Fan Dora Xia. SUMMARY - The latest Hollywood blockbuster The Big Short evokes strong memories here at Evergreen of the bubbly days leading up to the subprime housing bust in 2007 and 2008. - Like the film’s protagonists – hedge fund managers Mark Baum and Dr. Michael Burry – we spent several years warning about the risks to the creaky housing market and the overleveraged US financial system. While our caution was a source of frustration for some clients, it ultimately paid off for the patient majority who stuck with us. - While our defensive posture in the face of rising prices was eventually vindicated, that process did not happen overnight. As the movie reminds us, mortgage-backed security (MBS) valuations actually continued to rise even as defaults rose sharply. Being early in recognizing bubbles can be extremely painful for a year or two, but what matters most is being right in the long run. - Once again, we find ourselves in that uncomfortable position at Evergreen. After years of overly accommodative Fed policy, we see bubbles all around us and also signs that many of them are beginning to pop. Once the reality of how much people have lost in this correction/bear market sets in, panic is likely to develop. - That said, we are also keenly aware of the opportunities (or “anti-bubbles”) now beginning to present themselves in beaten-up investment sectors (aka asset classes) like energy. In the not-too-distant future, possibly even in the next few months, we expect many other asset classes to fall into the anti-bubble category. It will be terrifying for investors who are overextended in overpriced assets, but a tremendous opportunity for patient and disciplined investors with cash on hand. Read More

Click here to view as PDF. “For those properly prepared, the bear market is not a calamity but an opportunity.” - Sir John Templeton SUMMARY - Stocks have rallied over the past couple weeks as (1) China drew down its foreign exchange reserves to stabilize its currency, (2) the Fed decided to delay its second rate hike, and (3) the Bank of Japan surprised the world with a negative interest rate policy. - Some investors see these events as cause for celebration, but we see them as reason to be worried about global economic and financial stability. From that perspective, we believe the latest up-move in stocks is nothing more than a bear market bounce. - We believe the US dollar will ultimately weaken if fears of a US recession continue to rise and the Fed is forced to reverse course. However, history suggests the dollar can run a bit longer if foreign central banks ease aggressively, China’s currency free floats, and/or global risk aversion takes over in a powerful way. In that event, we would expect financial markets around the world to sell off significantly. - With Japan’s unexpected move to negative interest rates last week, 23% of global GDP is now governed by central banks charging sub-zero rates on bank reserves. While it will undoubtedly lead to more misallocation and more financial system instability over the coming years, it also increases the risk of a Chinese currency shock, widespread competitive devaluation, and another surge in the US dollar in the short-term. - Financial markets are likely to remain under pressure barring a sharp reversal in the US dollar. While it could be a head-fake, the greenback has softened considerably in recent days. Read More

Click here to view as PDF. “We are of different opinions at different hours, but we always may be said to be at heart on the side of truth.” - Ralph Waldo Emerson This week’s EVA features two recent pieces: Is Wall Street in a Bear Market? by Anatole Kaletsky and Here Comes Daddy Bear by Charles Gave. Below is a brief summary of each author’s piece: Anatole Kaletsky: Is Wall Street in a Bear Market? - The US is not in a bear market. - Bear market officially begins at -20%, currently US market is down 12%. - The recent market decline is a “pause that refreshes.” - This current market has survived a variety of scares like this already i.e.: -In 2010, US budget deficit worry, down 15% -In 2011, Treasury default fears, down 19.5% -In 2012, euro crisis, down 10% - During this bull market, corrections have been buying opportunities. - Keep an eye on three fundamental issues: China, Oil, and US/World Recession - China: If they lose control of exchange rates, it could trigger widespread panic - Oil: Low oil prices are a good thing for economies as it really equals cost savings - US/World: Stocks, historically, have performed well in times of low oil prices. If prices move higher that could be a headwind. Charles Gave: Here Comes Daddy Bear - There are two types of bear markets: “cub” and “daddy” bears. - In a “cub” bear market: 15% type corrections occur over 12-18 month which are just “pauses along the way.” - Ursus Magnus (“daddy bear”): In this type of market decline, it will take you 4 years to recoup your losses. In the last 45 years there have been 3 such episodes. - Normal bear markets are when share prices/exuberance get too high. - Ursus Magnus occurs as a result of a misallocation of capital. (Evergreen’s comment on misallocation: Exceedingly low interest rates fueled over-investment in the energy space as well as record amounts of share buybacks.) - Major bear markets need two key things to form: Exceedingly low rates for an exceptionally long time. Read More

Click here to view as PDF. “Always look for forced urgent selling.” - Seth Klarman, Superstar Money Manager SUMMARY - As our investment team at Evergreen GaveKal has been warning for the past couple of years, the US equity market is now in the throes of a well-overdue correction—if not in the early stages of a bear market. Fortunately, we are underweight this richly-valued asset class with a large allocation to US Treasuries, high-quality corporate bonds, and cash. - On the less fortunate side, at least short-term, we have been selectively dollar-cost-averaging in to crashing midstream Master Limited Partnerships (MLPs) for several quarters. While most of Evergreen’s high-conviction energy infrastructure businesses continue to generate steady revenue growth and meet their distributions, despite a hostile environment, even the highest quality securities have been falling almost in lock-step with oil prices. As we last saw in the fall of 2008, we believe such indiscriminate selling is clearly due to forced liquidation, such as closed-end MLP funds receiving margin calls. Even though this experience has been painful, we believe it presents a tremendous opportunity for investors who are getting paid to wait patiently for a recovery. - Looking at the broader US economy, it appears we are now on the edge of yet another deflationary bust where debt levels can no longer be sustained as a result of falling asset prices and declining cash flows. In 2007 and 2008, the deflationary bust came from the US housing market. Today, it appears to be coming from energy and other commodity markets, and what is happening in energy is not staying in energy. In the event that equities weaken further and corporate bond spreads* continue to blow out, we believe the coming quarters could give us just the opportunity we’ve been waiting for to put our cash reserves to work. Read More

Click here to view as PDF. “You pay a very high price in the stock market for a cheery consensus.” - Warren Buffett SUMMARY - Evergreen’s 2016 forecast letter focuses on the potential surprises that could happen over the course of the next year but are far off the radar of most investors. Such events can impact our clients’ portfolios in a dramatic fashion, so it makes sense to think ahead. - US Stock Market: Most commentators currently expect the S&P 500 to remain within a +10% to -10% range for 2016, so we consider the probability of a bigger move in either direction. While we believe an upside surprise is unlikely, we feel the stock market could fall by 25% to a support level of 1600. If that support level is breached, a 50% crash is possible. SUMM - Credit Spreads: While credit spreads (which indicate the cost of capital for US corporations above the “risk free” rate paid by the US government) have widened considerably over the past 18 months, this trend could continue in the event of an economic downturn in 2016. - US Economy: We believe there is more of a recession risk than the consensus currently thinks. The US manufacturing sector may already be contracting. While unemployment remains low and wages are showing some signs of escalating, these indicators often appear the most robust right before the economy rolls over. - Master Limited Partnerships (MLPs): While optimists believe MLPs are poised for a “V-shaped” 2009-style rebound, we are skeptical (though we’d love to be wrong!). However, even flat performance (supported by their high yields & low valuations) could make this sector one of the best performers in what we think could be a difficult year for risk assets, like stocks. It will likely take a sustained rally in energy prices to produce the next MLP bull market. - Oil: Oil prices (currently trading in the low $30s) can certainly fall further in 2016, but the big surprise could be a faster-than-expected recovery over the next few years. In fact, we believe widespread capital expenditure (CAPEX) cuts may be setting the stage for an oil shortage in the not-so-distant future. - Federal Reserve: After last month’s Fed rate hike, most market participants expect one or two additional rate hikes in 2016. In contrast, the Fed is signaling as many as four hikes over the next twelve months. Instead, we believe the Fed may be forced to make an about face from rising interest rates to negative interest rates. - Emerging Market Stocks, Bonds, & Currencies: While further sell-offs seem probable, we believe emerging market assets could bottom and rally explosively later in 2016. - China: The People’s Republic of China is shaking the world as its economy slows under the weight of a massive debt burden and is struggling to transition toward a more consumption and services-based system. This is a long-term story with profound (good and bad) implications for the global economy and it’s been the source (or at least the scapegoat) of the last two global market panic attacks. While investors worry that China could drag the US into recession and usher in a bear market for US equities, the deterioration in US credit conditions suggests the next crisis could be homegrown in the USA rather than imported from the Middle Kingdom. - Commodities: Should central banks decide to employ even more extreme monetary responses in a 2016 crisis, commodities could surprise to the upside. Read More

Click here to view the PDF. “Buy when there’s blood in the streets, even if the blood is your own.” - Baron Nathan Rothschild, 18th Century British nobleman SUMMARY - Kinder Morgan’s 75% dividend cut has cast a dark shadow on master limited partnerships (MLPs), those companies that operate pipelines and other “midstream” facilities. Investors are panic selling as if no MLP distribution is safe. A number of MLP management teams are saying they will maintain payouts and insiders are accumulating shares, but most investors are not listening. - While bearish sentiment on energy and other resource-related assets is as bad as we experienced in the worst days 2008 crisis, the market is plagued by cognitive dissonance. On one hand, energy prices are back to the lowest levels since the late 1990s because production has not fallen much thus far. On the other hand, MLPs have sold off because of expectations that US output will fall significantly in the coming year. - We believe energy prices will recover over the next year or two as North American energy production declines, but a more rapid recovery is possible in the event of a geopolitical shock in the Middle East. It’s going to be challenging for MLPs, but this industry has been able to adapt and survive amid harsh conditions before. - While energy has recently become one of the most hated asset classes, US energy producers are victims of their own success after ramping up production so successfully with innovations like hydraulic fracking and horizontal drilling. This is ultimately a positive development for America that ensures our energy independence. To that end, MLPs will be essential to maintaining the country’s energy gathering, transmission, and storage networks. - While MLPs could continue to suffer from indiscriminate, ETF-driven selling, these kind of selling frenzies are becoming more common throughout the financial markets. High yield bonds have come under fire in recent weeks and the equity market could be next. At such times, we want to be rational buyers and not irrational sellers. - At Evergreen GaveKal, our goals at this stage in the market cycle are to (1) provide livable cash flow for our clients while (2) protecting their portfolios against an equity bear market. Not only do high-yielding midstream MLPs help us in that effort, we believe they now offer compelling long-term return opportunities for disciplined investors who are willing to hold through the cycle as we did in 2008 and 2009. - There is opportunity in chaos. And if you believe that, this is a good time to buy more MLPs. Read More

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Click here to view the PDF. “I’d prefer to die on my feet than to live on my knees.” - Stéphane Charbonnier, martyred editor-in-chief of the French newspaper, Charlie Hebdo EVERGREEN VIRTUAL ADVISOR Introduction by Tyler Hay For many of our readers, Evergreen’s business relationship with Louis Gave is well known. Over the years, a true friendship has formed with the founding partner of GaveKal Research. Though Louis resides in Hong Kong, he and his family are French. When news broke of the terror attack in Paris last week, my first thought was of them. We are relieved to relay that Louis’ family and GaveKal colleagues (several of whom were in Paris at the time of the attacks) are safe and sound. Read More

Click here to view the PDF. “There is no training, classroom or otherwise, that can prepare for trading the last third of a move, whether it’s the end of a bull market or the end of a bear market.” - Paul Tudor Jones, one of America’s most successful hedge fund managers. EVA SUMMARY - The emotional parallels between today and the end of the late 1990s bull market are striking. It’s a trying time for value-oriented investors as richly-valued stocks continue to rally in the face of weakening fundamentals, a painful commodity bust, and shaky credit conditions. - Believe it or not, in the long-run valuations do matter. I’ve learned over the course of several decades that if you radically overpay for stocks, and don’t get out in time, you are going to lose money… even if you remain invested for many years. - Fortunately, markets rarely correct all at once. Even in a clearly overpriced market, opportunities can emerge that offer attractive current yields, the potential for compelling long-term returns, and meaningful margins of safety versus high-flying momentum stocks. - Just as previously beaten-up assets dramatically outperformed the NASDAQ from 2000 to 2002, today’s laggards will likely become tomorrow’s leaders. Investing in out-of-favor asset classes like MLPs, energy stocks, Canadian REITs, and high-grade/high-yield bonds demands enormous discipline and great courage at this point in the cycle. But I believe these positions – alongside large cash reserves and a healthy allocation to US Treasuries – offer the best way forward as the bull market takes its dying breaths. Read More