Thursday, November 30, 2017

Workers and Retirees Over Bondholders?

The National Union of Public and General Employees (NUPGE), one of Canada's largest labour organizations with over 370,000 members, put out a press release recently, NDP private member's bill shows pension plans can be protected:
“When a company in financial difficulties is giving $1.4 billion to shareholders and handing executives millions of dollars in bonuses, it’s ridiculous to claim that legislation to protect pensions will affect the ability of the company to survive. What legislation to give pension plans priority in bankruptcy proceedings will do is protect workers and retirees from greed and incompetence.”

— Larry Brown, NUPGE President

Ottawa (27 Nov. 2017) — A private member's bill, Bill C-384, introduced by Scott Duvall, NDP MP for Hamilton Mountain, shows that it is possible to protect pensions when companies enter bankruptcy proceedings.

In the last few years there has been a growing trend where workers and pensioners are seeing significant cuts to their pension plans after the companies they worked for went bankrupt. Sears Canada is just the most recent example. US Steel, Nortel, and Can-west are the better known of the other companies where pensions were cut after the companies went bankrupt.

There are 2 reasons pensions are being cut when companies enter bankruptcy proceedings. When pension plans are under-funded, companies find it easy to delay making the payments necessary to ensure they are fully funded. Then, when companies enter bankruptcy proceedings, workers and pensioners are at the back of the line when the company is wound up or restructured.

“Current pension rules make it far too easy for companies to put off dealing with pension plan deficits. Then if the company enters bankruptcy proceedings it is retirees who pay the price,” said Larry Brown, President of the National Union of Public and General Employees (NUPGE).

Bill C-384 would put workers and retirees first

Bill C-384 would amend the Bankruptcy and Insolvency Act (BIA) and the Companies' Creditors Arrangement Act (CCAA) so that a company going through bankruptcy proceedings would have to make sure its pension plan was fully funded before other creditors could be paid. The bill would also prevent companies going through BIA or CCAA proceedings from cancelling benefits for workers or retirees.

Sears Canada liquidation an example of why Bill C-384 needed

People who worked at Sears Canada could see their pensions cut by 20 per cent because the pension plan was not fully funded when the company entered bankruptcy proceedings. Extended health and dental benefits were cancelled. People who have worked at Sears for decades are being laid off without getting the severance pay they are owed.

But while low- and middle-income pensioners will see their pensions cut, pensions they worked decades to earn, some select executives and senior managers are getting $6.2 million in retention bonuses. Existing bankruptcy laws protect retention bonus payments to executives, even though the company is being liquidated.

Excessive payments to shareholders in the years leading up to bankruptcy proceedings are also not a problem under current legislation. At the same time that the workers’ pension plan slid into deficit, Sears Canada spent $1.4 billion on payments to shareholders.

“When a company in financial difficulties is giving $1.4 billion to shareholders and handing executives millions of dollars in bonuses, it’s ridiculous to claim that legislation to protect pensions will affect the ability of the company to survive. What legislation to give pension plans priority in bankruptcy proceedings will do is protect workers and retirees from greed and incompetence. That’s why NUPGE is joining with other unions to support Bill C-384,” said Larry Brown, NUPGE President.
Before I get to Bill C-384, let's have a look at what prompted this proposed bill. In September, the Canadian Press reported, Sears case shows the risk of defined benefit pensions for employees:
Sue Earl, a 38-year Ontario-based Sears Canada employee, was shocked when she found out she would only initially receive 81 per cent of the value of her pension as part of the company's insolvency process.

The 64-year-old from Cobourg, Ont., had assumed her defined-benefit pension was "money in the bank," a guaranteed amount she'd receive in retirement regardless of the financial health of the failing retailer.

But then, she also didn't think Sears would cancel the severance payments she'd been receiving since her store was closed last year — that's what happened after it filed for court protection from creditors in June.

She said the other 19 per cent of her defined-benefit pension is "up in the air."

"Our letter said it would be paid out to us in the next five years, but that depends what they do with it, whether they wind it up or what's going to happen," Earl said.
Severance gone, pension under threat

"It's just one more slap, really. You lose your severance and then you find out you might not get all of your pension money."

Personal finance experts say the Sears case shows the risk of depending too much on a defined-benefit pension plan to provide income in retirement if the plan is not fully funded and the sponsor goes bust.

James McCreath, an associate portfolio manager with BMO Nesbitt Burns in Calgary, says employer-sponsored pension plans are a good thing because they force people to save for retirement, but when a company isn't healthy enough to fund them, it can result in a lot of stress for employees.

"If I had a defined benefit plan, I'd certainly sharpen my pencil on reviewing it to see if there's an unfunded liability and how that perhaps would impact my retirement," he said.

Tony Salgado, director of CIBC Wealth Strategies in Toronto, says many don't even know what kind of pension plan they have, much less what their retirement income might be.

"Incorporate some wiggle room," he advises.

"If you were to take a 10 per cent haircut on what you have through your retirement pension plan, what other sources of income will you have available?"
Promise of retirement income

Defined-benefit plans promise members a retirement income usually based on salary and years of service. But an aging population that is living longer has increased the cost of the plans at the same time that low interest rates have also increased funding requirements, leaving many plan sponsors with a shortfall.

Sears has been paying $3.7 million a month to top up its underfunded defined-benefit plan, as required by Ontario provincial law, but has asked a court to allow it to suspend those payments while it restructures.

Meanwhile, Ontario has proposed new rules that would see defined-benefit pension plans it regulates not require topping up as long as they are 85 per cent funded, down from the current 100 per cent.

In Cobourg, Sue Earl says she is receiving employment insurance benefits and has started her Canada Pension Plan payments early to top up her RRSPs and pay down debt.
Remaining pension goes to locked-in account

She has received a payout on the defined-contribution pension plan Sears started in 2008, but is still waiting for payout of the defined benefit plan it replaced — both have to be reinvested in locked-in accounts until retirement.

Her husband, Ralph, has a small pension and, after a "hard look at our finances," she thinks they'll be OK.

"I mean, we're not driving Mercedes, we're going to drive our car into the ground. If we take a trip we're going to be budgeting for it. I mean, we're going to have to be careful with our money."
Sue and her husband are lucky, the new reality of old age in America (and Canada) is people have to work till they die. They simply can't afford to retire because they have little to no savings.

What happened to Sears Canada employees is tragic but nothing new. I've written about pensioners taking a back seat to bondholders as far back as 2009. Then it was Nortel employees who were under pressure.

Every time I read these stories, I cringe for two reasons. First, it's simply indefensible that people working ten, twenty or more years get screwed on their severance and defined-benefit pension, and second and more importantly, it just proves my point most companies shouldn't be managing pensions.

Sure, there are exceptions. Air Canada and CN come to mind. They both have great defined-benefit (DB) plans (I think Air Canada is shifting new employees to DC now), but the majority of corporations aren't doing a great job managing their corporate DB plan.

This is why I believe enhanced CPP is critical for the future of retirement security in Canada and have openly stated that CPPIB or some new federally backed, large, well-governed pension fund should manage the corporate DB pensions that still exist in Canada. Get companies out of pensions altogether and let them focus on their core business.

Of course, that will never happen, which is why the NDP is putting forth Bill C-384. While I'm all for the rights of pensioners and the disabled over bondholders, the reality is such changes to the Bankruptcy and Insolvency Act (BIA) and the Companies' Creditors Arrangement Act (CCAA) come at a cost.

In particular, it will make it more expensive for all companies to borrow in credit markets, especially those with underfunded pensions. Everything comes at a cost, if you change the law, it will cost more to borrow money.

Another option, which Rob Carrick discusses in his article on what Bill Morneau’s pension bill could mean for your retirement, is to shift everyone to a target benefit plan, but as I've stated before, while these plans are better than DC, they're still subjected to the vagaries of public markets and are far inferior to a large, well-governed DB plan which invests across public and private markets all over the world.

Lastly, for all of you worried about your company's pension and savings, I suggest you visit Diane Urquhart's website, Is My Money Safe?, where you will learn a lot and are even able to contact her if you have questions. Diane has worked vigorously on high profile files on behalf of Nortel pensioners and the disabled and she knows her stuff.

One last bit of advice. Wherever you work, whether it's a big or small company, always diversify and don't rely on company stock options for your retirement. I don't care if you work at Air Canada, Royal Bank, Bell Canada, or company XYZ, don't be stupid, you're already exposed to that company so diversify away from it in your retirement savings (use low cost exchange traded funds, balance your portfolio with global stocks and bonds or invest in mutual funds but first get advice from a financial advisor and ask them to be clear on fees).

I am saying this because sometimes I see some very smart people commit cardinal sins and they often don't realize it until it's too late.

Below, Sears Canada is going through a restructuring process, leaving retirees wondering what will remain of their pensions, and it could be a while before they find out. Amanda Ferguson with the details on defined benefit pension plans and their pitfalls (July, 2017).

I hate to say it but there will be more cases like this in the future which is why we need to think long and hard as to how we will protect workers and retirees going forward, not just bondholders.

Wednesday, November 29, 2017

The Grand Cayman Pension Scam?

David Sirota and Lydia O'Neal  of The International Business Times report, Paradise Papers: Your Retirement Cash May Be In The Caymans. Can You Get It Back?:
The release of the so-called “Paradise Papers” touched off new scrutiny of how moguls, celebrities and politicians stash their cash in offshore tax havens. The practice, though, is hardly limited to the global elite. In fact, government documents show that state and local officials have sent hundreds of billions of dollars of public sector workers’ retirement savings to a tiny archipelago most famous for white-sand beaches — and laws that shield investors from taxes.

Operating outside the U.S. legal system, the offshore accounts in the Cayman Islands give Wall Street firms leeway to make complex international investments and to earn big fees off investors' capital. But with offshore accounts featuring prominently in high-profile Ponzi schemes, some critics warn that the use of tax havens can endanger the retirement savings of millions of teachers, firefighters, cops and other public workersa situation that could put taxpayers on the hook for losses if the investments go bust, or the money goes missing.

The tidal wave of cash has flowed from public pension systems into so-called “alternative investments”: private equity, hedge funds, venture capital firms and real estate. While many alternative investment firms operate in Lower Manhattan, more than a third of all the cash in those private funds flows through vehicles domiciled in the Caymans, according to Securities and Exchange Commission records reviewed by International Business Times. Those same records show that public pension plans, university endowments and other nonprofits have funneled a massive $1.8 trillion into alternative investments.

“Based on SEC data, it appears that public pensions alone hold around $300 billion offshore in the Cayman Islands in hedge funds and private equity,” said Chris Tobe, a former state pension trustee and author of the book “Kentucky Fried Pensions.”

In recent years, SEC regulators have tried to crack down on alternative investment firms’ fee schemes that regulators say can end up enriching money managers at the expense of investors. At the same time, state officials and investor groups have pushed for more transparency in the alternative investment industry as a whole.

But with so many of the investments now running through a maze of shell companies in lightly regulated tax havens, some experts say the outflow creates the conditions for rampant fee abuse and financial shenanigans — and prevents pension officials and law enforcement officials from even knowing exactly where billions of dollars of public money is being held.

“The additional risks related to investing in funds established, regulated and custodied in tax havens are real,” former SEC attorney Edward Siedle has warned.

A trove of confidential hedge fund documents reviewed by IBT shows that major financial industry players acknowledge some of the potential risks that can arise when money is invested outside the United States. The documents show that in the fine print of their agreements, the firms admit that shifting cash to less-well-regulated foreign locales can end up putting money into brokerages that may not adhere to traditional banking regulations. They also acknowledge that moving money into international securities can reduce basic protections for investors and ultimately increase the risk of significant losses.

“How does investing in funds established in loosely regulated offshore tax havens benefit government workers — participants in a pension that doesn’t even pay taxes?” Siedle has written.

One answer to that question, say lawyers, involves pension systems seeking to preserve their existing tax exemptions. Under laws passed in the 1960s, those tax-exempt entities would have to pay taxes on the kinds of debt-financed earnings involved in private equity and hedge fund investments — but they can avoid those levies if they first route their investments through “blocker” corporations in tax-free jurisdictions like the Caymans.

“This is very standard planning — it’s a plain vanilla technique,” said the Tax Policy Center’s Steven Rosenthal, a former partner at the global law firm Ropes & Gray LLP, who advised universities on investments.

Public pension systems vary in how they report their investments. Many simply list the firms that are managing retirees’ money, but not where the firms are located, or whether the funds are ultimately being moved offshore. However, occasional references to offshore funds are scattered throughout public filings.

In South Carolina, for instance, the annual report for the government workers’ retirement system listed nearly $60 million invested in a Cayman-based fund run by Reservoir Capital Partners, which received more than $2 million in fees from the state last year. In New Jersey, state investment officials have in recent years committed more than a quarter-billion dollars of state pension money to hedge funds based in the Cayman Islands and Bermuda, the country at the center of the Paradise Papers controversy. And in Texas, a 2015 report from the teachers retirement system showed the state paying a combined $13 million in fees to Cayman-based funds run by Bain Capital and Soroban Capital Partners.

Siedle told IBT that Wall Street firms may set up shell corporations in tax havens “not to help public pension fund investors, but really to protect the managers from taxes and regulations.”

A 2008 Government Accountability Office report detailed some of the potential benefits financial managers can glean from domiciling their operations in the Caymans. The agency found that “some U.S. persons can minimize their U.S. tax obligations by using Cayman Islands entities to defer U.S. taxes on foreign income.” GAO also warned that “some persons have conducted financial activity in the Cayman Islands in an attempt to avoid discovery and prosecution of illegal activity by the United States.”

Law firms openly promote the benefits of offshore investment vehicles.

“The tax exempt, tax transparent, non-regulated and highly flexible nature of the [exempted limited partnership] and the absence of regulatory or licensing requirements touching the general partner, together with the flexibility of the Cayman Islands exempted limited company, combine to make the Cayman Islands the preeminent jurisdiction for offshore private equity funds,” said a recent memo from Mourant Ozannes, an offshore law firm whose website says it is “advising many of the world's foremost financial institutions” on the laws in the Caymans, British Virgin Islands, Guernsey and Jersey.

“The American People Are Not Against Offshore Wealth”

In the political arena, members of both parties have offered varied messages about the flow of American capital offshore.

Republicans faced Democratic attacks over Mitt Romney’s involvement with Cayman funds, but four years later, Republican Donald Trump ran for president promising to discourage the use of offshore tax havens. Some Democrats have sponsored legislation designed to try to stop the use of offshore tax havens. During the 2012 election, though, the Cayman Islands Journal reported that longtime Democratic Party official Donna Brazile told investors at a Cayman Islands conference that “the American people are not against offshore wealth, offshore ‘tax havens’, but they’re often told that, you know, this is taking something away from them."

When it comes to billions of dollars of public pension money leaving the country, Rosenthal said there is nothing inherently problematic about tax exempt organizations using offshore accounts to avoid taxes.

“If you thought the rules about debt-financed income make a lot of sense, then sure, you could get worked up about how this kind of tax planning contravenes congressional intent,” he told IBT. “But I don’t think those rules make a lot of sense, and this is an alternative way to structure investments to sidestep those rules.”

Some lawmakers have disagreed.

In 2007, Michigan Rep. Sander Levin, a Democrat, proposed a bill to allow tax-exempt organizations such as pension systems to invest directly in private equity and hedge funds, without incurring the tax on debt-financed income — a move designed to discourage the use of foreign blocker corporations.

Two years later, his brother, then-Sen. Carl Levin, introduced legislation that would have subjected offshore blocker corporations to U.S. taxes. Both measures were designed to keep investments within the domestic financial system and to discourage the use of offshore vehicles, but some lawyers who help financial firms navigate tax laws warned that the Senate legislation would harm the alternative investment industry.

“If enacted [the bill] could significantly reduce investment in U.S. hedge and private equity funds,” wrote Steve Bortnick of Pepper Hamilton, a compliance law firm. “The provision would tax income that simply should not be taxed in the U.S. (i.e., foreign source income) or tax it at inappropriate rates. This likely would force these funds to restructure in a manner that nevertheless would alienate tax-exempt and foreign investors. At a time when the U.S. economy is struggling, these provisions appear to establish an unnecessary impediment to investment in U.S. investment funds.”

Proponents of the legislation argued that offshore vehicles were being abused to help financial managers shield themselves from taxes.

“This would prevent companies (notably hedge funds) that are American for all practical purposes from avoiding U.S. taxes by claiming to be a foreign company simply because it did certain paperwork and maintains a post office box in a tax haven country,” declared Citizens for Tax Justice when the senate initiative was launched.

The Managed Funds Association, the self-described “voice of the global alternative investment industry,” was among the universities, foundations and advocacy groups lobbying Congress and the Internal Revenue Service on Sander Levin’s bill, federal lobbying forms show. The organization also lobbied throughout 2009 on Carl Levin’s bill. Other financial industry players that lobbied on the bill included the Blackstone Group LPCredit Suisse, the American Bankers Association, the Investment Company Institute, the Cayman Islands Financial Services Association and the Private Equity Council.

The legislation never passed.

“A Number Of Unusual Risks, Including Inadequate Investor Protection”

As public pension money continues to move offshore, taxes are not the only policy question at issue. There is also the matter of potential risks associated with investments outside of the United States.

One set of risks has to do with regulations — or lack thereof.

“Tax havens generally have laxer laws and oversight than in the United States,” wrote researchers Norman Silber and John Wei in a recent Hofstra University study of offshore investments. “The use of foreign blocker corporations also reduces the amount of information available to the government and the public.”

Some potential risks are outlined in documents from major hedge funds that have managed public pension money. While those documents are confidential — and have been exempted from state open records laws, at the behest of the financial industry — IBT reviewed some that show hedge fund managers admitting the potentially enormous risks of shifting retirees’ money outside the U.S. financial system.

For instance, 2015 documents from a Canyon Partners fund based in the Caymans tell investors that the fund is registered under a Cayman law that “does not involve a detailed examination of the merits of the fund or substantive supervision of the investment performance of the fund by the Cayman Islands government.” It also tells investors that “there is no financial obligation or compensation scheme imposed on or by the government of the Cayman Islands in favor of or available to the investors in the fund.”

A similar 2015 document from a Cayman-based Fir Tree Partners fund notes that while there is a Monetary Authority in the Caymans, “the fund is not subject to supervision in respect of its investment activities or the constitution of its investment assets by the Authority or any other governmental authority.”

The Cayman-based funds say they can move investors’ money into foreign assets. In separate disclosures applying more broadly to those assets, the hedge funds acknowledge the risk of international investing in emerging markets. These specific risk disclosures apply only to the international assets that the Cayman funds are investing in — and not the Cayman funds themselves. However, the disclosures appear to illustrate the general risks pension systems may face when they move money outside the U.S. financial system. For example:
  • Canyon’s documents warn that international investments in emerging markets can involve the risk of “lack of uniform accounting, auditing and financial reporting standards and potential difficulties in enforcing contractual obligations.” The same document later notes that those international investments can also expose investors “to a number of unusual risks, including inadequate investor protection.”
  • The Fir Tree Partners documents note that “accounting and financial reporting standards that prevail in foreign countries generally are not equivalent to U.S. standards and, consequently, less information is available to investors...There is also less regulation, generally, of the financial markets in non-U.S. countries than there is in the United States.”
  • A 2013 documents from a Cayman-based Mason Capital fund warn that risks of international investments include “difficulties in pricing securities and difficulties in enforcing favorable legal judgments in court.”
  • A Cayman-based Och-Ziff fund’s offering documents from 2014 note that “there is generally less government supervision and regulation of exchanges, brokers and issuers outside the United States” and that “the fund might have greater difficulty taking appropriate legal action in non-U.S. courts.”
  • Even though public pension trustees are legally obligated to adhere to United States fiduciary standards, Canyon’s Cayman-based fund points out that when it comes to its international investments, “anti-fraud and anti-insider trading legislation, and the concept of fiduciary duty, may be less developed or limited compared to those in more developed markets.” A 2014 offering document from Cayman-based AQR Capital fund similarly warns that foreign investments can expose assets to “less stringent laws regarding the fiduciary duties of officers and directors and protection of investors.”
Government records and reports from the financial analysis firm Preqin show that public pension systems in Rhode Island, Texas, Florida, California, Florida, Arizona, Oregon, IllinoisWashington, Louisiana, New York and New Jersey have invested in at least one of these aforementioned hedge funds.

“Shareholders May Be Unable To Liquidate Their Investment"

There is also the issue of investor rights. Last year, Rhode Island retirees sounded an alarm about the prospect of their state pension system’s financial managers allowing certain anonymous investors to receive more favorable terms from the same funds in which the pension system puts its money. They asserted that such schemes could end up enriching anonymous investors and financial managers at the pension fund's expense. Other experts have warned that because firms’ investments are not independently valued by third-parties, managers can use their own valuation process to fleece investors.

Those potential dangers were spelled out in 2015 documents from Luxor Capital and AQR funds in the Caymans, where, according to the Tax Policy Center’s Rosenthal, foreign investors and managers can avoid filing IRS disclosure paperwork and exposing themselves to U.S. transparency laws.

The Luxor fund, said the documents, had signed “side letter” agreements that allow the firm to provide certain shareholders “access to more frequent and/or more detailed information regarding the fund’s securities positions...performance, finances, and management.” That includes “notification of the commencement of certain disciplinary actions, legal proceedings, investigations or similar matters against the fund...possibly enabling such shareholders to better assess the prospects and performance of the fund.”

The documents also said “the fund may give certain shareholders the right to redeem all or a portion of their shares on shorter notice and/or with more frequency,” and that “shareholders may be unable to liquidate their investment promptly in the event of an emergency or for any other reason.”

The AQR fund, meanwhile, warns that it could put investors’ money into assets that “may be extremely difficult to value accurately.” That means “there is a risk that an investor that makes a redemption while the Fund holds such investments will be paid an amount significantly less than it would otherwise be paid if the actual value of such investments is higher than the value designated.”

Preqin data show pension funds in Texas have invested in Luxor’s Cayman-based fund, and government records show the state teachers’ retirement system has paid the offshore fund more than $21 million in fees between 2013 and 2015.

Most Cayman-based hedge fund firms managing pension money — including those whose documents IBT reviewed — are registered with the SEC. However, that does not necessarily mean the agency or American courts have as much power over them as they do over onshore funds.

“The Cayman Islands’ strong bank secrecy laws help shield assets,” wrote University of Hawaii accounting professor Thomas Pearson in a 2009 paper. “Therefore, because of concern that not all the assets are apparent or accessible, a U.S. bankruptcy court may refuse to provide assistance to liquidation of hedge funds domiciled in the Cayman Islands. Although the SEC has tried to collaborate with authorities offshore, hedge funds’ use of the Cayman Islands or another tax haven country lowers their risk that the SEC or other major securities regulators can acquire the real identity of certain traders and properly enforce insider trading laws.”

Taken together, the risks of investing offshore are significant, said Deborah Hicks Medanek, whose firm, the Solon Group, advises corporations on restructuring.

“If I were a fiduciary responsible for a large pension fund, I would be very careful not to assume that the legal environment in Cayman or Curacao or the British Virgin Islands was really similar to the legal environment I’m used to,” Medanek told IBT. “You cannot assume that the same kind of investor protections are out there. If I’m sitting there as a fiduciary of a public pension fund, my ass is already seriously on the line for people who can’t afford not to have pensions when they come due — so I don’t think I’m going to go take those risks, unless I am utterly convinced that the offshore investment gives pensioners access to an attractive manager that’s otherwise not available onshore.”

None of the hedge funds whose documents IBT reviewed offered any on-the-record comments for this story.

“The Fund Will Not Maintain Custody”

Out of all the risks of moving pensioners’ money overseas, few raise as much concern as “custody,” or where pensioners' money and assets are ultimately stored and accounted for, said South Carolina State Treasurer Curtis Loftis. He noted that whereas state and local governments’ investments in stocks and bonds are typically held in U.S.-regulated banks, offshore funds can hold money in opaque accounts and brokerages across the globe.

“Custody was a pretty big part of the Bernie Madoff and Jon Corzine problems,” Loftis told IBT, referring to high-profile cases where investors lost their money. “Those guys were custodying money all over the world, allowing them to do all sorts of things with it because offshore does not have the same protections as in the United States. So when public pensions are investing offshore, they are agreeing to have their money custodied in ways that are very risky.”

The hedge fund documents reviewed by IBT underscore Loftis’s assertion.

Under the heading “Absence of Regulatory Oversight,” a Cayman-based Governors Lane vehicle says “the fund will not maintain custody of its securities or place its securities in the custody of a bank or a member of a U.S. securities exchange in the manner required of registered investment companies under rules promulgated by the SEC.” Governors Lane has managed money for the Kentucky public pension system.

Och-Ziff’s documents include similar language, and note that the custody methods means that a bankruptcy “might have a greater adverse effect on the Fund than would be the case if it maintained its accounts to meet the requirements applicable to registered investment companies.”

In its section on custody risk, Mason Capital’s Cayman-based fund says it “may use counterparties and other financial institutions located in various jurisdictions outside the United States” and that “financial institutions may use sub-custodians and disclaim responsibility for any losses.” The firm warns that “investors should assume that the insolvency of any non-U.S. counterparty or other financial institution would result in a loss.”

The custody risks relate to other concerns about the overall governance of Cayman-based investment vehicles. A 2011 Financial Times investigation found that “a small group of Cayman Islands ‘jumbo directors’ are sitting on the boards of hundreds of hedge funds” based there. These directors are supposed to be watching over investors’ money and protecting their interests, but some experts have questioned whether they are adequately independent and able to provide oversight when they are working for so many different funds. Those questions, which have been simmering for years, have resurfaced in a recent hedge fund case in the Caymans.

“With perhaps two-thirds of all hedge funds domiciled in the Cayman Islands, Bermuda, and British Virgin Islands, a web of ‘independent directors’ has developed in these island paradises,” wrote George Mason University professor Janine Wedel, who has studied corruption and corporate governance. “Officially, these directors are independent watchdogs who protect the interests of investors, such as pension funds. The problem is that some appear to be little more than ‘paper directors,’ with perhaps billions of retirement dollars exposed to funds with weak oversight and potentially conflicted governance.”

While these risks of offshore investing may seem hypothetical, a landmark case in Louisiana suggests the opposite. There, three public pension systems found themselves unable to withdraw their collective $144.5 million in investments and earnings from a Cayman Islands-based hedge fund of New York City-based Fletcher Asset Management in 2011. The funds than had to rely on a Cayman court to force the fund to relinquish the money, the Wall Street Journal reported.

The following year, a Louisiana state legislative auditor produced a report urging the three pensions to better document any risk that stemming from an inability to quickly and easily withdraw their investments at market price. In 2013, trustees of the pensions sued affiliates of Fletcher, along with a law firm and an financial services firm involved, for overstating the fund’s value and liquidity.

Months after the case moved to a U.S. federal court, a trustee the pensions appointed — who, after on-site examination in the Cayman Islands, found the fund to be insolvent — placed the fund and its affiliates into bankruptcy in 2014. The case — which is ongoing  — is exactly the kind of situation that Loftis says he fears for states and cities all over America.

“I’m sure some of these firms set up offshore in order to offer pensions a way to avoid paying taxes, but I’ve always believed it is mostly about the managers creating a way in which they can limit their own taxes and their own legal liability and do whatever they want with the public’s money,” he told IBT. “The custody issue is one of the biggest problems: these offshore accounts mean we don’t really know where all of this money actually is. If we have another economic downturn, I’m not sure the money custodied all over the world ever makes it back home.”
This article has generated quite a bit of interest and a back and forth discussion between David Sirota and AQR's Clifford Asness on whether hedge funds and private equity funds are appropriate for public pension funds.

STUMP even followed up to take a look at allocations to alternative asset classes by public pensions and whether it has paid off.

My answer is it depends but overall, allocations to alternative asset classes have definitely benefited alternative asset managers and big banks on Wall Street a lot more than chronically underfunded US public pensions funds struggling to stay solvent. I've documented all this in the big squeeze.

Put bluntly, the astronomical fees paid out to hedge fund and private equity lords of finance over the last thirty years are nothing short of stupendous, propelling many elite and not-so-good managers to the ranks of the world's rich and famous. You won't read much about this in Thomas Piketty's book on inequality but there is no question that US public pension funds have contributed to rising inequality and most have gotten little to show for it.

Is there a rationale for alternative investments? Absolutely. In Canada, our big pensions also dole out huge fees to private equity funds but they hire qualified staff to do a lot of co-investments to lower overall fees.

In the US, top hedge funds and private equity funds have been milking public pensions dry for years, raking them on fees, which I have publicly stated need to be significantly cut.

The problem is all institutional investors -- pensions, endowments, sovereign wealth funds, insurance companies, family offices, etc. -- need to band together to put pressure on hedge funds to lower fees.

Anyway, one way or another, lower fees are coming, and there will be a paradigm shift in fees alternative investment funds charge. Why? Because deflation is headed our way, which means much lower rates for a lot longer. In a deflationary environment, it's much harder justifying 2 & 20.

I foresee another major shakeout in the hedge fund industry. In fact, the silence of the bears won't last forever, and when they come back growling, a lot of hedge funds are going to get killed.

Of course, a lot of index funds are also going to get killed, but it's a bit more palatable when they're charging negligible fees for tracking the market.

Is the solution getting out of hedge funds and private equity funds altogether, putting more money in index funds like North Carolina's pension? They're a bit late in the game, they should have done this years ago following the financial crisis.

But unless you have a qualified staff managing external hedge funds and private equity funds, forget about these alternative investments, most of the time you will end up relying on advice from useless consultants who will shove you in the latest hot funds, and you will get burned.

In a low return world, alternative investments definitely can play a role in a pension plan's asset allocation, but theory doesn't always translate well in practice, especially in these central-bank manipulated markets where literally every asset class is way overvalued. 

As far as the Caymans and offshore tax havens, it's much ado about nothing. I know for a fact Canadian pensions investing in US dollars in hedge funds and private equity funds prefer this type of arrangement and if done properly, it works in the best interest of everyone, including the plan's beneficiaries.

The big difference is a CPPIB and Ontario Teachers' which collectively invest billions in hedge funds and private equity funds, have specialized due diligence teams doing intensive due diligence on funds, their administrators, their prime brokers and directors at these offshore entities.

I guarantee you those Louisiana pensions unable to withdraw their collective $144.5 million in investments and earnings from a Cayman Islands-based hedge fund of New York City-based Fletcher Asset Management in 2011 didn't do a good job in terms of their due diligence.

Let me end by sharing with you a story that happened to me when I was investing in directional hedge funds at the Caisse back in 2002-2003. I asked one of our CTAs to shift assets from the high leverage to lower leverage fund and for some reason, his administrator said it could take up to a week.

I was pissed, really pissed. I called the manager up and said: "What's going on? You trade futures which are very liquid. Call your administrator immediately and I'd better see that money in the low vol fund tomorrow morning."

Trust me, the next day, the money was in the low vol fund and I never had any other issues with this manager's administrator.

I think there is a lot of misinformation and scaremongering going on with the potential risks of offshore funds.

Earlier this year, the Caisse's CEO, Michael Sabia, had to defend the Caisse's investments in offshore tax havens (they doubled from $15 billion in 2013 to over $30 billion now). Why the need to do this, especially since it's not in the best interest of the province to remove those assets from these tax havens.

No doubt, we need lower fees, more fee transparency and better reporting information linking fees to returns, but spreading misinformation and lies about offshore tax havens isn't helpful and most certainly isn't in the best interests of the plan's sponsors and beneficiaries (or taxpayers).

Maybe I'm missing something. If so, drop me an email at LKolivakis@gmail.com and let me know what you think. As far as I'm concerned, when it comes to hedge funds and private equity funds, these offshore structures have benefited everyone, not just the managers.

Below, a Bloomberg report from last summer on how Caymans ranked third among foreign holders of US debt, with hedge funds leading the trend. I wonder if hedge funds scared of the silence of the bears and VIX are increasing their exposure to US long bonds (TLT) now (if they're smart, they are).

Tuesday, November 28, 2017

North Carolina's Pension Woes?

Chris Butera of Chief Investment Officer reports, More Trials Ahead for North Carolina Pension Fund:
Despite State Treasurer Dale Folwell’s agency slashing millions in outside management fees, North Carolina’s $96 billion pension fund is going to need to do more to remain solvent and satisfy retirements of its nearly 1 million state employees.

While Folwell delivered on his campaign promise to make heavy cuts on the fees to the tune of $600 million, drawing some praise from his peers, he faced some criticism for his decision to transfer funds to low-earning, short-term accounts. WRAL.com reports that critics argue that while safe, keeping the transfer funds in savings accounts cost the pensions “tens of millions” in earnings during this year’s market growth.

However, despite these cuts and the fund being commonly referred to as one of the best-funded in the country, as per WRAL, it must still pay out $6 billion per year.

In addition, state government and employees only pay in roughly half of what the fund pays out, and there is no minimum retirement age. Of the state citizens receiving pension checks, the latest statistics show that nearly 100,000 are under age 65, while roughly 7,000 are age 90 and above.

“Fees have gone up, payouts have gone up, life expectancy has gone up, and interest rates have gone down,” Folwell told WRAL. “That’s what I inherited.”

As life expectancy increases, a possible solution debated to prevent the potential insolvency is raising the retirement age. While some see it as a logical step, others argue that it does nothing for public workers, as investment managers are the only ones benefitting.

“As age goes up, the working life should go up as well, I would think,” CPA and financial advisor Ron Elmer, a former Democratic candidate for treasurer, told WRAL.

“It might sound good. It might even be well-intentioned, but it’s not going to solve any problems,” Ardis Watkins, director of government relations for the State Employees Association of North Carolina, told WRAL. “The only thing that solves problems is to stop giving huge amounts of money away in multiple levels of fees to investment managers.”
Folwell was unable to provide comment.
It's been over three years since Edward Siedle uncovered North Carolina pension's secretive alternatives gamble, and now the chickens have come home to roost.

There definitely should be a minimum retirement age, but that's not enough. They need to improve the governance to hire qualified staff to bring more assets internally and do a lot more co-investments in private equity to lower overall fees.

Folwell is right: “Fees have gone up, payouts have gone up, life expectancy has gone up, and interest rates have gone down. That’s what I inherited.”

And yet, if you ask NCPERS, everything is fine at US public pensions, no need to dismantle them. Maybe not but Malcolm Hamilton, a retired actuary and astute reader of my blog, shared this with me after reading my last comment (added emphasis is mine):
The NCPERS analysis is somewhere between embarrassing and incompetent. The findings are true but largely irrelevant.

A pension plan that is 50% funded may have enough money to pay pensions for 10 years while simultaneously declaring a contribution holiday. This doesn't prove that the plan is in good shape. It is basically living on borrowed time. After 10 years there will be no money in the pension fund. At that point the plan can still be sustained by raising contribution rates to the "pay as you go" level, which would typically be around 40% of pay for a mature public sector DB plan. The plan can be sustained, but will anyone want to sustain it at that price?

The CPP (Canada Pension Plan) is a good example of the consequences of low funding levels. The CPP is currently about 20% funded - but the 20% is slowly trending up, not down as is the case for many badly funded U.S. public sector pension plans. The CPP can be sustained for a very long time as long as we are willing to pay the 9.9% contribution rate. Canadians don't notice that the CPP is expensive because they are accustomed to paying 9.9% for a benefit that would cost 5% to 6% if the CPP was fully funded. According to the CPP actuarial report, the pension fund needs to earn a 4% real return in order to give future members a 2% real return on their contributions. If the CPP was fully funded, members would earn the same rate of return as the pension fund.

Badly funded pension plans are not a good thing. They may be sustainable - but only at a price. People may be prepared to pay the price but the plan will not do a good job for whoever ends up footing the bill (members or taxpayers).
I think it's important to point out that North Carolina's pension woes aren't something new. Like so many other US public pensions, they have been festering for a long time, a by-product of lousy governance and a failed pension model.

Below, North Carolina State Treasurer Dale Folwell takes aim at fees paid for management of state pension fund. Fees are only part of the problem here, a lot more needs to be done to shore up this plan.

Monday, November 27, 2017

Time To Dismantle US Public Pensions?

Rebecca Moore of Plan Sponsor reports, Public Pensions Have Been Able to Pay Promised Benefits:
Some policymakers want to close participation in a public pension plan to all new hires, cut benefits and increase employee contributions, or convert defined benefit (DB) plans pensions into defined contribution (DC) plans. They usually cite the underfunding of public pension plans as the reason for these ideas.

New research shows that funding status has little correlation with a pension fund’s ability to pay its promised benefits. Michael Kahn, director of research for the National Conference on Public Employee Retirement Systems (NCPERS) used data from the annual survey of public pensions by the U.S. Census Bureau for 1993 to 2016 and other data and found that during the last quarter century or so, state and local pension plans have always been able to meet their benefit and other payment obligations.

In four years (2002, 2008, 2009 and 2012), income from contributions and investment earnings was less than benefit obligations, but in the remaining 20 years, when income from contributions and investment earnings was more than benefit obligations, pension funds were building up a cushion that enabled them to weather the 2001 recession, the Great Recession of 2008, and other economic downturns. Today, state and local pension funds have about $3.9 trillion that will provide a cushion during future economic recessions, the NCPERS analysis says.

While assets have grown, so have pension obligations. During 2012 to 2016, state pension obligations grew from $3.52 trillion to $4.19 trillion. Other sources of data show that pension obligations have steadily grown since 2000, when plans were almost 100% funded. NCPERS analysis shows that despite rising liabilities during the last quarter century, pension plans have been able to meet their annual benefit payments from contributions and investment income due to the cushion they built up in good years.

The analysis shows four states—Illinois, Kentucky, New Jersey, and Connecticut—had pension funds whose liabilities were more than twice their assets (that is, they were less than 50% funded) in 2016. On the other end of the funding spectrum are New York, Tennessee, South Dakota, and Wisconsin, which were all more than 94% funded. The majority of states’ pension plans were more than 70% funded. Twenty-eight out of 50 states (56%) had pension funding levels that were 70% or above. Overall, the 299 state plans had total assets of $3.05 trillion and pension obligations of $4.2 trillion—which translates into a funding level of 72.6%. However, using quarterly earnings data for 2016, the assets for the 299 state plans were $3.26 trillion, which results in a funding level of 77.6%.

According to the analysis, states in both top- and bottom-funded groups on average experienced situations in which contributions and investment income was not enough to meet annual benefit obligations about six out of 24 years during 1993 to 2016. The cash flow shortfalls were caused by the 2001 and 2008 recessions as well as other economic downturns. But both types of funds—partially and almost fully funded public pension plans—had adequate cushions to cover the cash flow shortfall.

The experience of the last quarter century suggests that state and local pension funds will face economic recessions in the next quarter century and beyond. To strengthen the ability of these pension funds to weather future recessions, NCPERS suggests state and local policymakers may consider the following policy options:
  • Stop dismantling public pensions because they aren’t 100% funded;
  • Strengthen funding mechanisms by adhering to principles that help determine the appropriate levels of required employer contributions;
  • Establish a pension stabilization fund that can set aside money from a certain revenue stream to be used in special circumstances such as a recession; and
  • Implement a mechanism to ensure that full employer contributions are made on a timely basis, perhaps by making employer contributions a nondiscretionary part of the budget.
“Our analysis demonstrates that pension plans can tolerate ups and downs in the markets and still meet their current obligations,” says Hank H. Kim, NCPERS’ executive director and counsel. “While funding ratios are an important actuarial tool, they are not a proxy for a plan’s ability to pay benefits here and now.”

Critics of public pensions often cite funding ratios of less than 100% as evidence of pressing financial problems, but this is faulty logic, Kim says. Contributions and earnings continue to flow into plans even as benefits are being paid out, he notes. “Shutting down a pension plan because it is not fully funded is … an incredibly short-sighted action that destabilizes workers and their communities, and we want it to stop,” Kim says.
First, I agree, shutting down a public pension because it's not 100% funded is incredibly shortsighted and downright dumb. Just because Kentucky lost its pension mind, doesn't mean everyone else needs to.

Second, take the time to read the NCPERS paper, Don't Dismantle Public Pensions Because They Aren't 100 Percent Funded, which is available here.

In the analysis, we can find some interesting state data, like the worst funding levels by state (click on image):


There are more but I wanted to focus on the worst offenders for a reason. NCPERS claims in Table 3 there is no significant difference between the top- and the bottom-funded state and local pension plans in terms of the plans’ ability to meet their benefit obligations (click on image):


This is quite a claim, one that has its share of skeptics. In fact, this analysis prompted Andrew Biggs of the American Enterprise Institute to tweet the following (click on image):


I guess fully-funded levels aren't worth it, especially if you believe the Mother of all US pension bailouts is in the works.

While the report is right, a bad funding level hasn't disrupted pension payments, it places an inordinate amount of stress on a plan to manage liquidity risk much more closely because if another crisis erupts, at one point, poor funding levels will not sustain pension payments, especially for mature (more retirees than active workers), chronically underfunded plans (less than 50% funded).

NCPERS suggests state and local policymakers may consider the following policy options:
  • Stop dismantling public pensions because they aren’t 100% funded;
  • Strengthen funding mechanisms by adhering to principles that help determine the appropriate levels of required employer contributions;
  • Establish a pension stabilization fund that can set aside money from a certain revenue stream to be used in special circumstances such as a recession; and
  • Implement a mechanism to ensure that full employer contributions are made on a timely basis, perhaps by making employer contributions a nondiscretionary part of the budget.
I agree with these recommendations but even more needs to be done:
  • US public pensions need a wholesale change in their governance model. They can learn a lot from the evolution of the Canadian pension model
  • Introduce a shared-risk model at all US public pensions which means contributions can be raised or benefits cut when these pension plans experience a deficit. Public-sector unions need to accept that pensions are all about managing assets and liabilities and investment income alone won't be enough to sustain public pensions over the long run. When plans run into trouble, contributions need to be raised, benefits cut or both.
The problem with the NCPERS analysis is it perpetuates this myth that nothing is broken, keep everything the way it is and just ensure full employer contributions are made on a timely basis.

This is pure rubbish. There are plenty of things wrong with the way US public pensions are being managed and my biggest fear is that when the pension storm cometh, it will expose these weaknesses and place many pensions in an even more dire situation.

Let me end however with one warning, shutting down public defined-benefit pensions isn't the solution. It will exacerbate deflationary pressures and reduce economic growth over the long run. We need to bolster public DB plans, not shut them down.

When it comes to public pensions, we need to be realistic and informed. Are there real issues with US public pensions? You bet but the solution to the problem most certainly isn't to dismantle them.

Below, students from Bath County School Television examine how Governor Matt Bevin's Proposed Plan and The Shared Responsibility Plan might affect classified and certified employees of Kentucky's school systems. I applaud these students for getting informed on a subject that isn't always easy to decipher and understand.

Update: Malcolm Hamilton, a retired actuary and astute reader of my blog, shared this with me after reading this comment (added emphasis is mine):
The NCPERS analysis is somewhere between embarrassing and incompetent. The findings are true but largely irrelevant.

A pension plan that is 50% funded may have enough money to pay pensions for 10 years while simultaneously declaring a contribution holiday. This doesn't prove that the plan is in good shape. It is basically living on borrowed time. After 10 years there will be no money in the pension fund. At that point the plan can still be sustained by raising contribution rates to the "pay as you go" level, which would typically be around 40% of pay for a mature public sector DB plan. The plan can be sustained, but will anyone want to sustain it at that price?

The CPP (Canada Pension Plan) is a good example of the consequences of low funding levels. The CPP is currently about 20% funded - but the 20% is slowly trending up, not down as is the case for many badly funded U.S. public sector pension plans. The CPP can be sustained for a very long time as long as we are willing to pay the 9.9% contribution rate. Canadians don't notice that the CPP is expensive because they are accustomed to paying 9.9% for a benefit that would cost 5% to 6% if the CPP was fully funded. According to the CPP actuarial report, the pension fund needs to earn a 4% real return in order to give future members a 2% real return on their contributions. If the CPP was fully funded, members would earn the same rate of return as the pension fund.

Badly funded pension plans are not a good thing. They may be sustainable - but only at a price. People may be prepared to pay the price but the plan will not do a good job for whoever ends up footing the bill (members or taxpayers).
I thank Malcolm for his poignant insights and think NCPERS should go back and rework their analysis.

Friday, November 24, 2017

The Silence of the Bears?

Sven Henrich of the Northman Trader posted a market comment earlier this week, The Silence of the Bears (click on images to enlarge; added emphasis is mine):
The silence of the bears is deafening. And who can blame them? The last 2 years have been absolutely brutal for any fans of price discovery, volatility and anything analytical mattering. Nothing matters. Be it divergences, valuations, earnings misses, slowing data, yield curve, equal weight, internals, catastrophes in nature, slowing loan growth, slowing auto sales, slowing real estate, retail apocalypse, debt levels, etc…I can drone on. Nothing matters. Markets keep drifting higher despite it all.

Price discovery as we used to know it, the back and forth of buyers and sellers engaging in the argument of forward valuations based on expected earnings growth, has ended with the disappearance of sellers as part of the normal market functioning:


Corrections as a means of price discovery don’t exist any more. Every day we don’t have a 3% correction is a new record in length of time without any such correction. And the chart above illustrates this adequately. It is a global phenomenon, it’s not only US based.

5% corrections, what also used to be regular part of markets and a bare minimum at that, have also disappeared:


Not quite at a record, yet the message is nevertheless clear: There’s not much happening in these markets on a day to day basis.

The abomination of what passes for intra-day trading ranges these days illustrates the point quite nicely:


Whatever downside does occur can’t sustain itself for more than minutes, a couple of hours at best. Case in point: The $DAX was only negative for 1 hour 16 minutes after the surprise collapse of German coalition talks on Monday. Nothing matters.

Hence it is no surprise sentiment is as bullish as it is. Recall allocations are all bullish, people, funds, even central banks all own the same shrinking universe of stocks.

Indeed there is not even a sense that anything could change this program:


This chart of the global Dow Jones, more than any other, shows how historically out of balance this rally has been. Red bars don’t exist and this is the steepest uninterrupted ascent ever accompanied by the steepest volatility compression ever.

In this context yesterday’s capitulation by Goldman Sachs was classic. They were the investment bank that kept citing valuations as a major concern and were the most bearish on 2017. Then they capitulated. Now their mid range target is 2850 for 2018.  with little to no downside risk:


That’s if the exuberance stays rational they say, if it goes irrational they covered themselves with an irrational scenario of 5300.

As I said classic. It is notable how both Monday and Tuesday were suddenly flooded with bullish forecasts. I won’t bother to recite them all here, I gave you a glimpse yesterday.

I’m just highlighting this as a latest example of the complete lack of any divergent views remaining in the marketplace. Which is fine. It simply illustrates market sentiment, but also again underscores the extent of the bubble.

Bulls will counter that growth is solid. I’ve documented variant signs of a slowdown in the works (Caution: Slowdown). And I’m not the only one to notice:

Growth in Developed Economies Slowed in Third Quarter, OECD Says

And yet while bulls cite supposed great growth figures the ECB keeps printing like we’re in the middle of the financial crisis:


The numbers behind the chart via Holger Zschaepitz: “#ECB ramps up balance sheet expansion despite booming #Eurozone economy. Total assets rose by another €24.1bn to a fresh life-time high of €4,411.9bn on QE program, equals to 40.9% of Eurozone GDP.”

Now that’s just intellectually insulting. If things are so great we wouldn’t need this level of intervention or any intervention.

But this is what they are doing. Every day. I keep asking: What is the organic market price balance without intervention? The answer remains the same: Nobody knows as we haven’t seen markets without intervention other than the brief moments were they produced full out panic. 2011 and early 2016 are examples coming to mind.

So I continue to view price extensions and disconnects to be a direct result of trillions of dollars in ongoing intervention and exacerbated by record ETF inflows.

Let’s be clear: I don’t know how or when it ends, but it will end. Our primary mission here is to figure out what we consider good risk/reward set-ups knowing that we are finding ourselves in the most one way focused and technically disconnected markets in decades:


But this is precisely the point in time when the Goldman Sachs capitulation takes place and all the bullish forecasts are coming out. And I understand why they are coming out. No corrections have taken place and we are in a bullish seasonal part of the year.

Now that we have entered the seasonally most bullish time of the year I can certainly understand the silence of the bears. What is there to say? No rationally reasoned argument has mattered, prices keep going up and there appears absolutely nothing on the horizon to stop this train.

Indeed, not only are bulls bullish, but some of the remaining bears I still see floating about have resigned themselves to talk blow-off top coming and are busily identifying higher upside targets from 2700-3000. Funny that. Bulls are bulls and bears are bulls.

But this is the lay of the land folks.

Add some oversold signal charts coinciding with new all time highs and I could easily argue 4 to 5 weeks of upside coming:



The message: Markets cannot possibly go down. There is no risk. Everybody is bullish, join the party.

Bottom line: Fading this action and sentiment is the most contrarian thing anyone can do here and for that reason it can also be the most dangerous. I have no illusions about that.

Folks are piling in long at the technically most disconnected market ever since the 2000 Nasdaq bubble. But that doesn’t mean it will stop here.

Are there any issues with the bull case here other than technical disconnects and divergences that don’t matter?

Well, here’s a few considerations I wanted to share:


This chart doesn’t tell us we can’t go higher. We can. But it suggests something disturbing and I’ve made reference to it in the past, but the overlay with the 10 year gives additional context: It could be argued that these waves of bullish action were driven by one primary factor: Cheap money. Artificial low rates and debt.

Furthermore it could be argued that the bearish break on the S&P 500 in 2008 was never technically repaired. Yes, massively higher prices as a result of over $20 trillion in central bank intervention, zero rates and a global explosion in debt levels to the tune of above $145 trillion in the non financial sector. All made possible by cheap money:


The lower the rates the higher the debt:


So the big question is simply this: What if that downtrend in the 10 year yield bursts above its trend line for the first time since 1987?

As you can see in the S&P 500 chart above we have never seen a break above trend to the upside. Yet the entire market advance has been dependent on its declining trend. All of it. To fix any downside in markets rates had to be lowered and lowered.

None of this tells us anything about this week or next, but it highlights perhaps the precarious nature of the construct.

While the ECB keeps printing $DAX remains at a critical long term juncture:


And the quarterly chart also raises red flags:


The ECB is scheduled to slow down their QE program in 2018, but not end it nor will they raise rates at any time during Mario Draghi’s reign. The ECB remains in full policy panic mode. Because that’s what NIRP is. Panic mode. And you know why they keep pressing? Because inherently they know prices could not sustain themselves. They have to keep rates low.

The yield curve keeps flattening, but it matters not, it is now at the flattest level since 2007:



We are told not to worry of course:


We can only go up and nothing matters.

The only thing that matters is that people keep piling long into these markets.

ETF inflows have now reached an all time history high of $400B of inflows just in 2017:


There’s a QE program right there.

I’ve been mentioning the weekly 5 EMA:


As you can see from the chart: No weekly close below the weekly 5EMA is permitted. Any break lower is saved by the end of the week.

This is what we need to see change before a change in trend can be considered.

For now, markets can only go up and growth is wonderful.

Now, who’s going to tell the bond market?


The screaming of the bears has ended. Their silence is deafening.

And perhaps that should worry bulls more than anything.
Sven Henrich of the Northman Trader sounds like a truly frustrated bear. You can track him on Twitter here and I highly recommend you read his team's market analysis regularly.

Another bearish blog I highly recommend you read is Edge and Odds, published here in Montreal from now-retired portfolio manager Denis Ouellet (great blog, subscribe to it).

A reader of my blog told me: "He uses the Rule of 20 to scale exposure, but supplements it with a rule of 120 which says that equity returns tend to be substandard with the 10 year/3 month spread is less than 120, as it is now."

Now, the silence of the bears is nothing new, it goes hand in hand with the silence of the VIX, which I covered in the summer.

In a nutshell, global central banks are heavily intervening in global equity, bond, and currency markets with one goal, namely, kill volatility and kill big hedge funds who are trying to short these markets.

Why are central banks intervening to the tune of trillions in markets? Because they are petrified of deflation and unfortunately no matter what they do, my forecast of deflation coming to the US will materialize, and this will most definitely bring about the worst bear market ever.

Those of you who don't understand the "baffling" mystery of inflation-deflation, including some members of the Fed concerned about low inflation, better wake up and smell the coffee or risk getting slaughtered.

Importantly, central banks cannot stop global deflation. There is no big reversal in inflation taking place. Global inflation is in freefall. Central banks can continue pumping trillions into markets but they will lose the war on deflation and if they're not careful and hike rates too aggressively, they will exacerbate global deflation.

Central banks also know markets are on the edge of a cliff and the bubble economy is set to burst, which is why they're desperately trying to reflate risk assets at all cost even if that means euphoria might creep into markets. Why do you think the Fed is openly talking about QE infinity?

So, while I still think it's as good as it gets for stocks, I'm back at trading shares full-time, carefully navigating through these prickly markets, using all information available to me, like what top funds bought and sold last quarter, but truth be told, these markets terrify me.

And they should terrify you too, especially if the quiet melt-up continues and you see a parade of bulls telling you to jump in, enjoy the party.

I keep coming back to this weekly chart of the S&P 500 (SPY) which every trader will tell you is bullish:


I want to see a meaningful correction right back down to its 200-week moving average. It is unlikely to happen at the end of this year but it has to happen because if it quietly keeps grinding higher, when the music stops, these markets are going to get destroyed, clobbering everyone, especially retail investors jumping in as bull stretches to new highs in a late-cycle rally.

Central banks are playing with fire here. They know it and I think the big canary in the coal mine remains credit markets where things look fine after a couple of shaky weeks:


Keep your eyes peeled on high yield (junk) bonds (HYG) because that's the first place trouble will show up and spill over to the stock market.

The stock market is just a show, real traders fear the bond market and the signals coming out of the bond market are what should concern all of you.

Importantly, while some think the collapse of the Treasury yield curve is due to coming changes of the US tax code and US corporate pensions, I think something far more ominous is in the works here.

I personally think the bond market is equally worried of deflation headed to the US, which is why US long bond prices (TLT) keep rallying as yields tumble in the long end:


Remember, the Fed controls the short end of the curve but inflation expectations determine the long end of the curve, so right now, you have an interesting dynamic where the Fed is raising rates but the long end keeps rallying despite the selloff in the short end.

For me, this is normal. The Fed is trying to restore its ammunition by raising rates so it can cut them later on when the next crisis hits, but the bond market is worried it's going too fast and will kill the economy and exacerbate deflationary pressures.

Interestingly, the US dollar (UUP) is still in a downtrend as they're trying to raise inflation expectations through higher oil prices (OIL):



But a lower greenback puts pressure on Europe and Japan where deflation is alive and well (higher euro and yen mean lower import prices there, which they can't afford for long because it exacerbates deflation there). And as I stated previously, if oil rises too fast, it’s deflationary because it will impact aggregate demand in a debt-laden economy.

Then there is China which is set for a major economic contraction but you wouldn't know by looking at Chinese large cap shares (FXI):


Given my worries of global deflation, I’m short Chinese and emerging market equities (EEM) and bonds (EMB). Because of deflation, I'm also short oil (USO), energy (XLE), metals and mining (XME) and financials (XLF) and remain long and strong good old boring US bonds (TLT), the ultimate diversifier in these insane markets.

By the way, all these frustrated bears are funny, if you diligently read my blog on how GE botched it pension math, you would have been short and made some serious money:


I used to invest in L/S Equity hedge funds and laughed when they told me there are NO shorting opportunities (there are plenty, you need to do your homework!!).

So, while most bears are silent, some are laughing all the way to the bank, and those are the bears you need to invest with.

Below, an excellent interview from USAWatchdog with former Federal Reserve insider Danielle DiMartino Booth says the record high stock and bond prices make the Fed nervous because it’s fearful of popping this record high credit bubble.

Danielle is one sharp lady who authored a best selling book, Fed Up. I obviously don't agree with her on everything since I remain long US long bonds and believe deflation is headed our way, but listen to her comments carefully as she gives you a very sobering view of today's credit markets.

Hope you enjoyed this comment, please kindly remember to donate or subscribe to this blog via PayPal on the right-hand side under my picture and support my efforts in bringing you insightful daily comments on pensions and investments. I thank all of you show who have contributed and continue to contribute to this blog, it's truly appreciated.

And since it's Friday, let's have a quick glimpse into what's moving up on my watch list today:


Take care, I wish all Americans a Happy Thanksgiving weekend. Those of you who took a long weekend off, make sure you read my last comment on OTPP's Barbara Zvan on managing risk.