Tuesday, December 12, 2017

Canada's Large Pension Pollutters?

HuffPost Canada reports, Canada Pension Plan Undermines Feds By Investing In Coal:
Canada's national pension fund manager is among a group of Canadian companies that are undermining the federal government's international anti-coal alliance by investing in new coal power plants overseas, an environmental organization says.

Friends of the Earth Canada joined with Germany's Urgewald to release a report today looking at the top 100 private investors putting money down to expand coal-fired electricity — sometimes in places where there isn't any coal-generated power at the moment.

The report lists six Canadian financial companies among the top 100 investors in new coal plants in the world. Together, Sun Life, Power Corporation, Caisse de depot et placement du Quebec, Royal Bank of Canada, Manulife Financial and the Canada Pension Plan Investment Board have pledged $2.9 billion towards building new coal plants overseas.

Urgewald tracks coal plants around the world and reports there are 1,600 new plants in development in 62 nations, more than a dozen of which don't have any coal-fired plants now.

While Environment Minister Catherine McKenna is claiming to be a global leader on phasing out the dirtiest of electricity sources, private investors are "undermining that commitment," says Friends of the Earth senior policy adviser John Bennett.

Canada and the United Kingdom last month teamed up to launch the Powering Past Coal Alliance, trying to bring the rest of the world on side with a campaign pledge to phase out coal as a power source entirely by 2030 for the developed world and 2050 for everyone else.

Twenty national governments and at least seven subnational governments — five of them from Canada — signed onto the alliance last month. The hope is to grow the number to 50 by the time the United Nations 24th climate change conference takes place in November 2018.

McKenna will meet with leaders and officials from the alliance this week in Paris, where French President Emmanuel Macron is hosting a climate change meeting to mark the two year anniversary of the Paris climate change accord. This meeting is largely focused on international climate finance as the world tries to meet the goal to have $100 billion a year to invest in climate change mitigation and adaptation projects in the developing world by 2020.

The accord commits the world to keeping the average global temperature from rising more than two degrees Celsius over pre-industrial levels by the end of the century. To do that, scientists suggest global carbon emissions have to start dropping in less than three years, and the only way that is going to happen is by shutting down coal plants.

Coal is responsible for almost half of global carbon dioxide emissions.

McKenna's office did not respond to a request for comment.

Last week, McKenna was in China where she said she was talking about phasing out coal. While China is trying to cut its own coal use, it uses more coal to make power than the rest of the world combined. Hence, McKenna said it's currently impossible to expect China to commit to eliminating it.

Canada can do more: climate institute

McKenna said she wasn't planning to raise the issue of China investing in new plants outside its borders. Urgewald's data show Chinese-owned companies are behind about 140 new coal plants in development outside China.

Turns out Canadian money is also financing international coal plants, through private investors.

Dale Marshall, national program manager for Environmental Defence, said the Paris meeting this week has a lot of work to do trying to figure out how national governments can increase their commitments but also leverage more from the private sector.

Erin Flanagan, director of federal policy for the Pembina Institute, said Canada can do more to discourage Canadians from investing in coal and encourage investments in clean energy. That could include a national requirement for investment companies to include climate change risks when publishing decisions about investment opportunities.
Friends of the Earth Canada released a press release, Canada is the 8th top backer of new coal plants around the world:
Today, the German organization Urgewald released a report revealing Canada as the 8th largest investor in new coal globally.  They provide a list of the top 100 investors in companies developing new coal plants. Canadian institutions on the list include:
  • SunLife at #31 with $895 million invested;
  • Power Financial Corporation at #53 with $631 million invested;
  • Caisse de dépôt et placement du Québec at #71 with $433 million invested;
  • Royal Bank at #86 with $356 million invested;
  • Manulife Financial at #98 with $282 million invested; and
  • the Canada Pension Plan Investment Board just missed making the list with $267 million invested.
Friends of the Earth, using the Urgewald findings and the Canada Pension Plan Investment Board publications, has produced “Canadian Coal Investment: Powering Past the Coal Alliance”.

“Minister McKenna is claiming leadership in the global phase-out of coal but the numbers show investors undermining that commitment,” says John Bennett, Senior Policy Advisor, Friends of the Earth Canada. “This isn’t just about right and wrong. It’s about making risky investments – largely with other people’s money,” said Mr. Bennett.

In the midst of growing evidence of the risks of investing in fossil fuels, initiated by government pronouncements on phasing out coal plants, carbon pricing and climatic events,  Canadian pension funds and financial institution are helping to bankroll the expansion of coal fired power plants in China, India, South Africa and other countries around the world. Link to spread sheets.

The Canada Pension Plan Investment Board’s total investment in coal stands at $12.2 billion CDN. This number is based on CPPIB Direct Investment of $339 million in Urgewald’s top 120 Coal New Developers, CPPIB Investments of $6,939 million in the Urgewald’s 100 Top Investors in New Coal and other CPPIB Coal Investments of $4,969.

“Will the Canada Pension Plan be there for Canadians if it continues ignoring climate change and making risky investments with our money? We need regulations requiring financial institutions to recognize the financial risks associated with climate change and ending investment in fossil fuels starting with new coal plants,” said Mr. Bennett.

Coal investments of $12.2 billion is a great deal of money; however, it is only 3.7% of the CPPIB’s $325 billion fund. Even if all the coal investments were wildly profitable, their divestment would have only a minor impact on returns. On the other hand, assessments by Corporate Knights have shown the Canada Pension Plan likely miss out on US$6.5 billion in profits by sticking with climate polluting industries.

For more information, contact: John Bennett, Senior Policy Advisor, Friends of the Earth Canada, 613 291-6888 johnbennett@foecanada.org

Friends of the Earth Canada (www.foecanada.org) is the Canadian member of Friends of the Earth International, the world’s largest grassroots environmental network campaigning in 75 countries on today’s most urgent environmental and social issues.
My first thought after reading this is Friends of the Earth Canada are no friends of the Canada Pension Plan and CPPIB.

Let me begin by stating flat out, this organization has no understanding of basic governance pricinples that have led to the success of CPPIB and other large Canadian pensions.

Importantly, CPPIB and other large Canadian pensions operate at arm's length from the federal and provincial governments, and that's undeniably in the best interests of all Canadians and the stakeholders of these pensions.

CPPIB's objective is the same as other large Canadian pensions, namely, to maximize returns without taking undue risks. Period.

The tricky business of divestments might sound right and ethical and in rare cases it is supported by overwhelming evidence, like in the case of OPTrust divesting from tobacco. There is a direct link between tobacco and people dying.

But in the case of coal, piplines, fossil fuels, we need to exercise a lot more caution when it comes to divestments. Coal is still a very important source of energy but it's declining. Pipelines have less of a carbon print than trucks and trains used to transport fossil fuels and coal (and pipelines are great long-term investments).

More importantly, this report from Friends of the Earth Canada neglects to mention that Canada's large pensions are already committed to fighting climate change. In October, the Caisse announced it aims to cut portfolio's carbon footprint 25% by 2025:
The Caisse de dépôt et placement du Québec is setting bold targets to shelter its portfolio against the impact of climate change.

The country's second-largest pension fund is seeking more profitable investment opportunities and means to avoid assets it forecasts will be left behind in a global marketplace being reshaped by an increasingly low-carbon world economy.

The move comes as institutional investors around the world are reassessing climate risks and other so-called environmental, social and corporate governance (ESG) factors in response to stakeholder pressures, marketplace shifts and new regulations.

"The world is changing, frankly, faster than most people expected," Michael Sabia, chief executive officer of the Caisse, said at a Montreal event to discuss the pension fund's new climate policy. "We need to change the way we make investment decisions."

The Caisse is setting measurable targets to guide its investment decisions for the coming years. Most crucially, it plans to reduce the carbon footprint of the overall portfolio by 25 per cent by the year 2025.

Carbon budgets will guide the Caisse in meeting and surpassing that 25-per-cent target, and give it a capacity to assess the performance of individuals and investment teams against the budgets – compensation will be linked to their success.
The Globe and Mail article also mentions that Canada Pension Plan Investment Board, climate change is one of its four key ESG pillars and is perceived as a significant risk factor that can affect investments:
"We think it's something that we have to take seriously in our time-frames and do more to understand, quantify and figure out whether we're paying the right price," Mark Machin, CEO of CPPIB, said of climate change's impact on investments at a recent conference in Toronto. "At the end of the day our mandate is simple. It's not to change the world. It's to maximize returns without undue risk of loss for our 20 million beneficiaries."
I highlighted that last part so all those environmentalists who think the CPPIB is an extension of the federal government can stop this nonsense and understand that CPPIB is a Crown corporation with its own board and governance which is separated from the federal and provincial governments (they look after the CPP, not the CPPIB).

Another problem I have with this report is it neglects to mention huge investments Canada's large pensions are making in renewable energy across public and private assets. It only targets coal, which quite frankly is a pittance in terms of the overall portfolio and will eventually be phased out completely.

Canada's large pensions aren't polluters, they're doing more than their fair share of ESG investments and even though they're not perfect, I think some environmental groups need to back off and stop distorting the facts, or at the very least present a much more balanced portrait of what is really going on.

I suggest Canada's large pensions put up some charts in their annual report showing the annual change in renewable energy investments and start being more transparent about what percentage of their portfolio is still in fossil fuels and how it compares to a decade ago.

If you have anything to add, feel free to contact me at LKolivakis@gmail.com and I'll be glad to publish your comments.

Below, clips from a very biased Guardian article which states the argument for divesting from fossil fuels is becoming overwhelming. Just "keep it in the ground" and "divestment is simple" according to this article.

Unfortunately, divestments are far from simple and such decisions have a material impact on pensions looking to maximize returns without taking undue risks. The reality is the world still needs fossil fuels and the myth of fossil fuel phase out needs to be exposed and laid to rest once and for all.

Update: John Bennett of Friends of the Earth Canada, sent me this after reading my comment above (added emphasis is mine):
We share a desire to see successful pension funds, but differ on the reality of the claims made by the CPPIB and other pensions and financial institutions.

First of all we do not call for divestment. We calling for regulation incorporating climate risk to investment be a real part of fiduciary responsibility. There is big difference.

There is plenty of evidence climate risk is real. Long term investments in fossil fuels, insurance and even real estate as well as other areas are subject to climatic events and changing regulations significantly altering the risks to those investments. Phasing out coal is one such risk.

Second, the CPPIB is investing public money collected as a tax by the federal government and under the act that created it, government has the authority to appoint the board and provide direction should it choose to do so. We have every right to expect the money we turn over won’t be used against our own best interest.

The Canadian government is leading a global campaign to phase out coal powered electricity which creates a double bind for the CPPIB if continues to invest in new coal either directly or indirectly. The value of those investments will drop as the government campaign grows – a climate risk.

As much as you and the CPPIB believe it is at arm's length from government, can it continue to invest public money in a manner that directly undermines government policy? The CPPIB already has changed investment policy to bring it in line with government policy when it comes to landmines, human rights and women on boards. Why not climate change or coal?

I’ve read the CPPIB sustainability report and it sounds good if climate change were minor issue requiring a good public relations response. It’s not. Climate Change is an existential threat to humanity. It is the moral responsibility of everyone, especially those with the capacity of the $325 billion fund to everything we can to avoid significant climate change.

The Paris Agreement set 2 degrees C as the limit but even if we hold it there the world will experience costly and disruptive climate changes including climatic events, sea level rise and more. We hold there if we continue to build coal fired power plants...

Quietly urging fossil fuel companies to report their emissions as the CPPIB claims it does just doesn’t cut it any longer. Perhaps 20 years ago when we had more time it would have been a adequate start. We no longer have decades to slowly wean ourselves from fossil fuels.

CPPIB does not take climate change seriously. The billions invested don’t lie. If it did it would not be continuing to make new investments in fossil fuels let alone coal.

And it refuses to even discuss climate change. It’s carefully worded policy on its website is just repeated over and over again. http://www.benefitscanada.com/pensions/db/canadian-investors-targeted-for-investments-in-new-coal-projects-107787

You refer to its ESG approach. Have you asked for a copy one of their ESG reports? I have. I asked for a copy of the report on investing a billion to buy ENCANA’s Colorado holdings and set up Crestone Peak Resources (96% CPPIB owned) private company. The CPPIB refused to release it because it would show how climate change and public health was ignored.

You may be satisfied with the CPPIB but should a government agency be allowed do what it pleases with $325 billion in public money without any real public scrutiny.
I thank John for sharing his thoughts but it's clear to me he doesn't understand CPPIB is not a government organization, it's the largest Crown corporation with its own independent board to make sure there is no government interference whatsoever in its investment decisions.

CPPIB's first "fiduciary responsibility" is to attain the actuarial return target set by the Chief Actuary of Canada without taking undue risks. 

Moreover, there is intense scrutiny on CPPIB and it's a highly transparent organization. To say CPPIB doesn't take climate change seriously is ridiculous. If that were the case, then why does it invest in renewable energy?

Lastly, CPPIB most definitely invests in the best interests of Canadians looking to retire with dignity and security. There is no doubt about this in my mind and the long-term performance backs it up.

Can CPPIB improve its ESG policies and be more transparent in this regard? Sure, but to claim it ignores climate change and public health is outlandish and just downright false.

Monday, December 11, 2017

Bitcoin's Big Bang?

Rob Urban, Camila Russo and Yuji Nakamura of Bloomberg report, Two trading halts, 26% gain: Bitcoin hits Wall Street with a bang:
Bitcoin has landed on Wall Street with a bang.

Futures on the world’s most popular cryptocurrency surged as much as 26 per cent from the opening price in their debut session on Cboe Global Markets Inc.’s exchange, triggering two temporary trading halts designed to calm the market. Initial volume exceeded dealers’ expectations, while traffic on Cboe’s website was so heavy that it caused delays and temporary outages. The website’s problems had no impact on trading systems, Cboe said.

“It is rare that you see something more volatile than bitcoin, but we found it: bitcoin futures,” said Zennon Kapron, managing director of Shanghai-based consulting firm Kapronasia.

The launch of futures on a regulated exchange is a watershed for bitcoin, whose surge this year has captivated everyone from mom-and-pop speculators to Wall Street trading firms. The Cboe contracts, soon to be followed by similar offerings from CME Group Inc. and Nasdaq Inc., should make it easier for mainstream investors to bet on the cryptocurrency’s rise or fall.

Bitcoin wagers have until now been mostly limited to venues with little or no oversight, deterring institutional money managers and exposing some users to the risk of hacks and market breakdowns.

Bitcoin futures expiring in January climbed to US$17,540 as of 11:29 a.m. in London from an opening level of US$15,000, on 2,798 contracts traded. The spot price climbed 6.4 per cent to US$16,647 from the Friday 5 p.m. close in New York, according to the composite price on Bloomberg.

The roughly US$900 difference reflects not only the novelty of the asset but also the difficulty of using the cash-settled futures to trade against the spot, strategists said.

“In a normal, functioning market, good old arbitrage would settle this,” Ole Hansen, head of commodity strategy at Saxo Bank A/S in Hellerup, Denmark, said by email. “If they were deliverable you could arbitrage the life out of it.”

Proponents of regulated bitcoin derivatives say the contracts will increase market transparency and boost liquidity, but skeptics abound. JPMorgan Chase & Co. Chief Executive Officer Jamie Dimon has called bitcoin a “fraud,” while China’s government has cracked down on cryptocurrency exchanges this year. The Futures Industry Association — a group of major banks, brokers and traders — said this month that contracts in the U.S. were rushed without enough consideration of the risks.

So far though, trading has kicked off without any major hiccups.

Dealers said volume was high for a new contract, even though it was tiny relative to more established futures. And the trading halts took effect just as Cboe had outlined in its rules. Transactions stopped for two minutes after a 10 per cent gain from the opening price, and for five minutes after a 20 per cent jump. Another five-minute halt will take effect if the rally extends to 30 per cent, Cboe said in a notice on its website.

“It was pretty easy to trade,” Joe Van Hecke, managing partner at Chicago-based Grace Hall Trading LLC, said in a telephone interview from Charlotte, North Carolina. “I think you’ll see a robust market as time plays out.” For now, Cboe futures account for a tiny slice of the world’s bitcoin-related bets. The notional value of contracts traded in the first eight hours totalled about US$40 million. Globally, about US$1.1 billion of bitcoin traded against the U.S. dollar during the same period, according to Cryptocompare.com.

Some people who would like to trade futures are having a hard time accessing the market because not all brokers are supporting it initially, said Garrett See, chief executive officer of DV Chain. Participation may also be limited because of higher capital requirements and tighter risk limits, See said.

“We’re in the early stages here, and there’s not enough professional liquidity from the big market makers who can provide depth and hold in the movements,” said Stephen Innes, head of trading for Asia Pacific at Oanda Corp. “It’s going to be a learning curve.”

It’s been painful for investors stuck on the sidelines. This year alone, bitcoin is up more than 17-fold. The surge has been driven largely by demand from individuals, with technical obstacles keeping out most big money managers like mutual funds.

The new derivatives contracts should thrust bitcoin more squarely into the realm of regulators, banks and institutional investors. Both Cboe and CME on Dec. 1 got permission to offer the contracts after pledging to the U.S. Commodity Futures Trading Commission that the products don’t run afoul of the law, in a process called self-certification.

Not everyone is happy with the expedited roll out. Exchanges failed to get enough feedback from market participants on margin levels, trading limits, stress tests and clearing, the Futures Industry Association said this month. In November, Thomas Peterffy, the billionaire chairman of Interactive Brokers Group Inc., wrote an open letter to CFTC Chairman J. Christopher Giancarlo, arguing that bitcoin’s large price swings mean its futures contracts shouldn’t be allowed on platforms that clear other derivatives.

Still, Interactive Brokers is offering its customers access to the futures, with greater restrictions. The firm’s clients won’t be able to go short, and Interactive’s margin requirement, or how much investors have to set aside as collateral, will be at least 50 per cent. That’s a stricter threshold than both Cboe’s and CME’s.

The start of futures trading is an important milestone for bitcoin’s shift from the fringes of finance toward the mainstream, but it could be some time before the cryptocurrency becomes a key part of investor portfolios — if it ever does.

“You never say never,” David Riley, who helps oversee US$57 billion as head of credit strategy at BlueBay Asset Management LLP in London, said in an interview on Bloomberg Television. “But I do think we’re quite some way from making cryptocurrencies even a relatively small part of some of the funds we manage at the moment.”
Claire Brownell of the National Post also reports, Big changes coming as bitcoin futures trading, ETFs launch:
Cryptocurrency fever was already rampant when Evolve Funds Group Inc. on Sept. 22 announced it was the first company to file a prospectus to offer a Canadian bitcoin exchange-traded fund. Since then, investor frenzy has reached a fever pitch.

Over the past two and a half months, bitcoin has more than quadrupled in price. Investors have poured US$1 billion into initial coin offerings, where startups offer cryptocurrencies in exchange for capital. Even digital cats — yes, digital cats — are being bought and sold for six-figure sums on the blockchain of Ethereum, a rival cryptocurrency platform.

Institutional investors will soon be able to join the fun by trading bitcoin futures for the first time, first through Cboe Global Markets Inc. on Sunday and then through rival CME Group Inc. on Dec. 18.

As a result, the amount of capital at risk if the cryptocurrency bubble bursts is probably going to grow exponentially. And the traditional financial system, which some predicted would be obliterated by Bitcoin, will become even further integrated into what was once considered a fringe curiosity.

Despite the potential dangers and an eye-popping trading price, bitcoin is going mainstream.

Evolve chief executive Raj Lala said the demand for a Canadian bitcoin ETF is incredibly strong. He said having a regulated futures market on reputable mainstream exchanges is an important first step before offering the fund, because it eliminates the need for actual bitcoin to change hands.

“Futures have become a great proxy way to participate in a commodity,” Lala said. “This just makes for an easier way for you to participate in the price performance of bitcoin.”

But participating in the price performance of bitcoin is certainly not for the faint of heart.

On Friday, bitcoin surged to a new high of more than US$17,000 overnight, plunged to just under US$14,000 by noon and finally recovered to about US$16,000 by the end of the day. Just one year earlier, a single bitcoin was worth just US$770.

Currently, many institutional investors are unable to buy cryptocurrencies for a variety of regulatory and practical reasons. But futures contracts and ETFs will make it possible for them to place bets on the price of bitcoin going up or down using familiar exchanges and financial tools.

Big-name investors might be anxiously awaiting the opportunity to trade bitcoin futures, but the banks, which have to guarantee those trades, are not so eager.

Walt Lukken, chief executive of the Futures Industry Association, which represents financial institutions that hold customer funds and clear trades, expressed his concern in an open letter on Thursday to the U.S. Commodity Futures Trading Commission.

“A more thorough and considered process would have allowed for a robust public discussion among clearing member firms, exchanges and clearinghouses to ascertain the correct margin levels, trading limits, stress testing and related guarantee fund protections and other procedures needed in the event of excessive price movements,” Lukken said.

“The recent volatility in these markets has underscored the importance of setting these levels and processes appropriately and conservatively.”

The bitcoin futures markets that are about to launch are all cash-settled, which means a trader who buys an option to purchase bitcoin at a certain price in the future and holds the contract to expiration will receive or pay the gain or loss in regular central-bank-issued dollars.

In other words, the futures market won’t directly affect demand for bitcoin for the most part, although some investors might spot arbitrage opportunities or hedge their positions by actually buying the cryptocurrency.

However, bitcoin futures and ETFs will increase the digital asset’s visibility and bring it to the masses. The financial instruments will also further cement bitcoin’s current principal use as a store of value, rather than a censorship-resistant payment network that’s independent of government control.

Anthony Di Iorio, a founder of Ethereum and chief executive and co-founder of Jaxx, a multi-cryptocurrency wallet, and Decentral, a Toronto innovation hub, said bitcoin’s evolution from a proposed payment network to an asset worth holding is not necessarily such a bad thing.

He said the big institutional money moving into bitcoin is likely to further increase the fee that miners charge per transaction — making it even less financially viable to use bitcoin as a means of buying a cup of coffee — but there are hundreds of other cryptocurrencies that may be better suited for that purpose.

“Perhaps Bitcoin is not going to be what people thought,” Di Iorio said. “It might not be Bitcoin for the day-to-day stuff, for the smaller things. But other ones are emerging, other ones will still find gaps.”

At a conference in Riga, Latvia, in late November, Bitcoin security expert and entrepreneur Andreas Antonopoulos said the entry of futures doesn’t necessarily mean the cryptocurrency is about to lose its radical roots and become a speculative playground for Wall Street types.

In a video of his remarks posted to YouTube, Antonopoulos said the futures market will perform a useful function for the Bitcoin ecosystem, allowing the miners who secure transactions to hedge against price swings by taking short positions.

“I think it’s important to recognize the CME is not Wall Street,” said Antonopoulos, who works on the oversight board of the exchange’s bitcoin reference rate. “I don’t think these people are as alien to our culture as many believe.”
So, bitcoin finally hit Wall Street with a bang? I've avoided jumping on the bitcoin bandwagon largely because I didn't know enough about cryptocurrencies, the blockchain technology underpinning them, and to be truthful, the whole bitcoin phenomena looked extremely silly to me.

Still, on Friday, I got a phone call from a broker buddy of mine who loves to boast about how much money he's always making in markets. "You gotta write something on bitcoin, it's going to explode up." He invested in it last year and told me "it's headed to $250,000 and when it does, I'm going to make millions, cash out and buy a nice big house."

I listened patiently and some of the points he made sense. For example, he thinks bitcoin is a better store of value than gold and its market cap will reach that of gold and likely supplant it. I mentioned recent events in Saudi Arabia and how elites around the world are growing increasingly anxious about their wealth being arbitrarily confiscated by monarchs, despots and governments.

Perhaps the biggest argument I can make for bitcoin is that rising inequality will eventually lead to political backlash. The power elite is aware of this and wants to protect its wealth using any means necessary from governments looking to redistribute it.

In fact, over the weekend, Marko Papic, Chief Strategist, Geopolitics at BCA Research, posted this on LinkedIn:

To which I replied:

The world is changing, many ubber wealthy individuals are worried about their wealth, especially in countries where they can be persecuted for political reasons, so it's not surprising that bitcoin has taken off in such a massive way.

My initial thoughts on bitcoin were it was being used for money laundering and authorities would allow it to estimate the size of the world's underground economy. As silly as this sounds, there most definitely is a lot of money laundering going on through cryptocurrencies and anyone who claims otherwise is ignorant.

But there is also no doubt in my mind that bitcoin is increasingly being used by high net worth individuals worried about future redistribution policies and looking to hide their wealth from tax authorities. It's not outright money laundering, it's tax evasion, however.

That's why when Jamie Dimon came out to call "bitcoin a fraud", I was shocked because it demonstrated a complete lack of understanding of the political dimensions propelling bitcoin higher. In recent days, Dimon is more "open-minded" on bitcoin and other cryptocurrencies using regulations (aka, he sees potential profits to be made and won't put his foot in his mouth again).

The same goes for Citadel's Ken Griffin who recently stated bitcoin has "elements of the tulip bulb mania". This too demonstrates a total lack of appreciation for what's truly driving bitcoin higher (too easy to dismiss it as just speculative fervor).

Now, I'm not advocating for anyone to jump on the bitcoin bandwagon but given my views, I wouldn't be surprised if bitcoin prices head much higher despite all the naysayers.

Importantly, there is definitely a political dimension to bitcoin which is completely underappreciated by skeptics who dismiss this as just another bubble.

Having said this, there are also risks attached to bitcoin. If bitcoin and other cryptocurrencies continue to thrive, adding billions more to the fortunes of the Winklevoss twins and others, you can bet governments are going to coordinate and find ways to regulate, disrupt, and even go as far as hacking cryptocurrencies.

In fact, there are already security concerns as it was recently reported North Korea was trying to hack bitcoin as the cryptocurrency keeps soaring to record levels.

Also, the SEC just issued a warning to cryptocurrency investors hours after the regulator stopped an "initial coin offering" (ICO) from restaurant review app Munchee and its chairman, Jay Clayton, also warned bitcoin offers ‘substantially less investor protection’ than other markets:
“We have issued investor alerts, bulletins and statements on initial coin offerings and cryptocurrency-related investments,” he said. “If you choose to invest in these products, please ask questions and demand clear answers.”

His statement included a list of sample questions, such as “What specific rights come with my investment?”

The SEC boss emphasized the global nature of the crypto frenzy — and the risks that come with that.

“Please also recognize that these markets span national borders and that significant trading may occur on systems and platforms outside the United States,” Clayton said.

“Your invested funds may quickly travel overseas without your knowledge. As a result, risks can be amplified, including the risk that market regulators, such as the SEC, may not be able to effectively pursue bad actors or recover funds.”
Moreover, the IRS recently ordered Coinbase, a popular platform for buying and selling bitcoin and other cryptocurrencies, to turn over identifying information on accounts worth at least $20,000 during 2013 to 2015. It's unclear whether the exchange will comply or contest the ruling:
The order, which affects about 10,000 accounts, is a narrowing of an earlier effort by the IRS. In a blog on the Coinbase website, the company notes that the first request would have impacted another 480,000 accounts.

The court case arose after the IRS found that for in each year from 2013 to 2015, only about 800 taxpayers claimed bitcoin gains. During that time, the cryptocurrency rose to $430 from about $13.

So how do you determine what you owe?

If you held it for one year or less, it is a considered a short-term gain and is taxed as ordinary income. Depending on your tax bracket for 2017, that could range from a tax rate of 10 percent to 39.6 percent.

Any bitcoin you sold or spent after owning it for more than one year is taxed as a long-term gain. Taxable rates on those gains range from 0 percent to 20 percent, with higher-income households paying the highest rate.

In a nutshell, although bitcoin and its brethren are often viewed as being anonymous, not reporting your gains could be viewed as tax evasion by Uncle Sam.

"I've told clients who own it that it's up to them to track their cost basis, their holding period and their sale price," Boyd said. "It might seem innocuous and veiled and like no one will follow up, but records of those transactions are available."
Earlier today I had a chance to speak with Fred Pye, President of 3iQ, a firm which looks to provide institutional quality portfolios that offer accredited investors core exposure to bitcoin, ether, and litecoin. Their funds will also provide access to leading external active managers in the digital asset space.

Fred is based here in Montreal, he obviously knows his stuff when it comes to bitcoin and other cryptocurrencies. He first showed me Bitnodes, a site which is currently being developed to estimate the size of the bitcoin network by finding all the reachable nodes in the network.

He then showed me how TradeBlock works, taking me over how all these cryptocurrency trades are registered. For example, you can see recent bitcoin blocks live here.

Fred also sent me two comments, one written by his partner Greg Foss, Spot the Horse, which was published on Zero Hedge, and another one, Fat Protocols, on understanding the differences between the Internet and the Blockchain.

Anyway, it goes without saying that Fred is bullish on bitcoin and thinks there is a lot more upside ahead, even if it will be very volatile. Fred used to work at Fidelity and he invested in gold way back when, which was interesting because he feels there can be a market for bitcoin and gold (one doesn't have to supplant the other).

He said there is now $275 billion in cryptocurrencies and the market value of gold is roughly $7 trillion (see figures here) whereas as the value of total global assets is roughly $200 trillion.

"So the first big move is bitcoin heading to 1% of total global financial assets ($2 trillion) and then once institutions like pensions and sovereign wealth funds invest, it can double or triple from that level."

But according to Fred, the real big move will happen "when there is a crisis in fiat currency" and everyone will be looking to cryptocurrencies to preserve their capital.

Fred isn't exactly some snake oil salesman. If you talk to him, you'll see he really knows his stuff and truly believes in the figures he's quoting, even if they seem wildly optimistic right now.

Exactly how the bitcoin market evolves and how it will impact monetary and fiscal policy remains to be seen. There are too many unknowns right now but as bitcoin becomes mainstream, it will present opportunities and challenges to investors and regulators.

One thing is for sure, institutional investors can't just sit back and ignore bitcoin, blockchain, and other cryptocurrencies. They need to stop listening to skeptics or perennial optimists and really do their homework properly.

As for me, I'm having way too much fun trading biotech shares to focus on bitcoin right now but given my views on the global power elite being scared of redistribution policies in an era of debt deflation, I wouldn't be surprised if bitcoin hits $200,000 before it hits $2000 again. It's just too speculative for my blood.

Still, the people reading this blog should get Fred Pye and other experts to come to their offices to talk to them about cryptocurrencies and how they can get cheap and secure long-only exposure.

Whatever you do, stop listening to Jamie Dimon, Ken Griffin or even Nassim Taleb and Mike Novogratz, do your homework and study these cryptocurrencies and the blockchain technology underpinning them very carefully and think carefully as to which economic and political factors will impact their value going forward.

Below, Andreas Antonopoulos gives you an introduction to bitcoin. You can view more clips on Andreas's YouTube channel here, including bitcoin for beginners.

[Note: Interestingly, Fred told me Andreas wasn't an early investor in bitcoin because "he had to pay the rent" but some investors set up a page to raise money for him to invest in bitcoin.]

Next, Mike Novogratz, Galaxy Investment Partners CEO, the man who called bitcoin $10,000, discusses his next call on bitcoin. He might be right but it will be a bumpy ride up.

Just to reinforce my last point, Interactive Brokers chairman Thomas Peterffy, who took out a full page ad in The Wall Street Journal to warn about bitcoin, insists he doesn't hate the cryptocurrency, but thinks it needs to stay far away from the real economy.

Peterffy said on CNBC's "Fast Money" on Thursday, his concern is that the cryptocurrency could continue to rise to $100,000 or more before crashing to zero, and could pull down small brokerages in the process (Interactive Brokers requires a 50% margin to trade bitcoin futures).

Fourth, Tom Lee, Fundstrat Global Advisors, gives his views on equity portfolio plays for bitcoin for investors that can't or don't want to buy the cryptocurrency. Social Capital's Chamath Palihapitiya also weighs in. Lee also talked about how bitcoin is the investment for millennials. Maybe but Mr. Wonderful isn't sold on the idea of settling deals based on bitcoins.

Lastly, Fred Pye, CEO of 3iQ, was interviewed by Michael Hainsworth of BNN. I didn't embed it below because it is easier to watch it here.

Friday, December 8, 2017

Best of All Worlds For Stocks?

Patti Domm of CNBC reports, Strong November jobs report shows solid economy and best of all worlds for stocks:
November's solid jobs gain and modest wage growth shows a strong economy with still low inflation, a perfect recipe for stock market gains.

There were 228,000 jobs added in November, and unemployment remained at a low 4.1 percent rate. Average hourly wage growth at 0.2 percent was a slight disappointment, as economists were hoping to see 0.3 percent, or a 2.7 percent year-over-year rise and a signal that inflation would be picking up.

"This is another addition in the 'Goldilocks' scenario—slightly better jobs, no faster wages, no pressure on inflation. It's not going to change the Fed from increasing rates next week, but there's nothing so dramatic as to accelerate their time table, or at this point ease back," said Ed Keon, managing director and portfolio manager at QMA. "It just shows a robust economy and not one yet that shows inflation pressures."

Stock futures rose after the 8:30 a.m. ET report, and the market opened higher with tech leading the gains. The important monthly jobs report comes after a sloppy period for stocks, but ahead of the time of year when seasonal forces and a "Santa" rally often give the market a boost.

Meanwhile Treasury yields at the short end trended slightly lower, particularly the 2-year note. That area of the yield curve is most affected by Fed rate hikes. The 2-year was at 1.80 percent in morning trading.

Strong areas of hiring included professional and business services, up 44,000; manufacturing, up 31,000; health care, up 30,000, construction up 23,000.

ZipRecruiter's chief economist, Cathy Barrera said manufacturing may be seen as an area that needs help, but it has been doing well.

"Manufacturing is continuing to be called out for a third or fourth month in a row. That usually surprises people. It seems that actually we've seen jobs added there...We've added about 175,000 since last October," she said.

The lack of wage growth may be a concern for economists, but for the markets, it buys more time for a Fed that can slowly increase interest rates.

"We've seen this dance before —strong growth, no inflation. It doesn't change the Fed for December. How much the Fed goes next year is going to be dependent on whether we get inflation pressures picking up," said John Briggs, head of strategy at NatWest Markets. "The fact the economy is doing well and the unemployment rate remains low...means you can keep them on track to gradually raise rates but there is a point where if you do not get inflation pressure, it might give them pause."

The market is now awaiting the Fed's meeting next week, where it is expected to raise interest rates by a quarter point. The Fed also issues its outlook and forecast for interest rates, the last in the Fed headed by Janet Yellen. Fed Governor Jerome Powell takes over as Fed chair in February.

The Fed has forecast three hikes for next year, and it is expected to keep its outlook about the same even though the market has been skeptical it will hike as much as it expects.

"You're starting to enter the transition from Yellen to Powell. I'm not sure this is the time you want to have a huge messaging shift from the Fed," Briggs said.
Jeff Cox of CNBC also reports, November nonfarm payrolls rise 228,000 vs. 200,000 est.:
Economists surveyed by Reuters had expected nonfarm payrolls to grow by 200,000.

A more encompassing measure of joblessness that includes discouraged workers and those holding part-time positions for economic reasons moved up one-tenth of a point to 8 percent. The ranks of those not in the labor force edged higher by 35,000 to 95.4 million.

Closely watched wage data fell short of expectations. Average hourly earnings rose 0.2 percent for the month and 2.5 percent for the year, versus projected increases of 0.3 percent for the month and 2.7 percent for the year.

"The November employment data is largely as expected. For an expansion that began in mid-2009, no negative surprises are welcome," said Mark Hamrick, senior economic analyst at Bankrate.com. "The lingering impacts of recent hurricanes and flooding have reverted back to relative calm in the statistics, meaning that this is a 'cleaner' number."

Federal Reserve policymakers have been concerned over the lack of income growth, though they are still expected to raise the central bank's benchmark interest rate a quarter point next week. The probability dipped a bit after the jobs release but remains above 90 percent, according to the CME FedWatch Tool.

"The jobs number in the report is good news for American workers, but the lack of stronger wage growth is not," said Robert Frick, corporate economist with Navy Federal Credit Union. "Without stronger wage growth, higher inflation remains in doubt, and that takes away one reason for the Fed being more aggressive in hiking rates."

The biggest November job gains came in professional and business services [46,000], manufacturing [31,000] and health care [30,000]. In total, goods-producing occupations rose by 62,000. Construction saw a gain of 24,000, almost all of which were specialty trade contracts, a profession that has added 132,000 jobs over the past year.

Heading into the holiday season, retail jobs also grew by 18,7000.

Markets reacted positively to the news, with major stock indexes opening higher.

Job growth has slowed this year — to 174,000 per month compared with 187,000 a year ago — as the economy edges closer to what officials consider full employment, or the condition where those looking for work have positions. However, Fed officials have been dismayed that the tight labor market has not resulted in significantly higher wages.

"With continued improvement in the labor market, room for continued upward trajectory in 2018 is likely limited because there's not much slack left to hire workers for further growth," said Steve Rick, chief economist at CUNA Mutual Group.

The quality of job creation tilted toward full time, whose ranks grew by 160,000, while part-time positions contracted by 125,000, according to the household survey.
Lucia Mutikani of Reuters also reports, Strong U.S. job growth in November bolster economy's outlook:
U.S. job growth increased at a strong clip in November, painting a portrait of a healthy economy that analysts say does not require the kind of fiscal stimulus that President Donald Trump is proposing, even though wage gains remain moderate.

Nonfarm payrolls rose by 228,000 jobs last month amid broad gains in hiring as the distortions from the recent hurricanes faded, Labor Department data showed on Friday. The government revised data for October to show the economy adding 244,000 jobs instead of the previously reported 261,000 positions.

Employment gains in October were boosted by the return to work of thousands of employees who had been temporarily dislocated by Hurricanes Harvey and Irma. November’s report was the first clean reading since the storms, which also impacted September’s employment data.

Average hourly earnings rose five cents or 0.2 percent in November after dipping 0.1 percent the prior month. That lifted the annual increase in wages to 2.5 percent from 2.3 percent in October. Workers also put in more hours last month.

The unemployment rate was unchanged at a 17-year low of 4.1 percent amid a rise in the labor force. Economists polled by Reuters had forecast payrolls rising by 200,000 jobs last month.

The fairly upbeat report underscored the economy’s strength and could fuel criticism of efforts by Trump and his fellow Republicans in the U.S. Congress to slash the corporate income tax rate to 20 percent from 35 percent.

“The labor market is in great shape. Tax cuts should be used when the economy needs tax cuts and it doesn’t need tax cuts right now,” said Joel Naroff, chief economist at Naroff Economic Advisors in Holland, Pennsylvania. “When politics and economics are mixed in the stew, the policies that are created often have a very awful smell.”

Republicans argue that the proposed tax cut package will boost the economy and allow companies to hire more workers. But with the labor market near full employment and companies reporting difficulties finding qualified workers, most economists disagree. Job openings are near a record high.

The economy grew at a 3.3 percent annualized rate in the third quarter, the fastest in three years, and appears to have maintained the momentum early on the October-December quarter.

The average workweek rose to 34.5 hours in November, the longest in five months, from 34.4 hours in October. Aggregate weekly hours worked surged 0.5 percent last month after October’s 0.3 percent gain.

“A six-minute increase in the work week does not sound like much, but given the size of the labor market, it turns out to be significant in terms of output,” said Marc Chandler, global head of currency strategy at Brown Brothers Harriman in New York.

The dollar was trading higher against a basket of currencies, while prices for U.S. Treasuries fell. Stocks on Wall Street rose.


While November’s employment report will probably have little impact on expectations the Federal Reserve will raise interest rates at its Dec. 12-13 policy meeting, it could help shape the debate on monetary policy next year.

The U.S. central bank has increased borrowing costs twice this year and has forecast three rate hikes in 2018.

Employment growth has averaged 174,000 jobs per month this year, down from the average monthly gain of 187,000 in 2016. A slowdown in job growth is normal when the labor market nears full employment.

The economy needs to create 75,000 to 100,000 jobs per month to keep up with growth in the working-age population.

The unemployment rate has declined by seven-tenths of a percentage point this year. A broader measure of unemployment, which includes people who want to work but have given up searching and those working part-time because they cannot find full-time employment, ticked up to 8.0 percent last month from a near 11-year low of 7.9 percent in October.

Economists believe the shrinking labor market slack will unleash a faster pace of wage growth next year. That, combined with the tax cuts, would help to boost inflation.

“Detractors will argue that wage increases are too slow but we have shown in our research that adjusting for demographic effects, wage gains are where one ought to expect them to be,” said John Ryding, chief economist at RDQ Economics in New York.
"Adjusting for demographic effects, wage gains are where one ought to expect them to be." I love that comment, it's a keeper.

Alright, it's Friday, let me take a step back, analyze this US jobs report and talk markets. First, the US economy is humming along nicely as are plenty of other economies all over the world. That is great news for stocks and other risk assets but it still begs the question, how sustainable is this going forward?

In particular, Zero Hedge notes the following on the November jobs report on where the jobs were:
Assuming that the BLS' estimate of avg hourly warnings growing only 0.2% in November is accurate, it would imply that - as has often been the case - the bulk of job growth in November took place in minimum-paying and other low-wage jobs. However, a breakdown of jobs added by industry shows the contrary to expectations, the bulk of new job creation, and 3 of the 4 top categories, were not in the "low wage" bucket. In fact, as shown below, with the exception of Education and Health jobs which rose by 54K in November, Manufacturing (+31K), Professional and Business Services (+27), and Construction (+24) were the fastest growing occupations in the previous month.

For those wondering, yes waiters and bartenders did hit a new all-time high of 11.783 million in November, an increase of 18.9k for the month.

Now, the folks at Zero Hedge are perennial gold bugs who see inflation conspiracies everywhere, so it doesn't surprise me they think the official numbers are under-reporting real wage inflation.

If you think wage infation is coming back strong next year, now is a great time to load up on SPDR Gold Shares (GLD) and in particular, junior gold miners (GDXJ) which are at critical make-or-break weekly levels:

I'm not in the "inflation is coming" camp so it's hard for me to get excited about gold. I think gold shares will take off after the next crisis, when central banks engage in QE infinity.

Right now, I'm far more worried about deflation headed to the US which won't happen tomorrow, but when it does strike, watch out, it will fundamentally transform markets and the global economy as we know it.

Interestingly, while stocks took off after the employment numbers were released, there was no big selloff in bonds as yields in the long end remain unchanged. US long bond prices (TLT) are still doing well despite all the great economic news:

One has to ask why aren't long bonds selling off strongly, especially if wage inflation is right around the corner?

My answer is that the bond market isn't buying this inflation argument, and neither should you. In fact, even though US inflation expectations edged up again in October to 2.61 percent, touching their highest level in six months, according to a Federal Reserve Bank of New York survey, some are worried about the trend.

Last month, Chicago Federal Reserve Bank President Charles Evans said he is worried about a drop in US inflation expectations and called for the US central bank to respond by flagging the likelihood of higher inflation ahead:
"When I look at the downward drift in multiple expectations measures, I find it tougher to confidently buy into the idea that inflation today is just temporarily low once again," Evans said in remarks prepared for delivery to the UBS European Conference in London.

To prevent low inflation expectations becoming entrenched, he said, "our public commentary needs to acknowledge a much greater chance of inflation running at 2-1/2 percent in the coming years than I believe we have communicated in the past."

Evans, a voter this year on Fed policy, did not say in his prepared remarks whether he would support an interest-rate hike in December, as many of his colleagues have said they would, and as markets overwhelmingly expect.

But his comments suggest he has become increasingly frustrated with falling inflation, despite an economy he said is headed for "continued solid growth" in 2018.

Evans warned Wednesday that unless the Fed addresses falling inflation expectations, "we could be in for the kind of trouble that Bank of Japan has faced for so long."

Inflation by the Fed's preferred measure, core personal consumption expenditures (PCE), was just 1.3 percent in September, even though the unemployment rate, at 4.1 percent, suggests the U.S. economy is at full employment.

Fed Chair Janet Yellen has said she believes that as the labor market tightens, inflation will rise back toward 2 percent. Evans is not so sure.

"With each low monthly reading, it gets harder and harder for me to feel comfortable with the idea that the step-down last spring was simply transitory," Evans said. "There is a big strategic risk in failing to get core PCE inflation symmetrically around 2 percent before this economic cycle ends."

Regional Fed presidents like Evans have varying degrees of influence on the direction of Fed policy.

In 2010, Evans tried and failed to win support at the Fed for a new strategy of monetary policy known as price-level targeting that at the time he thought could have lifted troublingly low inflation.

In 2012, though, the Fed included a promise to keep rates near zero until unemployment or inflation reached certain thresholds, an idea Evans had publicly championed for a year before it became policy.
When it comes to inflation, I'm with Charlie Evans and Minneapolis Fed President Neel Kashkari and fear with global inflation in freefall, it's only a matter of time before deflation rears its ugly head on this side of the Atlantic.

The mystery of inflation-deflation has baffled many market analysts but I assure you, there's no big reversal in inflation going on in the US (or elsewhere), and even the recent pickup in inflation expectations is a blip and can be explained by the decline in the US dollar (UUP) over the last year:

Remember, as the greenback sells off relative to the euro and yen, it increases US import prices, temporarily giving a lift to inflation expectations. There is nothing structural going on.

The only structural factor that will boost inflation expectations over the long run is wage inflation, which has been noticably absent despite the US economy being in full employment.

Why is this the case? Well, I think a lot of people are worried about losing their job and maybe, just maybe, the US economy isn't as strong as we think. Forget the baby boomers retiring in droves, there is a lot more Schumpeterian-style "creative destruction" going on than there is job creation.

I listened to Larry Kudlow this morning on CNBC stating that "tax cuts will unleash an investment boom" in the US, but all they will do is exacerbate rising inequality and maybe spur business to invest in more robots, not people.

I want all of you to note once again the seven structural factors that lead me to believe deflation is headed for the US:
  1. The global jobs crisis: High structural unemployment, especially youth unemployment, and less and less good paying jobs with benefits.
  2. Demographic time bomb: A rapidly aging population means a lot more older people with little savings spending less.
  3. The global pension crisis: As more and more people retire in poverty, they will spend less to stimulate economic activity. Moreover, the shift out of defined-benefit plans to defined-contribution plans is exacerbating pension poverty and is deflationary. Read more about this in my comments on the $400 trillion pension time bomb and the pension storm cometh. Any way you slice it, the global pension crisis is deflationary and bond friendly.
  4. Excessive private and public debt: Rising government and consumer debt levels are constraining public finances and consumer spending.
  5. Rising inequality: Hedge fund gurus cannot appreciate this because they live in an alternate universe, but widespread and rising inequality is deflationary as it constrains aggregate demand. The pension crisis will exacerbate inequality and keep a lid on inflationary pressures for a very long time.
  6. Globalization: Capital is free to move around the world in search of better opportunties but labor isn't. Offshoring manufacturing and service sector jobs to countries with lower wages increases corporate profits but exacerbates inequality.
  7. Technological shifts: Think about Amazon, Uber, Priceline, AI, robotics, and other technological shifts that lower prices and destroy more jobs than they create.
These are the seven structural factors I keep referring to when I warn investors to temper their growth forecasts and prepare for global deflation.

More importantly, when deflation strikes America, it will have devastating effects on risk assets across public and private markets and it will decimate private and public pensions, especially those that are already chronically underfunded.

[Note: Pensions are all about managing assets and liabilities. Deflation strikes both, especially liabilities which will soar to unprecedented levels when the pension storm cometh and rates decline to new secular lows.]

There is a reason why Jack Bogle -- Mr. Index -- is worried about US pensions. He sees the writing on the wall and knows the math simply doesn't add up and "it will end badly".

People confuse the stock market with the economy. Stocks are part of the leading economic indicators but stocks move up and down based upon a lot of factors, including plentiful liquidity.

In a world where bitcoin is going parabolic, Saudi princes are buying paintings for $450 million, and stocks keep soaring to new highs, all it tells me is there is too much money out there chasing risky assets higher and higher.

But as I keep warning you, stocks don't go up forever even if they can go up longer than pessimists and optimists think. There is a lot of money out there fuelling speculative frenzy, and it's coming from central banks, big trading outfits and hedge funds playing the momentum game, hoping to squeeze the very last dollar and get out in time.

The deafening silence of the VIX and bears leads many to erroneously conclude that central banks control these markets and what they say goes. The next generation of "Big Shorts" is anxiously awaiting for something, anything, to blow up (China, Eurozone, etc.) but thus far markets keep soaring higher, steamrolling over them.

Remember what I told you a long time time ago, there are two big risks in these markets right now:
  1. A meltdown unlike anything we've ever seen before, making 2008 look like a walk in the park.
  2. A melt-up unlike anything we've ever seen before, making 1999-2000 look like a walk in the park.
It might shock you to learn that it's the second risk that keeps asset managers awake at night because it forces them to chase risk assets at higher and higher levels knowing that downside risks are multiplying as asset vaues keep hitting record levels.

In other words, if we first get a melt-up before we get the next huge meltdown, it will buy central bankers some time but ultimately, it will ensure a much longer and deeper recession, and likely lead to that prolonged debt deflation scenario I keep warning of.

So maybe it's not as good as it gets for stocks, maybe there is more "juice" left to squeeze shorts and send stocks a lot higher but the bond market isn't buying any of it and neither should you. Trade stocks but be careful, when the music stops, we will experience the worst bear market ever.

Let me end by giving you some quick thoughts on market sectors I track.  As you know, given my fears of deflation, I'm short emerging market stocks (EEM), Chinese shares (FXI), oil (USO), energy (XLE), metals and mining (XME), industrials (XLI) and financials (XLF) and remain long and strong good old boring US bonds (TLT), the ultimate diversifier in these insane markets.

Now, if you look at financials (XLF), you'd think the US economy is just beginning a major expansion but I would use this weekly breakout to take profits:

Energy (XLE) shares have popped recently along with the price of oil but are hovering around the 200-week moving average and unable to make new 52-week highs:

Emerging market stocks (EEM) and Chinese shares (FXI) look like they're rolling over here after a huge run-up:

I definitely would be booking my profits and shorting these sectors going into the new year.

Earlier this week, a lot of fuss over the so-called FANG stocks selling off, but if you look at technology shares (XLK) they have yet to roll over in a meaningful way on the weekly chart:

One area of concern for technology is semiconductor shares (SMH) which look very vulnerable for a reversal here:

As far as biotech, right now I'm more bullish on large biotechs (IBB) than smaller ones (XBI) which ran up lot this year but in general, I still like this sector even if it's extremely volatile:

Lastly, it's Friday, so have fun peeking at stocks making big moves up and down on my watch list (click on images to enlarge):

The stock of the week this week was Sage Therapeutics (SAGE) which exploded up on hopes for breakthrough depression drug:

Once again, hope you enjoyed this week's market comment and please remember to take the time to contribute via Pay Pal on the right-hand side under this image:

I thank all of you who take the time to donate or subscribe to my blog, I truly appreciate it.

Below, Diane Swonk, DS Economics founder & CEO, and David Kelly, JPMorgan Funds chief global strategist, discuss November’s jobs report. Wage growth is disappointing and I fear it will not significantly improve over the next year.

Second, Michael Feroli, JPMorgan chief economist, and Daniel Skelly, Morgan Stanley Wealth Management, discuss the labor market, manufacturing and interest rates in 2018.

Third, days after hitting turbulence, a sustainable comeback for tech stocks could be in the offing, according to Bespoke co-founder Paul Hickey.

Fourth, David Tice, who's known for running the Prudent Bear Fund before selling it to Federated in 2008, predicts stocks could sharply rise again in 2018 before prices plunge and stay low for a long time.

Lastly, CNBC's Meg Tirrell reports on Sage Therapeutics soaring more than 70 percent after a depression drug breakthrough.

Coming from a family with two psychiatirsts, I can assure you there is a desperate need for new treatments for depression, especially hard to treat depression, but temper your enthusiasm because it's still way too early to conclude this new treatment is a "game changer" (there are very few game changers in psychiatry).

Thursday, December 7, 2017

Mr. Index Worried About US Pensions?

Lisa Abramowicz of Bloomberg reports, Jack Bogle Is Worried About U.S. Pensions:
Jack Bogle isn’t optimistic about the state of U.S. pensions over the next decade.

The founder of Vanguard Group thinks a conservative portfolio of bonds will only return about 3 percent a year over the next decade, and stocks won’t do much better, with a 4 percent annual gain over a similar period. This is “totally defeating” for pensions, which “are not going to be able to meet their 7.5 percent or 8 percent obligations,” Bogle said in a Bloomberg Radio interview that aired Thursday.

Bogle is well known for first conceiving of low-fee funds for individual investors, pegging strategies to indexes rather than giving managers free reign to buy what they wanted. This philosophy has helped Vanguard grow into a $4.5 trillion behemoth that will likely reach $10 trillion in assets within the next 10 years.

Bogle, 88, also has a self-professed knack for making accurate market calls. His prognostications on stocks have had about an 81 percent correlation to what actually happens, while his bond predictions have been accurate 95 percent of the time, he said.

“The only return you get on a bond is from the interest coupon,” with fluctuations in prices eventually evening out and becoming relatively negligible over the longer term, he said. Given a portfolio of about half corporate bonds and half U.S. Treasuries, the blended yield is about 3 percent today.

“So that’s what you get over the next decade,” he said.

This is a huge problem for pensions, which rely on bonds to provide steady, reliable income needed to cover benefit payments to plan participants. For example, the largest U.S. pension, California Public Employees’ Retirement System, is considering more than doubling its bond allocation to reduce risk and volatility as the bull market in stocks approaches nine years.

Pensions have generally lowered their returns targets over the past few years, but they’re still aiming for annual gains of more than 7 percent on average. To Bogle, that’s an unlikely scenario.

“It is almost a given that it will end badly,” he said.
Jack Bogle is absolutely right, this will end badly as there is no way US public pension funds will attain a 7 or 8 percent annualized rate of return over the next ten years without taking huge risks -- risks that can place them in an even worse predicament than they already are.

Let me repeat this, even if US pension funds aggressively allocate more to alternative investments -- hedge funds, private equity, real estate, infrastructure, etc. -- there is still little chance of attaining a 7 or 8 percent annualized rate of return over the next ten years.

And if my worst fears of deflation headed to the US materialize, even 4% annualized rate of return over the next ten years will be difficult to attain.

To understand why, go back to read my recent comment on pensions' brave new world where I noted the following:
Interestingly, the Alpine Macro report did discuss return scenarios under the deflation and inflation surprises, which you can see in table 2 below (click on image):

Quite shockingly, the authors conclude higher inflation would result in a worse outcome:
This is primarily because the P/E ratio would be compressed significantly, and the ERP would rise, both undercutting expected returns for stocks. For example, if we assume that steady-state inflation in the U.S. were to rise to 3.5%, with 2.5% steady-state real growth, equilibrium bond yields would be 6%. With the ERP at 200 basis points, the expected total return for U.S. stocks would be 3.2%. After inflation, the real return will be -0.3%.
I say shockingly because for pensions managing assets and liabilities, there is no question that unexpected inflation (which leads to higher rates) is a much better outcome than unexpected deflation.

I guess it all depends on what deflation scenario we're talking about because a prolonged debt deflation scenario I'm worried about will roil assets and make liabilities soar as the yield on the 10-year US Treasury note hits a new secular low. Mild disinflation is fine, prolonged debt deflation is a nightmare.
Let me quantify this so you understand my worst-case scenario for pensions. Prolonged deflation for me means an episode that lasts more than five years, where debt defation drives the yield on the 10-year Treasury note down to 0% or even negative territory.

We can argue whether this is a disaster scenario which is unlikely to occur barring another financial crisis of epic proportions, but if this happens, that 4% bogey won't be easy to attain for pensions even if they're heavily invested in alternative investments.

The problem now is stocks are quietly melting up and all risk assets are extremely overvalued, so people roll their eyes when I talk about the risks of prolonged debt deflation.

That's fine, even if we take Jack Bogle's sensible analysis which is nowhere near as dire as my worst case scenario, there is little chance US pensions will attain their desired rate of return.

So what does that mean in practice? Well, since many US public pensions are already chronically underfunded, what this means is contribution rates need to go up, benefits need to be cut or both to shore up these plans.

And neither unions nor state and local governments want to pump more money into their pensions but the problem is taxpayers don't want to see more hikes in their property taxes either, so something has to give.

No problem Leo, the Mother of all US pension bailouts is coming our way, Congress will quietly pass it and the Senate will approve it. Secretary Mnuchin will instruct the US Treasury to float a 50-year bond, and voila, the pension problem will disappear.

If you believe in fairy tales, be my guest, I prefer to stick to reality. And the truth is one way or another, US public pensions need to drop their pension rate-of-return fantasy even if that means contribution rates need to rise, benefits need to be cut or both.

By the way, it's not just Jack Bogle warning US public pensions to get real. Yale's David Swensen said the exact same thing recently, slamming US public pensions who justify a discount rate of 7.5 percent when he thinks they should be using the 10-year bond yield plus 50 basis points (roughly 3 percent).

Below, Vanguard's Jack Bogle isn’t optimistic about the state of US pensions over the next decade and talks about the inflows into passive investment products in Vanguard and BlackRock. See my comment on passive investing taking over and what that means exactly for investors.