If you follow Howard Marks of Oaktree Capital, you know he is clearly one of the most astute investors around and his newsletters are among the best as well. In his latest missive, he references the above Albert Einstein quote when discussing the measurement of risk and reward. This quote got us thinking as to the state of the investment landscape today. The explosion of Algorithmic trading based on up- to- the second “information” as well as a fixation on monthly data which is itself suspect in its measurement and meaning leaves capital markets appearing to focus on only that which can be counted. The focus on what cannot be counted has never been more absent, as the prevailing thinking is that the risks associated with the unknown can be alleviated with the existing, or further iterations of, Central Bank policy. Nassim Taleb would refer to these uncountables as black swans, and it would seem as we move further and further away from the events of 2008/2009, the capital markets amnesia regarding the potential for such black swan moments becomes greater and greater. Those asset classes whose returns have been driven by leverage and momentum are most at risk when the amnesia wears off.
You may or may not be familiar with the sharia law governing finance and speculation. Under the Islamic code, interest and speculation is forbidden, but followers may share risk through equity participation in physically based assets. The whole concept is actually fascinating as trillions of dollars in Bonds have been devised to synthetically create interest bearing vehicles with some underlying physical component. A quick perusal of negative nominal yields in a number of major sovereign government bond markets would make it appear like the whole world is currently living under sharia law. As we have mentioned before, it is curious that one of the criticisms of some particular hard assets is that they throw off little, or no, cash flow/interest. We have a hard time reconciling those kinds of comments with rates that give investors the privilege of taking on sovereign credit risk for a fee. If we are operating under sharia law, in terms of rates of interest, we would prefer to stick to the letter of the law and participate in the ownership of physical/hard assets.
As we look out across the investment opportunities available to investors today, the phrase ” In the land of the blind, the one eyed man is king” keeps rattling around in my head. However, the version that keeps coming back to me again and again is ” In the land of no return, those asset classes with even the slightest hint of return are king”. Whether it is royalty trusts, farmland, MLP’s, or whatever, assets and asset classes whose traditional return profile have hardly made investors giddy have now become the go to investment. Granted, some of these asset classes do possess the benefits of secular shifts (Farmland, pipelines, etc.) but it is clear to us that the reach for yield has morphed into a reach for yield at any price. It seems like any asset whose income stream can be monetized (and leveraged) is being driven to nosebleed levels.So, what is the proactive investor to do? In our opinion, there has never been a better time to avoid the low level perspective and take the 30,000 foot view. Massive amounts of Central Bank created liquidity will have consequences for currencies and real asset prices. BUY STUFF.
The Economist recently discussed the sudden massive influx of Hong Kong Dollar buying in response to the Russian Crisis. Russian oligarchs, ostensibly in response to the recent sanctions, were fleeing to the safety of what they consider to be a politically friendly environment. This influx caused a great deal of frenzied U.S.Dollar buying in order to retain the HK dollar/US Dollar peg. In addition, it also was reported that the strong bid to high end London real estate appears to have severely diminished, most likely due to a diminished Russian appetite for safe haven buying. What is interesting about these flows of capital is that the search for safe haven assets is now dictated by the “safety” of the political environment, and not necessarily by the perceived riskiness of the asset itself (stocks/bonds). Much like those seeking political asylum for purposes of exercising their basic freedoms, capital seems to be seeking out its own level of freedom. Clearly this kind of thinking bodes well for hard assets, particularly those with a higher degree of liquidity. Hard Assets Are Apolitical. BUY STUFF
We were quite amused at recent comments by Fed Governor Lockhart regarding a shift in Fed policy occurring when ” They can see the whites of their eyes”. This comment would be funny if not for the fact that markets have gone “all in” on the accuracy of Fed policy. Not only has Fed policy exacerbated the amplitudes of what used to be called the normal business cycle, they have sought to rewrite history by emphasizing their forecasting acumen when clearly none exists. The prize for the appearance of perceptiveness has to go to Mario Draghi, who is able to make similar bold predictions within the context of a Central Bank policy that simply has to make promises to successfully achieve their policy goals (whatever it takes… ad infinitum). I know that we are walking a fine line here when we rehash the same point over and over, but history and markets ( in our opinion) will ultimately prove that such professed tea reading skills are completely without merit.
We were somewhat surprised to see a tag line in the FT today denoting the shale industry as being “Fed Resistant”. What a sad commentary on responsible Central Banking. The tried and true market adage used to be ” Don’t fight the Fed”. That might have to be amended however to ” Don’t let the Fed fight you”. Central Bank activity has become so aggressive and pro-active over the past several years, that a simple unwinding of this hap hazard strategy will virtually ensure that those on the other side of this mis-pricing will feel the brunt of this realignment. We have been very upfront about those areas of the market that we feel, and still feel, are “Fed resistant”- Hard Assets. Join the resistance movement: Buy Stuff.
The latest talking head chatter deals with the recent Fed Meeting and the perception that somehow the Fed is now ” behind the curve”. With the jobless rate falling (under various measures-U3,U6) and prices moving up towards the Feds target rate, there is some that now question why the Fed is not moving more quickly towards the normalization of rates. The retort to those that pose this question is: THE FEDERAL RESERVE POLICY OVER THE LAST 5 YEARS HAS BEEN TO STAY BEHIND THE CURVE. The Federal Reserve has consistently stayed behind the curve by simply shifting their policy targets once they have been met or exceeded. The only question, in our minds, is why the only curve that matters (The yield curve) does not adequately reflect this. Equally as confusing, has been the lack of investor demand in those areas which might optimally take advantage of this purposeful lag in policy (Hard Assets).
The recent decision by Credit Suisse to exit their commodities business, marks the latest in a long line of Commercial and Investment Banks that have made the conscious decision to exit their respective commodity businesses. This decision reminds us of previous exoduses in the past, such as in the late 90’s when Merrill Lynch left the business, only to re-enter in the early part of the 2000’s. As Chuck Prince astutely remarked in response to the frothiness of the credit markets in 2007,” as long as the music is playing you’ve got to get up and dance”. Well, faced with additional capital requirements and a myriad of Dodd-Frank related regulations, the decision by banks to not dance is probably the proper response. However, if one believes (as we do) that there is no better contra-indicator of value (outside of Central Bankers) than the behavior of Bankers, than this decision clearly indicates that the commodity area is ripe for outsized returns.
I often make the statement that I would like the words ” He was early” emblazoned on my tombstone. From Farmland in the late 90’s to the drillers and the refiners in the early 2000’s we seem to be both blessed with foresight while at the same time cursed with an inability to frame that foresight within a reasonable time period. In short, it seems like we are always playing the waiting game, which as we all know, sometimes feels less than comfortable. Being early often feels like being wrong, and one has to continually revisit the underlying investment thesis to make sure that being early is not simply a refusal to admit ones mistakes. We have to admit that the environment over the past several years has simply not validated our thesis with respect to hard assets vis- a- vis financial assets. The question is: Are we wrong or Are We Early? Clearly the answer to this question will ultimately unveil itself, but in the interim we take comfort in the fact that fiat currencies rarely reign supreme over extended periods of time, particularly those that are expressly being devalued via Central Bank actions. The antidote to falling currencies is to hold stuff.Continue to Buy Stuff.
I never thought I would ever say this but I was thinking the other day how I long for the days of Alan Greenspan as Fed Chairman. Don’t get me wrong, I think that his arrogance and wrong- headed thinking rank right up there with the worst of the Fed Chairman. The Maestro’s long diatribes ranged from the appropriateness of adjustable rate mortgages, to the shape of the oil futures curve. One thing that he did however was couch the Fed intentions to always shelter the capital markets under a cover of obfuscation. Our most recent Fed Chairs feel no compulsion to “fake it”, their role is to micro-manage the capital markets and no one should be under any misconceptions otherwise. In fact, the latest Maestro is particularly adamant that the suppression of rates has not necessarily created anything that she can’t handle. Our response to that is: “We Will See”. We were describing the state of markets the other day to someone using the accident victim as an analogy. The capital markets/global economy in 2008/2009 experienced a self-inflicted crash, followed by a near death experience. The expanded role of Central Banks was initially to save the patient. However, their ever expanded duties included administering morphine, gassing up the new car and pulling it around front for the quasi-healthy patient to take another joy ride. The problem is that how many near death experiences can one person have, and no one car crash looks like another. As we have discussed, one would expect a certain amount of Central Bank hubris, given that markets have recovered in such a sharp and unexpected fashion ( who would expect that sub-prime loans are exploding and that AAA CLO’s containing the crummiest of credits are exploding as well). However, markets have a way of acting in very non-linear ways and the belief that macro-prudential market regulation will do the trick ignores the speed at which dislocations can occur. Fade Chairman Yellens woman’s intuition: BUY STUFF