Tag: episode 1127

2014’s BEST CALLS TRANSCRIPT

December 26, 2014

Who got the economy and markets right in 2014? We introduce the economist, strategist and portfolio managers who hit home runs on WEALTHTRACK this year. Best Macro Call: Nancy Lazar, Head of Economic Research Team and Co-Founder, Cornerstone Macro. Her correct call: The U.S. would resume its position as the driver or world economic growth and that China’s economy and influence would slow. Best Market Call: Francois Trahan, Head of Investment Strategy Team and Co-Founder, Cornerstone Macro. His correct call: U.S. stock markets would continue to rally and the dollar would strengthen against other major currencies. Best contrarian Call: Robert Kessler, Founder and CEO, Kessler Investment Advisors. His correct call for every year of the past decade: U.S. Treasury bonds yields would stay near record lows and make money for investors. Best Surprise Call: Robert Amodeo, Head of Municipals, Western Asset Management and Robert DiMella, Co-Head of MacKay Municipal Managers Their correct call: The health of the municipal bond market was improving and it would be a top performing bond market.

CONSUELO MACK: This week on WEALTHTRACK, the best calls of 2014 from WEALTHTRACK all stars. Hear the winning plays from Nancy Lazar on the economy, Francois Trahan on the markets, Robert Kessler on treasuries and Rob Amodeo and Bob Dimella on Munis. Next on Consuelo Mack WEALTHTRACK.

Hello and welcome to this edition of WEALTHTRACK, I’m Consuelo Mack. What have been the signature economic and market developments of 2014? Who got it right among our WEALTHTRACK guests? The best macro call goes to Nancy Lazar of appropriately named, Cornerstone Macro, an independent research firm she co-founded in 2013. Lazar, a perennially top ranked economist predicted the U.S. would regain its position as the world’s dominant economic power and that the Chinese juggernaut would slow. Here’s what she told us earlier this year:

NANCY LAZAR: Well, the two big powers of the global economy have been the U.S. and China, and up until this year China had been that driver of global growth, but over the past several years China has built up a tremendous amount of excesses, investment credit, corruption, pollution but particularly the investment and the credit, and they are now at the very early stages of unwinding those bubbles, if I can call them that, and as a result growth must slow. The only way they can unwind those bubbles is for growth to slow, and there are plenty of signs indeed that is happening.

In contrast in the United States, we’ve dealt with a lot of our excesses, our credit bubble for example burst hard as we now know, in particular taking housing down, but today we have long-term drivers of growth in the United States, making it easier for a sustained period of growth. I’m not suggesting that U.S. GDP growth will be extremely robust, five or six percent. We’re using about three and a half percent GDP, but when you go through the math and you look at how much the U.S. is going to grow this year and how much China is going to grow this year, on balance, yes. The U.S. is going to grow faster than China in dollar amounts here in 2014…

CONSUELO MACK: We are going to be growing faster than China? In dollar terms? Tell me what that means.

NANCY LAZAR: Well that’s because the dollar value of the U.S. economy is much bigger than China so the U.S. doesn’t have to grow seven, eight percent to actually exceed the growth rate of China. So we have China slowing down to about six, six and a half percent this year. This year the U.S. will be about two and a half, but in actual dollar values you do get a cross-over in the dollar increase in GDP here in the United States in 2014.

CONSUELO MACK: So all of that analysis that everyone’s been doing for the last 10 years including us, just kind of forget it. It’s actually going the other way or … ?

NANCY LAZAR: They grew too quickly and, as a result as I mentioned with China, inflation was too rapid. Investment grew too quickly. They now have these excesses and they have to unwind them. Slow down to contain inflation and to slow credit growth. In contrast, here in the United States, we had a very, very severe recession, and as a result we dealt with our credit bubbles, but more importantly there are long-term drivers of growth here in the United States, particularly driven by the energy renaissance but coupled with the manufacturing renaissance. Add to that housing. Housing obviously was hit very, very hard. On balance, it looks like capital spending, that would be the buildings of manufacturing facilities or things related to the energy renaissance and housing, which are about 16 percent of GDP, are likely in a three to five-year recovery here in the United States.

CONSUELO MACK: So three to five years starting from now or … ?

NANCY LAZAR: From now, from here. They’ve already been recovering for about three years. We think we have at least another three to five years left in the investment cycle in the United States because we don’t have those excesses. Inflation is still very, very low. Companies are incredibly healthy. I have a basic theme that companies are the backbone of any country. They hire. They spend on cap ex. Our companies are in great shape, and they have the ability and willingness to spend, and the economic conditions and the ease of doing business in this country is much simpler than it has been in China for example. I’m sure you’ve seen the stories about how the government is suggesting many foreign companies in China have been potentially taking advantage of certain situations, raising prices too much, and in turn they’re forcing many companies from technology companies to food companies to healthcare companies just today to actually lower prices, and that’s pulling. Companies are really pulling foreign direct investment out of China.

FDI in China was down 17 percent in July year over year, and it was down another 14 percent in August. So FDI, companies have found it too difficult to do business, so the bigger theme, one we’ve had for a while, is that if you sell it here in the United States, you actually make it here. The economic conditions, ease of doing business today now favor the U.S. over China. So that investment is what we see driving growth.

CONSUELO MACK: Another major development driving growth this year: lower energy prices. Thanks to a combination of forces including slowing overseas economies and a dramatic increase in U.S. oil production- the country’s highest since 1986- oil prices have plummeted and so have gasoline prices.

Regular unleaded gasoline prices have fallen more than a dollar from their June high and are lower on the year as well.

If gasoline prices stay under $3.00 a gallon some estimates are that the average American family could save as much as $750 dollars next year, providing a big boost to personal spending, our consumer driven economy and the bottom line of many companies.

It’s a thesis put forth by another WEALTHTRACK guest, Francois Trahan. Voted Wall Street’s Number One Portfolio Strategist for many years, Trahan is also one of the co-founders of Cornerstone Macro with Nancy Lazar.

Trahan turned bullish on the U.S. market in the fall of 2011 and has never looked back.

On his last appearance on WEALTHTRACK I asked him why he remains bullish.

FRANCOIS TRAHAN: Well, because the elements that have supported the rally are still in place. We’re one of the few countries in the world that have addressed our structural issues. If you think about the litany of things that people complained about five years ago, consumer leverage, we’ve come a long way. We had a big budget deficit problem. The sequester got rid of that. We’re now staring at a two percent deficit to GDP ratio. We have zero percent Fed funds rate, but I think the process of unwinding that is already in place, and we have an underinvestment cycle in the U.S. we’re starting to see a cap ex cycle which is very labor-intensive,and so the rest of the world is dealing with structural issues. Ours are largely behind us, but I would argue that the world’s problems are also America’s opportunity. Europe’s issues is having an impact on U.S. interest rates. It is artificially depressing U.S. interest rates, helping the consumer. China’s issues is having an impact on commodity prices. We have oil at $90 today, also helping the U.S. consumer.

CONSUELO MACK: Which is low. Right.

FRANCOIS TRAHAN: Which is low, which is down from 108 a little over six months ago, and so it’s an incredible backdrop, and you have a U.S. dollar that is now rallying. I keep encountering people that believe the U.S. dollar is about to melt. The reality is everybody else’s problems is lifting the U.S. dollar. If we did nothing in the U.S., the dollar would go up just because of Europe’s Problems, of Japan’s problems, of China’s problems, of everybody else’s problems, and a rising dollar means rising P/Es, and so I would argue that the elements that have been in place now for a few years are still very much intact. The market is not as cheap as it was, and so I’m not delusional. The P/E of 16 is different than a P/E of 11, but a P/E of 16 is where we were in 1996 when Chairman Greenspan made his famous irrational exuberance speech, and if you got out of the market then, you missed the best four years for equities in the last century. To me, this might be the cheapest market we see for the next five years. The market will be expensive when the story starts to change, and right now I think it’s still just beginning.

CONSUELO MACK: What are the risks to your scenario, major risks?

FRANCOIS TRAHAN: Well, the risks are misperceived first off on the part of the Street. If you remember, a year and a half ago the sequester was going to be the end of the world. Everybody thought it was going to be the end of the world, and people didn’t appreciate that when you take the deficit from negative eight to negative two, the U.S. dollar goes up. Dollar goes up. P/Es expand. The sequester is one of the reasons why the market went up as much as it did last year. It was incredibly bullish. It wasn’t perceived that way. I would argue Fed tapering is the exact same thing, I don’t understand this fear of tapering. If you remember a year ago on the day the Fed was expected to taper last September, the S&P was sitting at an all-time high. If tapering was bad, I’d assure you the market would have been down. The reality is when the Fed moves towards less accommodative conditions and the rest of the world does the opposite, the dollar goes up. Dollar goes up, P/Es expand, and so the Fed is not your enemy here. The Fed is your friend. In a P/E driven world, more often than not, the market does great in a Fed-tightening cycle. The risk in my opinion is that Europe gets its act together and that rates start to go up, or that China finds some sort of stimulus, gets investments going again. It’s hard for me to see how this happens, but it’s always possible, and that all of a sudden commodity prices start to rise again. That to me is probably the biggest risk for the U.S. right now.

CONSUELO MACK: In previous interviews, you have told me that inflation is the new Fed funds rate.

FRANCOIS TRAHAN: That’s right.

CONSUELO MACK: Explain what you mean by that and, therefore, why rising inflation would be such a problem for the market.

FRANCOIS TRAHAN: Sure. Well, in a world of zero percent rates, at the margin things that make a difference become much more significant, and so the ebb and flow of inflation, the ebb and flow of oil and other commodities become very significant on the average consumer’s wallet basically. You get the dollar to go up. That means that your grocery bill’s going down. It means that you heating bill, filling up your car goes down, and so the dollar is a very, very important component here.

CONSUELO MACK: Because you’re buying the more valuable. The dollar is the more you can buy of imported goods as well as obviously oil is priced in dollars as well.

FRANCOIS TRAHAN: That is correct.

CONSUELO MACK: Looking at the Fed and the Fed funds rate and the fact is that QE is ending, we did have a taper tantrum as it was called when it looked like the Fed was going to raise interest rates a year and a half ago or whatever it was, and so the market seems to be very sensitive to what the Fed does with interest rates. What is the outlook at Cornerstone Macro, number one, for what the Fed is going to do that would affect interest rates, and how does that affect your outlook?

FRANCOIS TRAHAN: Well, the tantrum was a four percent correction in the market. In the grand scheme of things, that’s nothing.

CONSUELO MACK: It seemed scary at the time.

FRANCOIS TRAHAN: I know, but it seemed scary because we’ve had a very, very steady market. We’ve had a market that’s been going up on the back of both P/Es and earnings which is very rare historically. Usually you have one driver or the other, and so that gives you a market that is kind of a steady eddy if you will, and so now we see four percent as a tantrum which is kind of incredible in the context of 2007, 2008. I call it noise personally, and so I don’t think it’s a big deal. I think next year you’re going to see, if the U.S. economy is as strong as we believe it will be, you’re going to see the Fed probably raise rates. Will it spook some people? Of course it will because there’s this mantra on Wall Street that says you shouldn’t fight the Fed, but again in the ‘90s you had four Fed tightening cycles. In three of those, the market went up. One of them, the market was flat, and so the key here is the dollar. If the Fed tightening cycle leads to a stronger dollar, and in today’s world I would say that’s a high-probability event in light of Europe’s problems, Japan’s problems, China’s problems, et cetera, I think you’re going to see P/Es that keep ticking higher and higher and higher.

CONSUELO MACK: Explain that to our viewers in case that they’re not aware of why the dollar’s going to higher. It’s largely because interest rates around the world are so low that we look very attractive. So is it the money’s going to flow into the dollar because you can get a higher return? Is it as simple as that?

FRANCOIS TRAHAN: Yeah, I would say it is. When you look at the U.S. trade-weighted dollar and you look at all the components in it, the euro of course is an important component. The yen is an important component, but the largest one, ironically, is China, and China is just beginning to see the unwind of its investment cycle. For all I know, we’re staring at a 10-year period of underperformance from China and emerging markets. Obviously it was the growth engine of the EM trade for so long, and so that alone will lift the U.S. dollar. Remember that the dollar is always relative to all these other currencies, and so if we do nothing and we just let China deal with its structural issues, well, it means the dollar goes up, but we are doing something. We’re doing a couple of really, really bullish things. We’re producing more oil than we ever have. That means our trade deficit is shrinking because most of it was energy related, and we have a Fed that’s about to embark on a tightening cycle when the rest of the world is far from that. It means the dollar is going to go up. I think it’s an incredibly bullish environment for U.S. assets.

CONSUELO MACK: There is one U.S. asset that has been out-performing consensus expectations for years now and has been a consistent favorite of one very independent and outspoken WEALTHTRACK guest.

The underestimated asset is U.S. Treasury bonds, especially those with maturities of a decade or more. This year, contrary to most predictions the benchmark ten year Treasury has turned in a respectable single digit return, but the universally maligned 30 year Treasury bond has delivered returns that any stock investor would be thrilled to have.

The guest promoting their value and usefulness in a portfolio is Robert Kessler, the Founder and CEO of Kessler Investment Advisors, a manager of fixed income portfolios specializing in U.S. treasuries for institutions and high net worth individuals globally.

For the 15 years I have been interviewing him he has correctly predicted that interest rates would fall, then remain low and that U.S. treasuries would do well.

He hasn’t changed his tune.

When I interviewed him this summer I asked him why rates have stayed so subdued for so long.

ROBERT KESSLER: Let me say that I think when we talk about so long, you’re talking about a period of time from the beginning of the ‘80s until now, and so we consider that a very long period of time. The fact of the matter is we had very low interest rates from the early ‘30s until the ‘60s. So this is not an unusual situation, and also in global economies, free enterprise systems, capitalism, there’s always this pressing for lower and lower costs and lower and lower rates. It’s the nature of a good market system which we’re in.

CONSUELO MACK: And productivity and competition and all that stuff. Costs go down.

ROBERT KESSLER: Productivity. All the things that go with it, and there’s a good and bad for that. The good part is that prices come down, and over time generally, if you’re not having a war and you’re not having total fiscal irresponsibility … And in this country we have no fiscal policy, so we’re pretty good on that. So under these conditions there really is no reason to not expect rates to continue to kind of ratchet lower…

We have, again, a marketplace of competitiveness. We have a marketplace right now in the treasury market. We’ll talk about the treasury market where actually the amount of Treasuries are shrinking. We had a deficit in this country of eight or nine hundred billion dollars, and now it’s going to drop to 600 billion. That means we’re going to issue less Treasuries.

CONSUELO MACK: Well, and the Federal Reserve, however, also owns or has been buying 50, 60, 70 percent of Treasury issuance, taking Treasuries off the market.

ROBERT KESSLER: It makes it even smaller in terms of the amount on the market, and the rest of the world looks at the United States. No matter how people may talk about it. We are the reserve currency. We are where you want to place money, and so as countries have grown and certainly countries have grown, regardless of whether they’re in a state of repression or kind of recessions, nonetheless there’s more money out there, and money has to go someplace, and so a huge amount of that comes into the safest, most secure security which is a Treasury. So there are really lots and lots of reason not even counting the fact, which is really important, that on a relative value treasuries are very cheap right now, and the reason they say …

CONSUELO MACK: On a relative value to other markets that have sovereign debt.

ROBERT KESSLER: Sovereign debt. That’s right. We’re not even a high rate compared to a number of countries in Europe or Japan certainly.

CONSUELO MACK: Another factor that could keep a lid on U.S. Treasury bond yields is the very low yields on Germany’s equivalent bond, the bund. According to the research team at Cornerstone Macro ever since 1990 when both bonds were yielding 9%, there has been a very high correlation, 96% between the movement of U.S. treasury yields and yields on German bunds, which are now under one percent.

So despite a pick-up in U.S. economic growth, they say Germany’s low yields could still pull rates on long term Treasury’s down.

There was another bond market that took most people by surprise, except for two WEALTHTRACK guests. The municipal bond market was rocked by problems in Chicago, Detroit and Puerto Rico but overcame those concerns and turned out to be an excellent place to invest. The benchmark Barclay’s Municipal Bond index and Muni High Yield indexes outpaced corporates and treasuries even before considering their considerable tax free advantages.

Early in 2014 I talked to two top Muni fund managers. Western Asset Management’s Robert Amodeo who runs several funds including Western Asset Managed Municipals and Western Asset Municipal High Income and Mackay Municipal managers’ Robert Dimella who runs five muni bond funds under the Mainstay name including Mainstay Tax Free Bond fund and Mainstay High Yield Municipal bond fund.

I asked them then to give us what turned out to be a correct assessment of the health of the municipal bond market.

ROBERT DIMELLA: The municipal marketplace actually is in a much better shape today than it has been in several years. State and local municipalities have been working very aggressively at their structural imbalances. You know, long gone are the days like three or four years ago when everybody was talking about the bankruptcies. So we actually are very positive and constructive on the marketplace. We actually believe it’s one of the most attractively priced fixed income areas for clients to think about when they’re rebalanced in their entire fixed income portfolios.

CONSUELO MACK: Okay, your take on the state of municipal finances right now.

ROBERT AMODEO: It’s a very similar view. The fundamentals are much stronger today than where they stood just a few years ago. Tax receipts coming in stronger, 15 straight quarters now of improved tax receipts.

CONSUELO MACK: That’s great.

ROBERT AMODEO: Modest spending at the state level. I would offer a bit of caution, though. The improvement in revenue collection is uneven. It’s uneven across regions and especially when you compare states to locals. Locals, predominantly their source of revenue comes from property tax receipts, and they remain somewhat lackluster, especially…

CONSUELO MACK: So these are towns, cities. Right.

ROBERT AMODEO: Towns and villages and smaller communities, and that’s opposed versus, say, strong sales, personal and corporate tax receipts. So there is some caution out there.

CONSUELO MACK: All right, so of course there are the headlines, and we are reading about Detroit bankruptcy. We’re reading about Puerto Rican problems. We’re reading about now Chicago possibly on the problem list. So let’s talk about the headliners.

ROBERT DIMELLA: We believe they’re outliers. If you look at Puerto Rico, if you look at Detroit and a lot of the other situations that have been developing over the last several years, they’re isolated cases. These are problems that have been building for many, many years…

CONSUELO MACK: Decades. Right.

ROBERT DIMELLA: That are basically coming to roost. Now you’ve got to figure it out. A lot of people were trying to blame it on the financial crisis of 2008. That’s not the case. It may have exacerbated the problem to a degree without question, but those are the isolated cases, and that’s why we kind of have been talking to our clients and kind of taking them through this whole process, but it’s the municipal marketplace. This is people’s sleep safe at night money. This is not where they take risk on in their portfolios. So any type of headline risk like those, Detroits, Puerto Ricos, Chicago, Illinois really causes a lot of concern and tensions and anxiety for clients, and so it does have an impact on our marketplace, and we just try to take them through as to we’ll manage that well, because like volatility in all marketplaces, that could be an opportunity for you.

CONSUELO MACK: And so let me ask you about Detroit, actually both of you about Detroit, because there was a legal decision that basically general obligation bonds, which I grew up thinking that those were the safest of all municipal bonds backed by the full faith and credit of the issuer, that in fact that they’re not necessarily going to be the top creditor. So what do we make of that decision? Rob, you first and then bob.

ROBERT AMODEO: Yeah, there’s a key point there, and there’s a change in the rank between general obligation debt or potential change in rank between general obligation debt and revenue bonds, especially when you look at Detroit. There’s secured and unsecured debt, and at the core of that decision will be how each fare. So far the unsecured debt which included other post-employment benefits, pension obligations, certificate of participations which was borrowings that were deposited into the pension systems, and along with some general obligation debt which is not backed by state aid. Then you have secured debt. You have state aid, back go debt, and you have water and sewer bonds.

CONSUELO MACK: Right. Go, again, general obligation.

ROBERT AMODEO: Secured bonds are likely to fare better than the unsecured bonds, and the unsecured bonds being that they include general obligation debt have investors fearful that go debt is not as secure as they once thought.

CONSUELO MACK: So is this a precedent-setting decision? I mean, is this going to be a problem when all of us from now on look at general obligation municipal debt and say it’s not so safe anymore?

ROBERT DIMELLA: It’s an important case study without question. As Rob had mentioned, there’s a lot of different nuances to the Detroit situation that has to go through the court process. As a bondholder, mind you, we actually wanted them to go into bankruptcy court, take it out of the political arena, because there has been precedents set in the court systems, but this is why it’s very important to really understand and know what you own in the municipal marketplace. This is no longer your mom and pop’s type of municipal marketplace.

CONSUELO MACK: Each and every one of these WEALTHTRACK 2014 star prognosticators are sticking with their theses in 2015.

Nancy Lazar and Francois Trahan are long term bullish on the U.S. economy and markets. Robert Kessler believes the pervasive weakness and upheaval in much of the world will continue to make U.S. Treasury bonds the choice for investors seeking safety, liquidity and yes decent returns. And Robert Dimella and Rob Amodeo believe the outlook for Munis is positive, but caution that careful security selection in this complex market is paramount.

As investors we can only hope they will all prove to be as prescient in the New Year as they were in the old. Following their advice definitely paid off!

Next week for the first show of the New Year we are looking to the future, the future of investing that is! For New Year’s weekend we are revisiting our interview with Motley Fool Co-Founder Tom Gardner. To see this program and others again, plus our exclusive EXTRA features please go to our website wealthtrack.com.

We want to thank you, our WEALTHTRACK community for joining us for this edition of WEALTHTRACK. We hope you had a wonderful Christmas holiday and wish you a fabulous New Year. Make it a joyful, profitable and productive one.

 

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