Wednesday, September 30, 2015

Who Gets The Last Laugh on Stocks?

Myles Udland of Business Insider reports, Bill Gross is literally laughing at the stock market:
Bill Gross is literally laughing at the stock market.

In a tweet on Tuesday morning, Janus Capital's Bill Gross said: "Stock market refrain from a few months ago: "Where else are you gonna put your money?" LOL ... Ever considered cash?"

Put another way, Gross is laughing at people who invested in the stock market because there was nothing else to invest in.

Folks who have been reading Gross' investment updates over the past year or so most likely know that Gross would prefer holding cash to being invested in the stock market — or almost anything else.

Early in September, Gross' monthly missive basically said everything sucked.

Gross wrote:
Global fiscal (and monetary) policy is not now constructive nor growth enhancing, nor is it likely to be. If that be the case, then equity market capital gains and future returns are likely to be limited if not downward sloping. High quality global bond markets offer little reward relative to durational risk. Private equity and hedge related returns cannot long prosper if global growth remains anemic. Cash or better yet "near cash" such as 1-2 year corporate bonds are my best idea of appropriate risks/reward investments. The reward is not much, but as Will Rogers once said during the Great Depression – "I'm not so much concerned about the return on my money as the return of my money."
Early Tuesday, stocks were falling after getting crushed on Monday.
I guess we can add the former bond king to a growing list of investment gurus warning of a looming catastrophe ahead. The only problem is the stock market is laughing right back at Bill Gross and other doomsayers.

In fact, ever notice how every time we get a big pullback in stocks you get all these dire warnings from gurus that the worst is yet to come? Sure, stocks are getting clobbered and some sectors like biotech just experienced a real drubbing in Q3 but if you ask me, it's better to ignore these dire warnings from eminent "investment gurus" and remember the wise words of the late comic genius George Carlin: "It's all bullshit and it's bad for you!".

That's right folks, there is so much nonsense and misinformation being spread out there from informed sources that it's no wonder many retail and institutional investors are having a hard time navigating through these volatile markets. And some of the best and brightest are taking a real beating this year.

Take the time to read my recent comment on the looming catastrophe ahead.  I cleaned up some typos and dates I got wrong but my message remains the same. In fact, I was listening to Jim Cramer on CNBC this morning (cynics call him the king of bullshit but he has spurts of great insights) and he made a few excellent points on how Tuesday was the fiscal year-end for mutual funds and many sold stocks for tax reasons and how these markets are highly illiquid, exacerbating downside moves.

What else? Tim O'Neill, Goldman Sachs' partner and global co-head of the investment management division, has a warning: If passive investing gets too big, then the stock market won't work.

I should know, I trade biotech stocks and have seen huge and unbelievable downside moves which makes me highly suspicious that either Fidelity (the biggest biotech investor in the world) is playing games here to "shake out weak hands" or there was some big hedge funds suffering from redemptions and forced to close out their big leveraged biotech bets. Either way, I'm not panicking here and prefer to sit tight and ride out this storm.

On Wednesday, things are looking much better. Sure, we're heading into the dreaded month of October but I'm confident the worst is behind us, especially in the biotech sector which everyone now loves to hate. Pay close attention to the iShares Nasdaq Biotechnology (IBB) and the SPDR S&P Biotech ETF (XBI) as I think they are going to bounce big from these way oversold levels once these markets stabilize (click on images):

Keep in mind the former is made up of large biotech stocks and leads the latter which is made up of smaller biotech stocks and is thus a lot more volatile. The same goes for the ALPS Medical Breakthroughs ETF (SBIO). It too is made of small cap biotech shares which swing like crazy (all biotech stocks are definitely not for the faint of heart).

Below, I list a few small biotech companies I track and trade. Some are way oversold and look terrible from a technical point of view but I'm confident many will recover from the latest biotech bloodbath (click on image):

There are plenty more but the truth is this sector just experienced a good thrashing and it scared the crap out of many investors. Still, if you think the rout in biotech is awful, check out the carnage in energy (XLE) and metals and mining shares (XME) or even in top hedge fund picks like Sun Edison (SUNE). OUCH!!

Below, CNBC's Brian Sullivan looks at how much market cap has been lost by the big oil companies during the commodities crush. In his latest comment, We’ve Seen This Picture Before—–Global Markets Down $13 Trillion Already, David Stockman warns the worst is yet to come.

I prefer listening to the ageless wisdom of George Carlin than all these so-called investment experts.  He nails it in the clip below and if you need a good laugh to get your mind off markets, watch it.

Tuesday, September 29, 2015

Ontario Teachers’ Eyes London Expansion?

Joseph Cotterill of the Financial Times reports, Ontario Teachers’ eyes London expansion:
Ontario Teachers’, the Canadian pension plan that owns the UK’s High Speed One railway and its National Lottery operator, is planning to expand further in London, tripling the size of its European investment team.

It revealed on Thursday that it aimed to grow its private equity arm by adding staff in infrastructure and in what it calls “relationship investing” — investing in public or nearly-public companies and working closely with the managers.

Teachers’, which has $160bn in assets, this month moved from Leconsfield House, MI5’s former haunt, into a bigger steel-and-glass building overlooking Marylebone’s leafy Portman Square.

Its expansion is expected to lead to further purchases in the UK, where it also owns Birmingham and Bristol airports.

“We own four airports, so why wouldn’t we look at London City Airport?,” says Jo Taylor, Teachers’ European head, highlighting one asset that is coming to the market. (Teachers also owns Brussels and Copenhagen airports.)

“If an asset like London City became available, or an asset like HS2 [HS1’s potential successor] became available for funding, clearly we would be interested,” he adds.

Ontario Teachers’ is one of a rare breed of pension fund investors — many of them Canadian — that are using in-house teams to find and buy assets independently, or alongside buyout firms, as well as paying fees to traditional third-party funds.

They are increasingly seen by some buyout managers as rivals in a market where prices are high and deals scarce.

“They’re the poster boy, the role model if you like, for increasingly active investors in private equity,” says Stephen Gillespie, a partner at Gibson Dunn.

Mr Taylor, a veteran of 3i, the British buyout firm, prefers to talk about partnership.

Expanding in London, in a timezone where the fund can quickly give feedback on investment offers, provides “the ability for us to develop strategic relationships for the plan over the long term”, he says. “Teachers’ is very much focused on partnering.”

Last year it invested in CSC, a coin-operated laundry machine company owned by Pamplona Capital Management. Last week it continued the relationship, buying a stake in Pamplona’s OGF, France’s biggest operator of funeral parlours.

The nature of these businesses — unglamorous, but with inflation-busting cash flows — is not the private equity norm.

Part of the reason Teachers’ has become a large investor in infrastructure — typically a long-term investment — is that its private market returns have to protect future payouts to its more than 300,000 pension members. Public-sector pension plans must be fully-funded under Canadian law. (LK: this is false, only true in the Netherlands)

Ron Mock, chief executive, says the UK is the “model that the rest of the world follows” on infrastructure investment policy.

“It’s about clarity of outcome, it’s the regulatory environment,” he adds. “There’s not a lot of, or hardly any, renegotiation after a deal is done.”

But in both infrastructure and private equity, asset prices are high, as capital is flooding into what are inherently scarce assets from low-yielding public markets.

In buyouts, some question whether Teachers’ edge is simply overpaying and reducing its future returns.

Teachers’ view is that it takes a different perspective to traditional private equity firms by holding investments for the longer term.

Private equity firms can often own businesses for half a decade or more — but the limited lives of funds means they have to sell within a set period.

The nature of leverage, used to juice returns, can also make funds unwilling to inject more capital after the first investment.

“We can provide multiple subsequent rounds of capital,” Mr Taylor says. “We can hold an asset for seven, 10, 12 years . . . we look at these projects with a conservative approach. We’re more likely to apply lower levels of debt.”

In terms of Teachers’ returns, Mr Taylor says the fund has a 24-year record in private equity of 20 per cent net returns.

There is some academic evidence to back this up. In 2014 a Harvard Business School paper found ‘solo’ direct investments in private equity by seven anonymous large institutional investors returned more than public markets between 1991 and 2011.

Although these deals fared better than co-investing in companies alongside private equity managers, their outperformance versus investing in buyout funds was more mixed.

“While direct investments consistently outperform the market, they do not regularly outperform other private equity investments,” the paper argued.
This is an excellent article but let me go through some of my thoughts. First, unlike the Netherlands, there are no laws forcing public sector pension plans in Canada to be fully-funded. It's too bad because I think everyone should be going Dutch on pensions, including our much touted Canadian funds which are global trendsetters.

Second, I have mixed feelings about Canadian pension funds opening up offices in London, New York, Hong Kong or elsewhere. On the one hand, I understand why they need "boots on the ground" but is it really necessary, especially if they have solid partners in these regions to work with? I'm not convinced about opening up foreign offices and paying people a lot of money for a job that can be done by pension fund professionals in Canada working with solid partners (here I prefer PSP's approach than CPPIB's and Teachers'). But if it works and helps reduce fees, maybe there is a rationale for such an approach.

Third, while direct investments in private equity do not regularly outperform other private equity investments, more and more private and public companies are looking for a long-term partner like Ontario Teachers' when it comes to improving their operations. Even private equity funds are thinking long-term these days, emulating Buffett's approach.

But don't kid yourself. Mark Wiseman, president and CEO of CPPIB, told me a few years back that Canada's pension fund invests and co-invests with top private equity funds because he "can't afford to hire a David Bonderman." However, in infrastructure, he told me CPPIB goes direct like most of Canada's large pension funds.

Fourth, Ron Mock, the president and CEO of Ontario Teachers', sounded the alarm on alternatives in late April. He knows the current environment is extremely difficult for liquid and illiquid investments but he and his team are always on the hunt for reasonably priced prize assets, especially in infrastructure.

In fact, Ron clearly explained OTPP's asset-liability approach to investing when we chatted about the plan's exceptional 2014 results. Everything at Teachers' is about matching assets to liabilities. So, when I read that Teachers' recently bought a stake in a French funeral business, I wasn't surprised. These type of businesses aren't glamorous but they provide steady cash flows over a long period, just like infrastructure.

Let me end this comment by plugging a firm in Toronto, Caledon Capital Management. I recently met three partners -- David Rogers, Stephen Dowd and Jean Potter -- here in Montreal and was thoroughly impressed with their approach in helping small and medium sized pension plans and family offices gain a foothold in infrastructure and private equity.

Prior to founding Caledon, David was the SVP at OMERS' Private Equity and Stephen was the SVP, Infrastructure and Timberland, at Ontario Teachers' before he joined Caledon last year. Together, they have years of experience working at public pensions which gives them an advantage when they assist their clients on board investment committees, helping them invest in these alternative asset classes.

[Footnote: David Rogers is one of the nicest guys I ever met in the pension fund industry and he helped Derek Murphy, PSP's former SVP of Private Equity, and I a lot when we prepared the board presentation on private equity back in 2004. Derek, if you're reading this, contact David at

Also worth noting that Guthrie Stewart joined PSP Investments in September 2015 as Senior Vice President, Global Head of Private Investments. He will be replacing Derek Murphy in this new role and you can read about him here.]

Below, I embedded a May 2015 Bloomberg interview with Ron Mock, CEO of Ontario Teachers'. Listen carefully to his comments as you track the latest moves from this exceptional pension plan.

As always, please remember to subscribe and/ or donate to this blog via PayPal at the top right-hand side and support my efforts in bringing you the very best insights on pensions and investments. I thank all of my institutional supporters who value the work I provide them with.

Monday, September 28, 2015

A Looming Catastrophe Ahead?

Caroline Valetkevitch of Reuters reports, Wall Street braces for grim third quarter earnings season:
Wall Street is bracing for a grim earnings season, with little improvement expected anytime soon.

Analysts have been cutting projections for the third quarter, which ends on Wednesday, and beyond. If the declining projections are realized, already costly stocks could become pricier and equity investors could become even more skittish.

Forecasts for third-quarter S&P 500 earnings now call for a 3.9 percent decline from a year ago, based on Thomson Reuters data, with half of the S&P sectors estimated to post lower profits thanks to falling oil prices, a strong U.S. dollar and weak global demand.

Expectations for future quarters are falling as well. A rolling 12-month forward earnings per share forecast now stands near negative 2 percent, the lowest since late 2009, when it was down 10.1 percent, according to Thomson Reuters I/B/E/S data.

That's further reason for stock investors to worry since market multiples are still above historic levels despite the recent sell-off. Investors are inclined to pay more for companies that are showing growth in earnings and revenue.

The weak forecasts have some strategists talking about an "earnings recession," meaning two quarterly profit declines in a row, as opposed to an economic recession, in which gross domestic product falls for two straight quarters.

"Earnings recessions aren't good things. I don't care what the state of the economy is or anything else," said Michael Mullaney, chief investment officer at Fiduciary Trust Co in Boston.

The S&P 500 is down about 9 percent from its May 21 closing high, dragged down by concern over the effect of slower Chinese growth on global demand and the uncertain interest rate outlook. The low earnings outlook adds another burden.

China's weaker demand outlook has also pressured commodity prices, particularly copper.

This week, Caterpillar slashed its 2015 revenue forecast and announced job cuts of up to 10,000, among many U.S. industrial companies hit by the mining and energy downturn. Also this week, Pier 1 Imports cut its full-year earnings forecast, while Bed Bath & Beyond gave third-quarter guidance below analysts' expectations.

"We are continuing to work through the near-term issues stemming from our elevated inventory levels and have adopted a more cautious and deliberate view of the business based on our first-half trends," Jeffrey Boyer, Pier 1 chief financial officer, said in the earnings report.

On the other hand, among early reporters for the third-quarter season, Nike shares hit a record high after it reported upbeat earnings late Thursday.

Negative outlooks from S&P 500 companies for the quarter outnumber positive ones by a ratio of 3.2 to 1, above the long-term average of 2.7 to 1, Thomson Reuters data showed.

"How can we drive the market higher when all of these signals aren't showing a lot of prosperity?" said Daniel Morgan, senior portfolio manager at Synovus Trust Company in Atlanta, Georgia, who cited earnings growth as one of the drivers of the market.

To be sure, the vast majority of companies usually exceed their earnings forecasts when they report real numbers.

"This part in the earnings cycle is typically the low point for estimates," said Greg Harrison, Thomson Reuters' senior research analyst. In the first two quarters of 2015, companies went into their reporting season with analysts predicting a profit decline for the S&P 500, and in both quarters, they eked out gains instead.

In the last two weeks, analysts have dropped their third-quarter earnings predictions by about 0.3 percentage point. There was no change in estimates in the final weeks of the quarter in the first two quarters of 2015.

And companies may be snapping their streak of squeezing profits out of dismal revenues. For the first time since the second quarter of 2011, sales, seen down 3.2 percent in the third quarter from a year ago, are not projected to fall as fast as earnings. Companies have been bolstering their earnings per share figures by buying back their own shares and thus reducing their share counts, and that may happen again this quarter.


Even with the recent selloff, stocks are still expensive by some gauges. The S&P 500 index is selling at roughly 16 times its expected earnings for the next 12 months, lower than this year's peak of 17.8 but higher than the historic mean of about 15. The index would have to drop to about 1,800 to bring valuations back to the long-term range. The S&P 500 closed at 1,931.34 on Friday.

Moreover, forward and trailing price-to-earnings ratios for the S&P 500 are converging, another sign of collapsing growth expectations. The trailing P/E stands at about 16.5, Thomson Reuters data shows. Last year at this time, the forward P/E was also 16 but the trailing was 17.6.

The last period of convergence was in 2009 when earnings were declining following the financial crisis.

The 3.9 percent estimated decline in third-quarter profits - down sharply from a July 1 forecast for a 0.4 percent dip - would be the first quarterly profit decline for the S&P 500 since the third quarter of 2009.

Energy again is expected to drag down the S&P 500 third-quarter forecast the most, with an expected 64.7 percent decrease in the sector. Without the energy sector, the forecast for third-quarter earnings shows a gain of 3.7 percent.

Earnings for the commodity-sensitive materials are expected to fall 13.8 percent, while industrials' earnings are seen down 3.6 percent.
No doubt, stock market investors are bracing for an earnings recession or possibly worse. Akin Oyedele of Business Insider reports, A radical shift is coming to the markets:
The days of double-digit returns are over.

Lisa Shalett, head of investment/portfolio strategies for Morgan Stanley Wealth Management, said at a press briefing on Tuesday that since the end of the financial crisis, investors have enjoyed healthy returns on stocks and bonds, partly because of the Federal Reserve.

But that's about to change.

Shalett said:
"Over the last six and a half years, the S&P 500 has compounded roughly 15%, at the same time that the US bond market has compounded at 9% ... So if you had a balanced portfolio of stocks and bonds, you experienced superior returns, and that portfolio had double-digit returns.

Our outlook is that that balanced portfolio that delivered those double-digit returns probably over the next five to seven years is going to return something a lot closer to four to six percent. "
The Federal Reserve's bond-buying program, known as quantitative easing, together with low interest rates, made it easy for corporations to borrow money and encouraged investors seeking higher returns to invest in riskier assets like stocks.

Now that the stimulus is gone and the Fed is in a "tightening bias" — implying that even if the Fed isn't raising rates it isn't making policy any more friendly for businesses — asset prices could begin to reflect a value that is unsupported by monetary policy.
Indeed, last week was another ugly one hitting many sectors, including high-flying biotech shares which got clobbered on Friday, dragging down the Nasdaq and S&P 500.

Below, I'm going to go over a few sectors and wrap it all up at the end with some thoughts. First, let's look at some ETFs I regularly monitor (click on image):

As you can see, apart from the iPath S&P 500 VIX ST Futures ETN (VXX) and government bonds (TLT), all sectors are now in a downtrend (relative to their 200-day moving average). This doesn't portend well for the overall market and it hardly surprises me that analysts are revising down their earnings estimates as they tend to react to price action, not lead it.

Let me go over some of these sectors below, beginning with the biotech sector since it got slammed the hardest last week weighing down major indices.

Biotech: It was a bloodbath in biotech last week. The week didn't start well with Democratic candidate Hillary Clinton crushing biotech stocks after tweeting  she promised to unveil a plan on Tuesday to take on "outrageous" price increases, referring to this New York Times article.

If you ask me, after hearing her speak, that was much ado about nothing. Still, biotech shares kept getting slammed and it was particularly ugly on Friday afternoon as I watched over 200 biotech shares getting clobbered. Below, I provide you with a list of some of the hardest hit biotech stocks as of Friday (click on image):

Interestingly, among the biggest movers on Friday were two biotech stocks, Bellerophon Therapeutics (BLPH) and Prima Biomed (PBMD) and the short biotech ETFs, namely, the ProShares UltraPro Short Nasdaq Biotech (ZBIO), ProShares UltraShort Nasdaq Biotech (BIS)
and the Direxion Daily S&P Biotech Bear 3X ETF (LABD).

There were plenty of bearish articles pointing out that biotech stocks have fallen into bear market territory as the Nasdaq Biotechnology Index is down more than 22% from its peak in July. The decline is roughly double the losses of the S&P 500 and the Nasdaq over the same period.

If you look at the chart of the Nasdaq Biotechnology Index (IBB), you will see how after it hit an intra-day low of 284 a month ago, it surged higher to its 50-day moving average and then started sinking again, going below its 200-day moving average and it might even go below its 400-day moving average this week which I use to gauge the longer trend (click on chart):

The huge drop in biotech shares is also weighing down the Health Care Select Sector SPDR ETF (XLV) which was one of the outperformers this year but is now in bear territory (click on image):

Despite the vicious selloff, I'm sticking with my call from a month ago, namely that now is the time to load up on biotech. However, I'm looking at that 284 low the biotech index made a month ago and I realize this sector is extremely volatile especially in these Risk On/ Risk Off markets dominated by algorithmic trading (Cramer was right, China could cause biotech stocks to plunge) .

Still, if you ask me, in a deflationary environment, there's a lot more risk in energy and commodity stocks than biotech stocks and even though it's counterintuitive, I'm more comfortable buying the big dips in biotech than bottom fishing in energy and commodities. Despite huge volatility, the former sector is still in a secular bull market while the latter two are already in a deep bear market.

Energy, commodities and emerging markets: These sectors are all inter-related and it's pretty much a China story. Regular readers of my blog know I'm not bullish on emerging markets (EEM), Chinese shares (FXI), energy (XLE), oil services (OIH), metal and mining stocks (XME) and have warned my readers that despite counter-trend rallies, they are better off steering clear of these sectors.

Have a look at the charts of these below which paint an ugly picture as most are already in a deep bear market (click on images).

Emerging Markets (EEM)

iShares China Large-Cap (FXI)

Energy Select Sector SPDR ETF (XLE)

Market Vectors Oil Services ETF (OIH)

SPDR S&P Metals and Mining ETF (XME)

As bad as these charts look, there are plenty of investors betting big on a global recovery. Over the weekend, I read that hedge funds are primed for an oil rebound, increasing their bullish bets. If I were them, I'd pay close attention to what Pierre Andurand is saying as he sees crude prices falling below $30 a barrel.

And if you look at the stocks I posted in my comment on betting big on a global recovery, you will see most keep making new 52-week lows (click on image):

This is why I keep telling you it's better to wait for a turnaround in global PMIs before you stick your neck out and bottom fish in these sectors. If the global economy, especially China, starts showing signs of a turnaround, you will see a major countertrend rally in all these sectors.

Industrials: This sector is also related to China and others mentioned above. In an ominous sign of the times, Caterpillar Inc. (CAT) slashed its 2015 revenue forecast last Thursday and said it will cut as many as 10,000 jobs through 2018, joining a list of big U.S. industrial companies grappling with the mining and energy downturn.

Have a look at the charts of  Caterpillar Inc. and the Industrial Select Sector SPDR ETF (XLI) below and you will see pretty much the same weakness as the sectors above (click on images):

Financials: Interestingly, financial shares (XLF) fared pretty well last week, especially on Friday following news that the Fed might raise rates but on Monday they resumed their downturn and the way markets are heading, I strongly doubt we will see a Fed increase this year which is why I see continued weakness in this sector (click on image):

Related to financials is the retail sector (XRT) which remains relatively weak as most consumers are debt-constrained and petrified of losing their job, putting off spending (click on image):

There is one bright spot for financials, however, and that is housing. If you look at the SPDR S&P Homebuilders ETF (XHB), you will see it's holding up relatively well (click on image):

But Wall Street's big bet on housing isn't paying off and this sector is vulnerable to a rate increase and more importantly, to rising unemployment. So far, the U.S. economy is doing relatively well but that can all change abruptly, especially if we get a market crash.

[Update: The SPDR S&P Homebuilders ETF (XHB) is down almost 5% on Monday after pending home sales tumbled in August.]

Utilities, REITS and dividend yielding sectors: These sectors are sensitive to interest rates and tend to do well as long as the Fed stays put. But even their chats don't inspire much confidence in these markets and they are vulnerable to any good news on the global economic front (click on charts).

As you can see, consumer staples (third chart; ticker is XLP) are doing relatively well in a tough market but in my opinion, this is more of a Risk Off and flight to safety trade than conviction buying.

Bonds: Good old government bonds (TLT) continue to do relatively well and provide investors with the ultimate hedge against deflation and the ravages of markets (click on chart):

What isn't doing well is the high-yield corporate bond market (HYG) and that concerns many investors, including the bond king, Jeffrey Gundlach who has warned the Fed to stay put as long as the junk bond market remains weak (click on image):

Gold will shine again?: If you've been reading Zero Hedge and firmly believe the world is coming to an end and that we're heading to "QE Infinity", then now might be a good time to load up on gold shares (GLD). But I'm not in that camp and think that the latest rally in gold will peter out again once markets stabilize following some good economic news (click on chart):

In fact, as you watch all the gloom and doomers parading on television, pay close attention to this chart on volatility (VXX) below as I think we're in for a bit more pain but things will reverse course fast once it hits its 400-day moving average (click on image):

Conveniently and not surprisingly, this selloff is happening at quarter-end. I would be very careful here not to overreact to what's going on in markets, especially in extremely volatile sectors like biotech which experience sharp selloffs followed by huge rallies.

In the short-run, I expect to see a rally in the S&P 500 (SPY) right back up to its 400-day moving average (click on image):

Whether or not it goes higher remains to be seen as the overall market is weak and there's a risk we will see a major bear market if things go awry from here on.

Below, CNBC's Scott Wapner reports on billionaire investor Carl Icahn's warning of a potential looming catastrophe. Wapner shows an extract of the video going over 5 things that keep Carl Icahn up at night (second clip).

Icahn also spoke with Andy Serwer of Yahoo Finance stating it's going to be a real bloodbath and going over a policy paper on income inequality that the billionaire financier recently sent to Donald Trump and others on Wall Street and in Washington.

In the paper, Icahn warns of “dangerous systemic problems that will affect each and every American in the coming years.” The five and a half page paper has some similarities to the video that Icahn is releasing on, but focuses more on imbalances in our society.

While I agree with Icahn on the buyback bubble exacerbating inequality, take these ominous warnings on markets by hedge fund gurus with a shaker of salt and pay attention to their portfolios, not what they're warning of on CNBC. Icahn is betting big on a global recovery and he's right to hedge as he's losing his shirt on energy and commodity shares.

Hope you enjoyed reading this comment and remember to always breathe in from your nose and out from your mouth when dealing with anxiety from these Risk On/ Risk Off markets. Also, please remember to support my efforts in bringing you the very best insights on pensions and investments via a donation or subscription on the PayPal buttons at the top right-hand side. Thank you!!

Friday, September 25, 2015

The End Of The Deflation Supercycle?

Ambrose Evans-Pritchard of the Telegraph reports, The world economy as we know it is about to be turned on its head (click on images to enlarge):
Workers of the world are about to get their revenge. Owners of capital will have to make do with a shrinking slice of the cake.

The powerful social forces that have flooded the global economy with abundant labour for the past four decades years are reversing suddenly, spelling the end of the deflationary super-cycle and the era of zero interest rates.

"We are at a sharp inflexion point," says Charles Goodhart, a professor at the London School of Economics and a former top official at the Bank of England.

As cheap labour dries up and savings fall, real interest rates will climb from sub-zero levels back to their historic norm of 2.75pc to 3pc, or even higher.

The implications are ominous for long-term US Treasuries, Gilts or Bunds. The whole structure of the global bond market is a based on false anthropology.

Prof Goodhart says the coming era of labour scarcity will shift the balance of power from employers to workers, pushing up wages. It will roll back the corrosive inequality that has built up within countries across the globe.

If he is right, events will soon discredit the sweeping neo-Marxist claims of Thomas Piketty, the best-selling French economist who vaulted to stardom last year.

Mr Piketty's unlikely bestseller - Capital in the 21st Century - alleged that the return on capital outpaces the growth of the economy over time, leading ineluctably to greater concentrations of wealth in an unfettered market system. "Piketty was wrong," said Prof Goodhart.

What in reality happened is that the twin effects of plummeting birth rates and longer life spans from 1970 onwards led to a demographic "sweet spot", a one-off episode that temporarily distorted labour economics.

Prof Goodhart and Manoj Pradhan argue in a paper for Morgan Stanley that this was made even sweeter by the collapse of the Soviet Union and China's spectacular entry into the global trading system.

The working age cohort was 685m in the developed world in 1990. China and eastern Europe added a further 820m, more than doubling the work pool of the globalised market in the blink of an eye.

"It was the biggest 'positive labour shock' the world has ever seen. It is what led to 25 years of wage stagnation," said Prof Goodhart, speaking at a forum held by Lombard Street Research.

We all know what happened. Multinationals seized on the world's reserve army of cheap leader. Those American companies that did not relocate plant to China itself were able play off Chinese wages against US workers at home, exploiting "labour arbitrage". US corporate profits after tax are now 10pc of GDP, twice their historic average and a post-war high.

It was much the same story in Europe. Volkswagen openly threatened to shift production to Poland in 2004 unless German workers swallowed a wage freeze and longer hours, tantamount to a pay cut. IG Metall bowed bitterly to the inevitable.

Cheap labour held down global costs and prices. China compounded the effect with a factory blitz - on subsidised credit - that pushed investment to a world record 48pc of GDP and flooded markets with cheap goods - first clothes, shoes and furniture, and then steel, ships, chemicals, mobiles and solar panels.

Lulled by low consumer price inflation, central banks let rip with loose money - long before the Lehman crisis - leading to even lower real interest rates and asset bubbles. The rich got richer.


This era is now history. Wages in China are no longer cheap after rising at an average rate of 16pc for a decade.

The yuan is overvalued. It has appreciated 22pc in trade-weighted terms since mid-2012, when Japan kicked off Asia's currency war. Panasonic is switching production of microwaves from China back to Japan.

But the underlying causes of the deflationary era run deeper. The world fertility rate has steadily declined to 2.43 births per woman from 4.85 in 1970 , with a precipitous collapse over the past 20 years in east Asia.

The latest estimates are: India (2.5), France (2.1), US (two), UK (1.9), Brazil (1.8), Russia and Canada (1.6), China (1.55), Spain (1.5) Germany, Italy, and Japan (1.4), Poland (1.3) Korea (1.25), and Singapore (0.8). As a rule of thumb, it takes 2.1 to keep the population on an even keel.

The numbers of working-age rose sharply relative to children and - for a while - the elderly. The world dependency ratio dropped from 0.75 in 1970 to 0.5 last year. This was the sweet spot.

"We are on the cusp of a complete reversal. Labour will be in increasingly short supply. Companies have been making pots of money but life isn't going to be so cosy for them anymore," said Prof Goodhart.

The dependency ratio has already bottomed out in the rich countries. It is now rising far more quickly than it fell as baby boomers retire and people live much longer.

China will face a double hit, thanks to the legacy effects of the one-child policy. "They kept it going 15 years too long, disastrously," said Prof Goodhart. China's workforce is already shrinking by 3m a year.

It is widely assumed that the demographic crunch will pull the world deeper into deflation, chiefly because that is what has happened to Japan - probably for unique reasons - since it pioneered mass dotage 20 years ago.

The Goodhart paper makes the opposite case. Healthcare and ageing costs will drive fiscal expansion, while scarce labour will set off a bidding war for workers, all spiced by a state of latent social warfare between the generations. "We are going back to an inflationary world," he said.

China will no longer flood the world with excess savings. The elderly will have to draw down on their reserves. Companies will have to invest again in labour-saving technology, putting their great stash of idle money to work.

We will see a reversal of the forces that have pushed the world savings rate to a record 25pc of GDP and created a vast pool of capital spilling into asset booms everywhere, even as the global economy languishes in a trade depression.

The "equilibrium rate" of real interest will return to normal and we can all stop talking about "secular stagnation". Central banks can stop fretting about the horrors of life at the "zero lower bound" (ZLB), and they are certainly fretting right now.

The Bank of England's chief economist, Andrew Haldane, warned in a haunting speech last week that we may be stuck in a zero-interest trap for as far as the eye can see, with little left to fight the next downturn - typically requiring three to five percentage points of rate cuts to right the ship.

"Central banks may find themselves bumping up against the ZLB constraint on a recurrent basis," he said. His answer is a menu of quantitative easing so exotic it trumps Corbynomics for heterodoxy.

Professor Goodhart makes large assumptions. He doubts that robots will displace workers fast enough to offset the labour shortage, or that greying nations are culturally able to absorb enough immigrants to plug the jobs gap, or that India and Africa have the infrastructure to repeat the "China effect".

The world has never faced an ageing epidemic before so we are in uncharted waters. What is clear is that the near vertical take-off of the dependency ratio is about to shatter all our economic assumptions.

The last time Europe's serfs suddenly found themselves in huge demand was after the Black Death in the mid-14th century. They say it ended feudalism.
This is a great article for deflationistas like me who think the world is heading into a prolonged period of global deflation. I like being challenged so I welcome these views from professor Goodhart and Manoj Pradhan.

Unfortunately, while talk of the end of the deflationary supercycle and revenge of labor sounds fantastic, workers of the world shouldn't unite and rejoice just yet as the shift discussed above, if it materializes accordingly, will take decades and there are plenty of pitfalls that can arise along the way.

For the foreseeable future the global economy is mired in deflation. The Financial Times reports that Japan has fallen back into deflation for the first time since April 2013 in a symbolic blow to prime minister Shinzo Abe’s economic stimulus program.

Andrew Sheng and Xiao Geng wrote an excellent comment for Project Syndicate explaining why China now faces the same debt-deflation challenge that much of the rest of the world must address. the authors end on this cautionary note:
The advanced countries have fallen into the debt-deflation trap because they were unwilling to accept the political pain of real-sector restructuring, relying instead on financial engineering and loose monetary and fiscal policies. Here, China’s one-party system provides a clear advantage: the country’s leaders can take politically painful decisions without worrying about the next election. One hopes that they do.
But I'm not sure Chinese leaders are willing to take politically painful decisions and judging by their response after the bursting of the China bubble, including using the country's pension fund to bolster the plunging stock market and devaluing the yuan, I worry that the response from China's leaders will be similar to that of leaders from advanced countries (ie. extend and pretend). 

The slowdown in China is wreaking havoc on commodity-exporting nations and the world economy. It's also influencing monetary policy around the world, including in the United States where there's a sea change going on at the Federal Reserve

In fact, too many analysts are underestimating China's deflation threat, much to their demise. Already you have retail giants like Wal Mart (WMT) putting the squeeze on their Chinese suppliers to lower prices of the goods they're offering and no doubt other global companies are doing the exact same thing. This is all stoking fears of deflation.

No wonder the European Central Bank will likely increase its quantitative easing program following a report which shows that efforts to bring inflation levels up in Europe may be failing. Europe is still a structural mess but the decline of the euro will help bolster growth temporarily.

Finally, there's the United States, the last bastion of global growth. While many hailed the August jobs report as unemployment fell to 5.1%, the lowest rate in more than seven years, the reality is wage growth remains slight and millions remain relegated to the sidelines of the job market.

This is the new normal folks. Get used to lower growth around the world and take all this talk of the end of the deflation supercycle with a shaker of salt. The global economy is sick and will remain weak for a very long time even if there are cyclical spurts of growth along the way.

Below, Albert Lu of the Power & Market Report welcomes Michael Pento, the founder and president of Pento Portfolio Strategies and author of The Coming Bond Market Collapse. I obviously don't agree with Pento and other bond market bears but it's worth listening to his views.

I wish you all a great weekend and remind you to please subscribe or donate to my blog at the top right-hand side and support my efforts in bringing you the very best insights on pensions and investments.

Thursday, September 24, 2015

Sea Change At The Fed?

Mary Childs of Bloomberg reports, Gross Tells Fed to `Get Off Zero Now!' as Economies Run on Empty:
Bill Gross said the Federal Reserve needs to raise interest rates as soon as possible, trading some near-term market losses for longer-term stability and a healthier financial system.

If zero interest rates become the long-term norm, economic participants will soon run on empty because their investments aren’t producing the gains or cash flow needed to finance past promises in an aging society, he wrote in an investment outlook on Wednesday for Denver-based Janus Capital Group Inc. That’s already beginning to happen as Detroit, Puerto Rico, and, he predicts, soon Chicago, struggle to meet their liabilities.

“My advice to them is this: get off zero and get off quick,” Gross urged the central bankers. He said it’s time for a “new thesis” that allows people in developed economies to save, enabling liability-based business models to survive and spurring more private investment, “which is the essence of a healthy economy. Near term pain? Yes. Long term gain? Almost certainly. Get off zero now!”

The Fed last week decided to keep its benchmark rate near zero, showing reluctance to end an era of record monetary stimulus in a time of market turmoil, rising international risks and slow inflation at home. Futures traders are betting the Fed is unlikely to act in October, as they put 43 percent odds on an increase by December and 51 percent by January, according to data compiled by Bloomberg.

‘Wreak Havoc’

Last week, Gross said the Fed was right to keep interest rates near zero at the September meeting, and that it may take years for the economy and rates to return to more normal levels. Monetary policy has exhausted its effectiveness, with asset prices distorted by years of near-zero rates, and fiscal policy will be needed to get the economy back on stronger footing, Gross said in a Sept. 18 interview with Tom Keene and Michael McKee on Bloomberg Radio.

“They did the right thing,” he said in that interview, citing current financial conditions. “When they did the wrong thing, and this is way back in terms of past history, they went below 2 percent in terms of the short-term rate. They didn’t have to do that, they didn’t have to go to zero. So now getting back up there will wreak havoc on asset markets.”

Gross, 71, joined Janus about a year ago after leaving Pacific Investment Management Co., where he once ran the world’s biggest mutual fund. He now oversees the $1.4 billion Janus Global Unconstrained Bond Fund. The fund lost 1.7 percent this year, putting it behind 76 percent of similar funds, according to data compiled by Bloomberg.

‘Revolving Spit’

Gross underscored that it’s not just insurance companies and giant pension funds that are suffering from low interest rates. Investors aren’t getting the 8 percent to 10 percent returns they counted on to pay for education, health care, retirement or vacation.

“Mainstream America with their 401(k)s are in a similar pickle,” he wrote. “They are not so much in a pickle barrel as they are on a revolving spit, being slowly cooked alive while central bankers focus on their Taylor models and fight non-existent inflation,” Gross said, referring to a rule named for Stanford University economist John Taylor.

Fellow famed bond manager Jeffrey Gundlach, co-founder of $80 billion DoubleLine Capital, sees a fifty-fifty chance the Fed will raise interest rates in December. Gundlach forecast “choppiness” in fixed-income markets, though he said yields won’t actually change much. Los Angeles-based Gundlach has been saying for months that the Fed may not be able to raise rates this year for reasons including a strong dollar.
Bill Gross is right about mainstream America where the 401(k) nightmare continues. In fact, if you ask me, it's time to declare the 401(k) experiment a failure and realize the United States of pension poverty needs to come to grips with the brutal truth on DC plans. Now more than ever, the U.S. needs to implement radically new retirement policies that enhance Social Security and are modeled after the Canada Pension Plan and the Dutch pension model.

But is Gross right about the Fed needing to move off zero rates now? Here I'm perplexed as he recently warned that the global economy is "dangerously close" to becoming a "deflationary world" and raised alarm over weakness in emerging market currencies and commodity prices.

In other words, Gross agrees with me that the Fed has a deflation problem, especially after China's Big Bang, and can ill-afford to raise rates and watch the mighty greenback surge higher stoking more fears of deflation and raising the specter that it eventually comes to America.

So why is Gross pressing the point for the Fed to move off zero now if he's warning the world is perilously close to deflation? I think he sees that zero rates have been a boon for overpaid hedge fund managers borrowing on the cheap and leveraging up their stock and bond investments as well as corporations on a buyback binge, but they haven't helped regular people struggling to find work and save for their retirement.

In other words, the Fed's zero interest rate policy (ZIRP) is exacerbating inequality which is deflationary. Worse still, by maintaining rates at zero, some argue the Fed is introducing more uncertainty into the financial system and reinforcing a deflationary mindset that can that easily devolve into a dangerous deflation trap.

While I'm sympathetic to these concerns, I agree with Jeffrey Gundlach who recently stated on CNBC the Fed shouldn't raise interest rates and if it does, it will introduce more uncertainty in the financial system. Gundlach is worried about the high-yield corporate bond market (HYG) and for good reason, he sees it as a leading indicator for risk assets and thinks it will head lower if the Fed hikes rates (click on image):

But apart from the junk bond market, I think the Fed made the right call last week because it's rightfully concerned of global economic weakness spreading to the U.S., especially now that inflation expectations are so low. As Lawrence Lewitinn of Yahoo reports, this shift from domestic to international focus represents something huge from the Fed:
The Federal Reserve hasn’t raised rates in 9 years, but its latest reasons why may indicate a shift in how the Fed makes decisions.

Last week, the Federal Open Market Committee decided to keep the federal funds rate between 0% and 0.25%. When issuing its latest statement after its meeting, the Fed said its assessment took into account unemployment and inflation, the bank’s two stated mandates. But a third factor was also mentioned: “readings on financial and international developments."

This indicates a sea change in the Fed’s policy motivations, according to Ira Jersey, senior client portfolio manager at OppenheimerFunds.

“The acknowledgement that the Federal Reserve is going to be looking at things like global deflation and a slowdown in the global economy is a big deal,” said Jersey. “U.S. data is actually holding up reasonably well. But with the market volatility and the slowdown of emerging economies, they’re really concerned about that.”

The recent shakeup in China’s markets after fears the country’s growth may slowdown took its toll on U.S. financial markets. The Shanghai Composite index has plunged 37% since its mid-June record highs while the S&P 500 is off by 6% during that same time frame. Jersey said the Fed has grown worried about the impact on the overall U.S. economy.

“Just in June, you only had two members of the Federal Open Market Committee saying that they wanted to see hikes in 2016,” he said. “Now you have four members who think that they should be hiking only in 2016 or later. It’s hard to see what’s going to change over the next couple of months that is going to convince them that it’s actually time to hike without any significantly detrimental affects on the U.S. economy or market.”

By holding off on a rate hike, the Fed also made it easier for other central banks to take on their own monetary stimulus measures, Jersey added. It may relieve some of their concerns that capital could flee out of flagging economies and into the U.S. with its relatively higher rates.

“If the ECB were considering extending their own quantitative easing program beyond 2016, this would be an opportunity for them to do that,” said Jersey. “Other central banks like the People’s Bank of China or even the Bank of Japan could also potentially come up with additional easing mechanisms without having to worry too much about their currency really devaluing a lot against the dollar.”

Lower U.S. rates also makes slightly riskier American assets more attractive by keeping the hurdle fairly low. Jersey expects that to continue.

“Once it becomes common consensus that the Fed is going to be very, very slow once they do hike sometime, ultimately equities and corporate bonds can do very well in that environment,” he said.
I agree with Jersey, there's a sea change going on at the Fed and this isn't necessarily a bad thing given the world is perilously close to global deflation. If the Fed holds off a bit longer, allowing other central banks to keep pumping liquidity into their financial system, then those betting big on a global recovery might turn out to be right (so far, it's been painful). 

Conversely, if the Fed hikes rates too soon, ignoring the dire warning of the bond king, it will be making a monumental mistake which is why Ray Dalio is worried about the next downturn and why Harvard's endowment is warning of market froth.

Below, take the time to listen to Ira Jersey, senior client portfolio manager at OppenheimerFunds, discussing a sea change in the Fed’s policy motivations.

Update: Bloomberg reports Federal Reserve Chair Janet Yellen said the U.S. central bank is on track to raise interest rates this year, even as she acknowledged that economic “surprises” could lead them to change that plan:
“Most FOMC participants, including myself, currently anticipate that achieving these conditions will likely entail an initial increase in the federal funds rate later this year, followed by a gradual pace of tightening thereafter,” Yellen said during a speech Thursday in Amherst, Massachusetts. “But if the economy surprises us, our judgments about appropriate monetary policy will change.”

Yellen, 69, spoke a week after the Federal Open Market Committee left its benchmark federal funds target near zero, saying "recent global economic and financial developments" might damp growth and inflation in the U.S. Concerns over a slowdown in China following a surprise Aug. 11 devaluation of the yuan triggered turmoil in financial markets and raised questions about the outlook for the global economy.

While “there wasn’t anything significant enough that changed in one week for her to give us a different take,” said Tom Porcelli, chief U.S. economist at RBC Capital Markets LLC in New York, Yellen “finally acknowledges that she, specifically, does believe that a rate hike is appropriate this year.”

Porcelli expects a December increase, but thinks there’s a high hurdle to moving this year.

Slower demand from China, where growth is projected to drop below 7 percent this year, has helped push down commodity prices, sapping already low inflation in the U.S. The Fed’s preferred gauge of price pressures rose 0.3 percent in the year through July and has been under its 2 percent target since April 2008.
We'll see if global economic conditions improve enough to warrant a rate hike this year. I remain skeptical but if global PMIs come in stronger than expected, the Fed will likely move.

As for Fed Chair Yellen, I hope she's feeling better on Friday as she paused a few times during her speech in Amherst, Massachusetts on Thursday (see below, h/t Zero Hedge).  The 69-year-old Fed chief got medical attention after struggling with her speech and was said to be dehydrated and exhausted after speaking for nearly an hour before a packed university auditorium.

Wednesday, September 23, 2015

Harvard Endowment Warns of Market Froth?

Stephen Foley of the Financial Times reports, Harvard endowment warns of market ‘froth’:
Harvard is looking for investment managers with expertise as short-sellers, as the world's biggest university endowment becomes more cautious about the outlook for financial markets.

In its latest annual report, which showed investment returns fell to 5.8 per cent in the year to June, the $38 billion endowment said its managers had started to increase cash holdings and feared that some markets had become "frothy"."We are proceeding with caution in several areas of the portfolio," Harvard Management Company chief executive Stephen Blyth wrote in the report.

"We are being particularly discriminating about underwriting and return assumptions given current valuations.

"In addition, we have renewed focus on identifying public equity managers with demonstrable investment expertise on both the long and short sides of the market."

Mr Blyth, a British-born statistician, was promoted to run the endowment last year after the resignation of Jane Mendillo, whose returns failed to keep pace with those at other Ivy League institutions.

Mr Blyth unveiled an overhaul of Harvard's asset allocation process which is likely to be examined widely among other institutions.

Endowments such as those at Harvard, and particularly Yale under its chief investment officer David Swensen, have been seen as pioneers in asset allocation and portfolio management theory.

Harvard is ditching its traditional approach of assessing the likely risk and return of each separate asset class and instead focusing on five key factors: the outlook for global equities, US Treasuries, currencies, inflation and high-yield credit.

The result is that Mr Blyth will be sharply scaling back the university's holdings of overseas equities, dialing up real estate and bond investments, and giving himself more flexibility.

He set out a new promise to beat inflation by 5 per cent a year over 10 years.

The 5.8 per cent gain for the Harvard endowment in the year to June 30 compared with 15.4 per cent the previous year, when global equity markets were rising more sharply.

Its $6 billion allocation to hedge funds also held back performance, returning only 0.1 per cent.

While disappointing hedge fund performance has led some big institutions, including the California public pension fund Calpers, to pull out of the sector all together, Harvard is understood to be happy with its hedge fund portfolio, which outperformed its benchmark in the five previous years.

The endowment's real estate portfolio was its top performing asset, up 19.4 per cent last year.
So, Mr. Blyth will scale back the endowment's holdings of overseas equities but dial up real estate and bond investments and is giving himself more flexibility.

Interestingly, the real estate portfolio was the endowment's top performing asset, up 19.4 per cent last year, which makes me wonder if there's a performance bias attached to the decision to dial up this asset class while other big investors are dialing down real estate risk.

Mr. Blyth should go back to read David Swensen's thoughts on real estate in his seminal book, Pioneering Portfolio Management: An Unconventional Approach to Institutional Investment (page 116; added emphasis is mine):
"Real estate markets provide dramatically cyclical returns. Looking in the rear-view mirror in the late 1980s, investors generated wild enthusiasm for real estate as historical statistics dominated numbers for traditional stocks and bonds. A few years later, after the market collapse, those same investors saw nothing other than dismal prospects for real estate. poor returns nearly eliminated interest in real estate as an institutional investment asset. Reality lies somewhere between the extremes of wild enthusiasm and despair."
It's worth noting that Harvard's endowment may have hit record assets but as Geraldine Fabrikant of the New York Times reports, its performance is hardly exceptional and it's lagging its peers:
The Harvard University Management Company, which oversees an endowment of $37.6 billion, the academic world’s largest, generated a 5.8 percent return for its most recent fiscal year, significantly lower than several of its rivals.

The return, for the year that ended June 30, beats the preliminary 5.6 percent figure that Cambridge Associates released as the average for endowments over $3 billion that it tracks.

Still, “the Harvard result was disappointing,” said Charles Skorina, owner of a company that recruits chief investment officers for endowments.

Mr. Skorina noted that Harvard had consistently underperformed its rivals over the last few years despite having one of the biggest and most expensive endowment offices.

While Harvard’s biggest rivals in the universe of large endowments — including Princeton and Yale — have yet to release their returns, several people in the endowment sector said that those schools were all expected to release results of well over 10 percent. The people spoke on the condition of anonymity.

Massachusetts Institute of Technology, for example, just reported a 13.2 percent return. Bowdoin College, a far smaller school with a $1.3 billion endowment, this week reported returns of 14.6 percent.

Still, results varied widely. The University of Texas Management, which has $26.6 billion to manage, reported that it had a weighted 3.5 percent return for its two funds.

Weak returns in the market are expected to depress investment performance at schools where portfolios are limited to stocks and bonds. But schools such as Harvard have access to a range of alternative investments such as private equity, hedge funds and real estate.

In the last fiscal year, private equity and real estate fared particularly well. Although Harvard did not disclose its asset allocation in its most recent report, it had roughly 20 percent of its assets in private equity in the 2014 fiscal year; Yale, by contrast, had about 33 percent of assets in that sector. Harvard’s decision not to provide its asset allocation numbers made it harder to evaluate the impact of allocation decisions on performance.

And although Harvard outperformed the internal benchmarks it sets for itself in all but the “absolute” or hedge fund category, the outperformance may not necessarily have been as impressive as those at other endowments. There were, however, some savvy moves, such as eliminating investment in commodity indexes when such investments were posting steep declines.

Endowment performance is crucial at all colleges because a portion of the returns are used to finance their annual budgets. Harvard relies on the endowment for roughly 35 percent of its yearly expenses.

Still the Harvard endowment’s leadership team has had a lot of turnover ever since Jack Meyer stepped down as its head in 2005. Harvard had — and continues to have — a strategy in which a portion of its money is managed internally and a portion is managed externally by investment firms including hedge funds. It is the only large university to use such an approach. Most endowment chiefs allocate the school’s funds to outside managers.

Before Mr. Meyer’s departure, some members of the Harvard faculty had complained that money managers who worked at the Harvard Management Company were paid enormous sums of money compared with academics. The negative publicity was said to be a factor in Mr. Meyer’s decision to leave, despite a stunning record. He was replaced first by Mohamed El-Erian who had been at Pimco. Mr. El-Erian left in 2007 to return to that firm.

He was followed by Jane Mendillo, who had once worked at Harvard and then ran the endowment for Wellesley College, but she quit in 2014 after returns proved disappointing.

She has since been replaced by Stephen Blyth, who was promoted to president and chief executive after many years at the endowment firm. Mr. Blyth had previously held posts as head of internal management and public markets.

In a long letter released with the performance figures, Mr. Blyth signaled that he intended to keep with Harvard’s history of managing some of its money internally, but he suggested that he would make changes.

For example, he wrote that he would aim to have his internal money managers work more closely with one another by tying their compensation not just to the assets each one managed but also how the endowment as a whole performed.

Still, Harvard may not pay the same sums as private firms, which could lead to difficulties in attracting and keeping talent.
You can read Mr. Blyth's long letter here. I think his proposed changes to the way managers are compensated is right on the money and here he's following the compensation model many large Canadian pension funds have successfully implemented.

Below are two figures I want to bring to your attention from HMC's Annual Report (click on image):

Sure, rich universities have the mother of all tax breaks but every single investment fund should post these figures. You will notice the standard deviation of fiscal year endowment returns in Figure 1 is 12.5%, which is a bit high but mostly owing to risks the endowment takes to achieve its return objective.

More importantly, the long-term performance (ten and twenty years) over the domestic and global 60/40 stock-bond portfolios in the second figure is what ultimately matters and it's stellar (provided these returns are net of all fees and internal costs).

While HCM seems satisfied with their hedge funds, the truth is small and large hedge funds took a beating this summer but the former were better able to navigate through this turbulence.

As far as HMC's warning of market froth, I would agree that all assets are priced richly but some investors are betting big on a global recovery while others are warning of more pain ahead.

You already know my thoughts. I'm preparing for a long period of global deflation but in the meantime there's plenty of liquidity in the global financial system to propel risk assets much higher. In the current environment, I continue to steer clear of energy (XLE), oil services (OIH) and metal and mining stocks (XME) and anything related to emerging markets (EEM) and Chinese shares (FXI).

In fact, check out the price destruction in the stocks I covered in my comment on betting big on a global recovery, it's just brutal (click on image):

On the long side, I still like tech (QQQ), especially biotech (IBB, XBI and SBIO) and keep tracking what top funds are investing in. For example, today I noticed shares of Heron Therapeutics (HRTX) popped 20% after the company announced positive results from its Phase 2 clinical study of HTX-011 in the management of post-operative pain in patients undergoing bunionectomy (click on image).

And who are the top holders of Heron Therapeutics? Who else? The Baker Brothers, Fidelity, Broadfin, Tang Capital Management, ie. the very best biotech funds. This is why I tell you to pick your spots carefully when investing in single biotech names, diversify and focus on companies where you see many top biotech funds investing at the same time.

Still, investing in biotech isn't for the faint of heart and as I warned you in my comment on time to load up on biotech, it will be extremely volatile. Earlier this week, a tweet by Democratic candidate Hillary Clinton sent biotech shares plunging. It was much ado about nothing and she was right to blast the CEO of that drug company for price gouging.

Below, CNBC's Meg Tirrell interviews Martin Shkreli, Turing Pharma founder & CEO who explains the spike. After public outcry, Shkreli backtracked and said on Tuesday he will lower the cost of the life-saving medication (controversy follows this guy).

In the third clip below, Tirrell summarizes Hillary Clinton's statements on rising prescription drug prices. Listen carefully to Clinton's comments, she's hardly proposing anything radical and hasn't dissuaded me from holding on to my biotech stocks.