Outlook 2017: The Reflation Chimera?
Texan hedge fund manager J. Kyle Bass, the founder of Hayman Capital, says that global markets are at the “beginning of a tectonic shift.”Back in October, Bass warned that stagflation is coming in 2017:
“Today, global markets are at the beginning of a tectonic shift from deflationary expectations to reflationary expectations. What happens to economies at maximum leverage when interest rates begin to rise? Reconciling the potent strengths of the world’s largest economies with their inherent weaknesses has revealed various investable anomalies. The enormity of the apparent disequilibrium is breathtaking, making today a tremendous time to invest,” Bass wrote in a year-end letter to investors seen by Yahoo Finance.
He added: “One opportunity in particular has the greatest risk-reward profile we have ever encountered in our decade of being a fiduciary.”
He didn’t provide specifics about the opportunity in the letter.
On Tuesday, Hayman launched its third Asia-focused fund, which is “designed to provide investors with nuanced access to perhaps one of the largest imbalances in financial markets history.”
The first Asia-focused fund was the Japan Macro Opportunities Fund, which returned capital to investors after the Japanese yen depreciated 40% from 2012 to 2015. The second Asia-focused fund was the Hayman China Opportunities Fund, which launched in July.
Bass had a knockout 2016, with Hayman Capital’s Master Fund finishing the year with an estimated net-performance of 24.83%, according to the letter. This compares to the S&P 500, which was up a modest 9%.
Meanwhile, the average macro hedge fund returned 0.28% through the end of November, according to HFR. Since Hayman’s inception in 2006, the fund has returned 436.75% and an annualized return of 16.7%.
2016 got off to a rough start for many investors. At the time, Bass returned to his core competency — global macro investing. In the letter, he noted that he expects the next few years to be the best years for macro since the late 1990s.
“We reorganized our portfolio to invest in the macro themes that began to reveal themselves early in the year. Exploiting our reflationary view, we invested in global interest rate markets, currencies, and commodities across the world,” he wrote in the letter.
A number of macro fund managers have voiced concerns about central banks distorting markets with extraordinary monetary policy. This had made macro investing particularly challenging.
“Over the past several years, economic gravity has been pulling one way and central banks have been using aggressive monetary policy to pull the other. Investing in macro, while this phenomenon has existed, has been difficult to say the least,” Bass wrote, adding, “From here-on, we expect to encounter significant changes in global fiscal policies along with a continuation of the upward movement of general price levels for consumers and producers alike.”
Bass has been making a huge bet against China’s “recklessly built” banking system. Back in February, Bass unveiled his case in an investor letter entitled “The $34 Trillion Experiment: China’s Banking System and the World’s Largest Macro Imbalance.”
Bass, who gained notoriety for correctly betting against the US subprime crisis, wrote at the time that similar to the US banking system, China’s banking system has “increasingly pursued excess leverage, regulatory arbitrage, and irresponsible risk taking.” He believes that the Chinese banking system losses will be gargantuan.
"You have wages up, you have real estate rent moving up, now you have commodities bouncing. So 2017 is going to be a year of increasing inflation but economic growth lagging," Bass said during an interview on CNBC's "Power Lunch." "We're moving into a stagflationary environment in my view."Bass's timing of that announcement was perfect as we all know what happened after the presidential election, US long bond yields surged, bond prices fell and all those gurus warning that the bond bubble will burst got some temporary vindication.
From an investment standpoint, the Hayman Capital Management founder and CIO said the main advice is for investors to stay away from long-duration bonds. Inflation usually causes bond yields to rise and prices to fall, creating capital losses for investors.
The rout in US long bonds after Trump was elected helped Bass's fund end the year with sizable gains of 25% after being down 10% at the midpoint of 2016 (a little leverage also helped). Other macro funds, including some backed by Soros, didn't fare as well (I would be investing with them, not Bass, at this point).
Now, notice I emphasized "temporary vindication" for all those bond bubble clowns and delivering alpha gurus that keep warning us that US long bonds are toast.
I don't buy this nonsense and went on record in my recent comment on trumping the bond market to state that from a risk-reward point of view, US long bonds offer the best potential in 2017, recommending institutions and retail investors load up on them after the latest backup in yields.
I know, all the talking heads on Wall Street are out full force talking about the "huge reversal" taking place as institutions dump bonds and get back into stocks. They've even given it a catchy name, "The Great Rotation" to propagate this myth that the bond bull market is dead and we should all rush into stocks for the long run.
Even well-known bulls that are now throwing in the towel on stocks are buying the global reflation story, stating that bond yields are headed higher as inflation expectations are recovering, reversing four years of disinflationary trends.
Every year I hear the same nonsense and ignore it knowing all too well the bond market has the last laugh and all these people are really out to lunch, erroneously proclaiming deflation is dead and inflation is coming.
Case in point, Bryan Rich's recent article in Forbes, Trumponomics Is Finally Reflating Europe And Japan. He shows you nice charts of how inflation is picking up in Europe, the UK, Japan and the US. Unfortunately, what he doesn't tell you is that the driving force behind the pickup in inflation is all due to huge currency depreciation and this isn't good or sustainable inflation.
It's this type of flimsy economic analysis that I can't stand reading but to the layperson out there, they read these articles and think, oh wow, global reflation is back, inflation is coming full force, especially now that Trump and his billionaire A-team are coming to power. Even Ray Dalio thinks Trump could reignite animal spirits and unleash something wonderful.
Total and utter nonsense! Forgive me, I'm in a very crabby mood, been sick like a dog over the past two weeks, first suffering from painful gastro, then the flu and now coughing and wheezing for air (the 1-2-3 knockout punch!). On the health front, I've had a terrible start to the new year and only slowly recovering as I'm very weak.
The flu season is getting worse but I still don't believe in the flu shot and I'm convinced this happened because I was too lazy to go pick up my Genestra D-Mulsion 1000 (Citrus) drops and load up on vitamin D (I still take 10,000 IUs a day and recommend everyone take a minimum of 2000 or 3000 IUs a day, especially in the winter months and wash your hands often!).
But my crabby mood aside, if I hear another person on CNBC warn me of how US long bond yields are headed "much higher" and the world has escaped deflation now that Trump is getting into power, I'm going to puke or throw something at my television set.
Oh wait, China is going to export inflation to the rest of the world even though it has a huge yuan problem. Who buys this nonsense? Who? I'm seriously dismayed and perplexed that any serious macro economist thinks deflation is dead and global reflation is coming back with a vengeance.
To all you delusional reflationistas, do you realize the world has huge structural imbalances that cannot be cured by currency depreciation alone? Sure, Trump will cut taxes and spend on infrastructure but it won't really make a dent in economic trends and it will be too little, too late as the US economy will stall in the second half of the year (his policies might even hinder long-term growth).
Then there is Greece, the debt boomerang story that keeps coming back every second or third year to haunt financial markets. That saga continues but as bad as Greece is, it's a walk in the park compared to Italy which saw annual deflation for first time since 1959 and is dealing with a looming banking crisis (and deflation happened despite the decline in the euro!).
The world is a structural mess and anyone who thinks otherwise should have their head examined and go back to school to understand the new macroeconomic reality.
What about stocks? Dow 20000? There are plenty of prognosticators out there warning us that the stock market could 'melt up' 10 percent right before a meltdown or that this year reminds them of 1987.
I ignore them too and if you followed my advice and loaded up on biotech before the elections, took profits and reloaded on biotech shares, you would have made great returns in the last two months alone.
In fact, have a look at the daily chart of the equally weighted SPDR S&P Biotech ETF (XBI) since the elections in early November (click on image):
You see how it popped, came back to its 200-day moving average (filling the gap) and then headed right back up? This is a classic bullish technical pattern.
The longer term weekly chart is equally bullish and I expect biotechs to have a great year and this is where I will be focusing my trading once again (click on image):
The biotech ETF however only tells you part of the story, when you dig deep to search for individual names, you will find plenty of biotech shares that can really move huge this year, like ARIAD Pharmaceuticals (ARIA) which surged 72% on Monday after it got bought out by Japan-based Takeda Pharmaceutical Company Limited for approximately $5.2 billion.
I'm in a crabby mood but will even give you Leo's biotech watch list (click on images below):
Among these stocks are some of my core holdings and I think there are real gems in this list that top funds have invested in.
What about Valeant Pharmaceuticals (VRX)? The stock jumped this morning after the company announced it is divesting $2 billion in assets to shore up its balance sheet. We'll see how it ends the day but the news was sold after the initial pop which tells me lots of short sellers are still shorting it and lots of bag holders are itching to dump their shares.
This could be the turnaround story of 2017 (Bill Ackman and Bill Miller sure hope so) but the weekly chart remains very ugly (click on image):
Apart from biotech, I like technology shares (XLK) in general, and note the Nasdaq hit a record today (click on image):
How long will the Trump rally last? I don't know but you can feel that 'panic is starting to set in' about missing the rally and lots of nervous portfolio managers praying for a pullback are getting very nervous about a melt-up in stocks.
Keep your eye on the US dollar index (DXY) because the higher it goes, the more trouble down the road. There could be a short term reversal here but if the longer term uptrend continues in the greenback, watch out, it will spell trouble for the US economy and stock market, especially for the high flying sectors of 2016 like Industrials (XLI), Metal & Mining (XME) and Energy (XLE) shares.
I continue to recommend taking profits or better yet, actively shorting all these sectors including emerging markets (EEM) and Chinese (FXI) shares on any strength in Q1. The same goes for financials (XLF), book your profits as they too will struggle once people realize the reflation chimera is just that, an illusion that will never be sustained.
Also, in a deflationary, ZIRP & NIRP world, I still maintain nominal bonds (TLT), not gold, will remain the ultimate diversifier and still think US long bonds (TLT) offer investors the best risk-reward going forward (click on image):
That pretty much sums up my outlook 2017. There will be tradeable opportunities in biotech and tech shares but investors who need income and safety should continue to invest in US long bonds, especially if yields go back up (I doubt it).
I'm still sick and in a crabby mood. I'm also not really in the mood to continue blogging and think there are a lot of people out there who can help me reach my real potential. Begging people for a donation is just a dead end (I hardly get any) and it's not worth my time and effort to continue blogging. I can be making a lot more money trading on my own or as part of a global macro or global stock team at a large Canadian pension fund (Hint, hint!!).
On that note, take very good care of yourself, this flu season is nasty, wash your hands often and thoroughly, do your flu shot if you can as it's not too late (some people hate it and I understand why but it might shorten the duration and severity of the flu), eat properly getting plenty of fruits and veggies and take your vitamin D (trust me on vitamin D, even my doctor friends are now true believers but it took some persuading on my part).
Below, once again, Wall Street’s number one ranked strategist, Cornerstone Macro’s François Trahan explains why he isn't bullish. François might be off by a month or two but his analysis is spot on and I highly recommend his research to any serious institutional investor (read his latest with Stephen Gregory, The Mother Of All Traps For Stock Pickers: Ex-TRAP-olating Into 2017).
He will be in Montreal at the end of the month delivering his outlook along with my former boss and colleague, Clément Gignac and Stéfane Marion. It should be a great luncheon.
By the way, I received no donations or subscriptions over the holidays. Not surprising as most people are spending on other things but if you appreciate my comments, the least you can do is support the work via your dollars. Like I said, I'm not in the mood to blog any longer and I am looking at working and getting paid properly for my analysis and recommendations, so if you know of anything in Montreal, please let me know about it.