Friday, July 20, 2018

From Trade War to Currency War?

Tae Kim of CNBC reports, Trump says stock market gains since election give him opportunity to wage a trade war:
President Donald Trump said the stock market rally since his election victory gives him the opportunity to be more aggressive in his trade war with China and other countries.

“This is the time. You know the expression we’re playing with the bank’s money,” he told CNBC's Joe Kernen in a “Squawk Box” interview aired Friday.

The president has a big cushion. The S&P 500 is up 31 percent since Trump's win on Election Day, Nov. 8, 2016, through Thursday. The market's gain has slowed this year as the administration has implemented new tariffs on countries, with the benchmark index up 4.9 percent for 2018 through Thursday.

Trump added the market would likely be much higher if he didn’t escalate the trade issues with China and the rest of the world.

“We are being taking advantage of and I don’t like it,” he said. “I would have a higher stock market right now. … It could be 80 percent [since the election] if I didn’t want to do this.”

The president also said he is willing to slap tariffs on every Chinese good imported to the U.S. should the need arise.

"I'm ready to go to 500," Trump added.

The reference is to the dollar amount of Chinese imports the U.S. accepted in 2017 — $505.5 billion to be exact, compared with the $129.9 billion the U.S. exported to China, according to Census Bureau data.

So far in the trade war between the two largest economic powers in the world, the U.S. has slapped tariffs on just $34 billion of Chinese products, which China met with retaliatory duties.
So Trump came out swinging on Friday, appearing on CNBC to state he is willing to put tariffs on all $505 billion of Chinese goods the US imports:
"I'm not doing this for politics, I'm doing this to do the right thing for our country," Trump said. "We have been ripped off by China for a long time."

Trump said the U.S. is "being taken advantage of" on a number of fronts, including trade and monetary policy. Yet he said he has not pushed the tariffs out of any ill will toward China.

"I don't want them to be scared. I want them to do well," he said. "I really like President Xi a lot, but it was very unfair."

Trump also said he was told by unspecified Chinese officials that "nobody would ever complain" from past administrations "until you came along — me. They said, 'Now you're more than complaining. We don't like what you're doing.'"
President Trump also criticized the Federal Reserve's monetary policy again on social media Friday, a day after his initial negative remarks were revealed on CNBC:
“I’m not thrilled,” he told CNBC's Joe Kernen in the interview that aired in full Friday. “Because we go up and every time you go up they want to raise rates again. I don't really — I am not happy about it. But at the same time I’m letting them do what they feel is best.”

Fed officials, including Chairman Jerome Powell, have raised interest rates twice this year and have pointed to two more before the end of 2018. The Fed did not comment on the president's remarks Thursday.

After Trump’s criticism of the central bank aired on Thursday, the White House sent a statement to clarify the president’s remarks.

"Of course the President respects the independence of the Fed. As he said he considers the Federal Reserve Board Chair Jerome Powell a very good man and that he is not interfering with Fed policy decisions," the statement said. “The President’s views on interest rates are well known and his comments today are a reiteration of those long-held positions, and public comments."

But then Trump hit the Fed again on Friday in the tweet.

So what is going on? Is Trump poised to take over the Fed as he slaps more tariffs on China?

Here's the problem. More protectionism will temporarily boost inflation as corporations pass on higher prices to consumers but it also means a higher US dollar which made a 52-week high on Thursday before dropping Friday after Trump's remarks.

And a higher US dollar means lower import prices, which lowers inflation. It also means more pain for commodities and emerging markets which have been reeling this year.

In short, Trump needs inflation and he knows it, but his disjointed policies are not going to achieve this end. Also, he risks a currency war with the Chinese at a time when the yield curve is flattening, which isn't exactly smart macro policy.

So why is Trump so fixated on tariffs? I've already discussed my thoughts back in April looking at whether the trade war will crash markets, noting this from a friend who placed it all into context:
  • For 30 years, US policy toward China was to build a solid economic relationship so US corporations can produce goods at a lower cost and sell them to Americans and others all over the world. Politically, this moved China away from a purely communist country like North Korea, which is what the US wanted, to a mixed market economy which is still communist but has a growing middle class which can buy US and European goods. This policy also weakened labor unions and allowed US corporate profits to soar to record levels, kept inflation and wage growth low in America and elsewhere, and the current account deficit with China was tolerated as long as Wall Street benefited from a capital account surplus to recycle China's savings and speculate on risk assets all over the world. 
  • Now comes Trump who is tapping into the disenchantment of American workers in the Rust Belt, he tells them the level playing field isn't there and that's why manufacturing jobs have left the US but he's going to rectify the situation by standing up to China. The truth is China does get away with murder when it comes to trade but the problem is it's still a communist country. Moreover, it's paying for students to come study in the US so it can steal intellectual property and become a leader in many high-value industries, competing with the US and Europe head-on.
  • In effect, Trump is promoting his economic nationalistic agenda, so it's odd people are surprised. He's not listening to Larry Kudlow, he's listening to Peter Navarro, appealing to his disenchanted base who feel that Republicans and Democrats have let them down over the years to solely pander to corporate interests (ie. campaign contributors).
  • Sure, US corporations don't like trade wars but Trump has given them a huge tax break and has told large companies the US government will do business with them. The money US corporations are saving in taxes can go into investing, increasing wages, paying off debt or buying back shares but they will all opt for share buybacks to increase their senior level compensation which is based on earnings per share. 
  • But China isn't stupid, it's striking back with its own tariffs on American products coming from Rust Belt states, ie. Trump's base. It knows it can hit Trump in areas where midterm elections are taking place in November. It might also choose not to finance US debt but I doubt this will occur and besides, the Fed can just buy US bonds through QE if it needs to.
  • I do not see a US recession before 2020. Trump still has the billion-dollar infrastructure program in his arsenal. The only wild card is the stock market which can get clobbered but even there, he will force the Fed and Treasury to buy stocks, it's already going on through the Bank of Israel and the Swiss National Bank via swaps and outright purchases, and don't be surprised if he privatizes Social Security to force it to invest in US stocks if things get really bad.
My friend got me thinking that maybe there is a method to Trump's madness. He obviously has a clear nationalistic economic agenda to fulfill and he's going to try to score a victory with China, even if it's a pyrrhic one.
Now, a few points here. The timing of a recession is very hard to predict, it could be sooner than 2020 if all hell breaks loose and a trade war degenerates into a full-blown currency war.

As far as infrastructure spending, that is a possibility, it has bipartisan support, but in a political year like 2018 with mid-term elections looming large, I wouldn't hold my breath.

It's also worth noting that a trillion-dollar infrastructure program is still government spending which crowds out private investment and raises interest rates, precisely what Trump doesn't want now.

Infrastructure spending is needed but it's a long-term boost to the economy, not a short-term one.

What else? I was struck this morning by this nonsense on Zero Hedge, Global Bonds Stumble, Yield Curve Steepens After Trump, BoJ, and expressed my disagreement on Twitter:

Can we all please stop deluding ourselves that the yield curve is steepening? It’s not, every selloff in bonds will be bought hard as global investors prepare for the global slowdown ahead.

And if a currency war ensues, China will export deflation all over the world and it's going to really be game over for risk assets.

This isn't the time to take dumb risks in markets or in politics. Can the US afford a trade war? Probably. Can it afford a currency war? No way. Trump's advisors are playing with fire here, and they, not the Fed, will sow the seeds of his demise if they continue down this path.

Below, President Donald Trump spoke with CNBC anchor Joe Kernen on Thursday just outside the Oval Office at the White House. The conversation touched on the state of the U.S. economy, America's trade wars — and the president's news-making remarks about the Federal Reserve's ongoing interest-rate hikes.

Thursday, July 19, 2018

Meet PSP's New CIO?

Sameer Van Alfen of Investments & Pensions Europe reports, Former APG CEO leaves University of California after one year:
Eduard van Gelderen, former APG chief executive, is to leave his position as senior managing director at the $107bn (€91.4bn) investment fund of the University of California after less than a year in the role.

Jagdeep Bachher, the fund’s chief investment officer, confirmed to IPE’s Dutch sister publication Pensioen Pro that Van Gelderen was to leave the university’s investment office, which runs endowment, pension and cash assets.

According to Bachher, Van Gelderen has accepted a new position as chief investment officer of the Public Sector Pension Investment Board, a CAD153bn (€99bn) investment manager based in Montréal, Canada. This has not been confirmed by the Canadian company.

When contacted, the former APG CEO indicated he could not comment, citing his current employer’s rules that forbid him to talk to the media.

Van Gelderen left APG in August after seven years at the Dutch asset manager. He joined initially as CIO, before succeeding Angelien Kemna as CEO in 2014.

When APG announced his departure in May 2017, its spokesman told Pensioen Pro that he had always wanted to work in the US. He added that Silicon Valley close by would make Van Gelderen’s new role “even more attractive”.

US publication Institutional Investor first reported Van Gelderen’s departure last week. It highlighted two other resignations from the university investment team in a three-week period.

In Bachher’s opinion, the job changes proved that the talent at his investment fund was being noticed by other large institutional investors.

However, he also made clear that Van Gelderen’s position would not be filled in and that other members of the executive team would take over his tasks.
Leanna Orr of Institutional Investor was the first to report on van Gelderen's departure last week in her article, Exodus at the University of California as van Gelderen Quits:
Eduard van Gelderen — the former CEO of APG Asset Management — has put in his notice to resign from the University of California’s investment office, according to a source familiar with the situation.

Van Gelderen joined the team one year ago almost to the day, relocating from Amsterdam to Oakland, California, for the senior managing director position.

This is the second resignation of the week for UC’s investment office and the third in three weeks.

On Monday, investment officer Tom Fischer told UC leadership he would be stepping down, and correctly predicted more of his colleagues would follow.

“Yes, there has been a high number of departures, and I expect there will be more,” he told Institutional Investor by phone Wednesday. “I think the proof is in the pudding, and the factual aspect is that there are a lot of people who are leaving.”

Fischer’s last day is Friday. Next week he will return to the world of commercial real estate operations and acquisitions as senior vice president and director of investments at JB Matteson, a private property firm based in San Mateo, California.

His departure follows the resignation of public equities chief Scott Chan last month. Chan is leaving the university system to become deputy chief investment officer of the California State Teachers’ Retirement System in August, the pension fund announced June 21.

Van Gelderen, reached by II late Thursday evening, declined to comment.
As of now, PSP Investments has not made a public announcement on its website in regards to Mr. van Gelderen taking over as the new CIO, but an announcement is imminent as Jagdeep Bachher confirmed it to I&PE.

Bachher is the former CIO of AIMCo, worked with Leo de Bever there before moving over to head the University of California’s investment office. He's highly regarded as a tour de force in the investment world and I covered him last year in my comment on University of California's pension scandal.

I don't know what led to this "exodus" of talented individuals from the University of California’s investment office but I suspect it's a mixture of opportunities elsewhere and disagreements with Bachher who undoubtedly has a strong character and strong views.

Anyway, I don't want to speculate and neither do I really care about why these people left. It's a free market, they might have been courted to leave by recruiters and they might not have been happy with developments at U of C.

All I know is Eduard van Gelderen was the former CEO of APG Asset Management, one of Europe's largest and best pension funds. The Dutch are world leaders when it comes to pensions and both APG and ATP are highly regarded all over the world.

In fact, early this year, I wrote a popular comment on how APG is pushing the limits on factor investing, where Gerben De Zwart, Head of Quantitative Equity and his team are focusing on innovating and improving quantitative investing in the developed equities portfolio.

Van Gelderen joined APG Asset Management in 2010 as CIO for capital markets investments. He previously held positions as deputy-CIO at ING Investment Management and head of investments at Swiss private bank Lombard Odier Darier Hentsch.

In other words, he has top-notch investment experience, really knows his stuff which is why Bachher courted him to Oakland to be part of his team at the University of California’s investment office.

But I think van Gelderen will enjoy living in Montreal over Oakland, it has more of a European flavor, and he will enjoy his new role as CIO of PSP which is a huge job which will pay him very well over the long run if he manages to deliver the long-term target returns.

Right now, I don't have details. I don't know if van Gelderen will be in charge of public and private markets or only public markets like PSP's former CIO, Daniel Garant.

In my humble opinion, a good CIO like him should be in charge of both public and private markets in the tradition of a Bob Bertram, Neil Petroff and Ziad Hindo who was recently named Ontario Teachers' new CIO. There are other great CIOs at Canada's large pensions, some in charge of public and private markets.

But PSP has always kept public and private markets apart and it already has a head of private markets, Guthrie Stewart who is the Senior Vice President and Global Head of Private Investment.

Van Gelderen will have his work cut out for him understanding PSP's extensive operations in all asset classes, public and private but he will also have a great team of hard-working dedicated employees to help him in his new role.

He will also have his work cut out for him because the yield curve is flattening and I foresee very tough markets ahead in all asset classes.

Anyway, there has been no official announcement from PSP yet but when it comes, it will be on its news hub here.

Canada's large pensions are beefing up their investment teams, hiring outstanding CIOs, and Mr. van Gelderen will fit in perfectly with his peer group.

I don't know the man, never met him, but if Neil Cunningham hired him, it tells me a lot about his knowledge, experience and character. Neil wouldn't put someone in the CIO chair unless he had the utmost confidence in this person to take on the huge responsibilities of this all-important position.

In related CIO news, CalPERS is looking for a new CIO to replace Ted Eliopoulos who I think did a great job during his tenure. It's worth noting CalPERS next CIO can reach $1.77 million in total compensation which is a step in the right direction in order to attract top talent to Sacramento.

I say this because I'm appalled at what's going on in Texas where they're scrutinizing"high" salaries for executives at their public pension funds.

One passage in the article says it all:
The investment executives’ salaries range far beyond what even the governor and executives of Texas’ largest agencies make.

Charles Tull, director of investments for the Employees Retirement System, is on schedule to earn more than $783,000 in salary and bonuses in 2018, the most for any state investment executive. Jerry Albright, chief investment officer for the Teacher Retirement System, came in second at $760,398, according to the data provided to The Texas Monitor. Eric Lang, an investment fund director for Teacher Retirement, was third at $699,498.

By contrast, James Bass, head of the Texas Department of Transportation, overseeing more than 11,000 employees, will receive a little less than $300,000 this year. In fact, 20 investment executives for public pension funds in the state make more than Bass — and three times or more than the $153,750 salary of Gov. Greg Abbott.

Sixteen of those top 20 earners work for the state’s two biggest pension plans, the Teacher Retirement System and the Employees Retirement System. The Teacher Retirement System carries more than half of the total unfunded liabilities — $35.5 billion — for all of the 92 public pensions in the state.

The steady increase in such salaries comes as political attention has turned to the growing debt of public pension systems throughout the state. At the end of 2016, Moody’s Investors Service ranked Dallas second only to Chicago among major American cities in the amount of pension debt it was carrying. Houston ranked fourth, Austin was ninth and San Antonio came in at 12th among the top 15 cities.
In other words, blame the chronic deficits on high salaries of pension execs instead of lousy governance, no shared-risk model and the politicization of state pension plans.

I'm here to tell you those salaries are very reasonable and not the problem but it's a circus show in Texas where cowboy politicians shoot first and ask questions later.

If you want to pay public pension fund execs like politicians and senior civil servants, don't be surprised if you can't attract top talent to your public pension and long-term results will end up being much worse.

Luckily, Mr. van Gelderen and the rest of Canada's top CIOs and other senior execs at our large pension plans don't have to deal with this nonsense, they get paid very well for delivering great long-term results.

Below, an older clip where Eduard van Gelderen, then chief investment officer of APG, talked to AAM about the Dutch pension manager’s strategy for Asia Pacific. You can watch this clip here if it doesn't load below.

Notice how he focuses on asset-liability investing and how to properly measure the risk of illiquid investments and how to properly ascribe valuations on them after the credit crisis. He also talks about the importance of developing solid relationships with partners all over the world.

He's obviously a very sharp man, wish him luck at PSP and will update this comment once PSP makes a public announcement on his appointment.

Wednesday, July 18, 2018

Time To Divest From Fossil Fuels?

The Institute for Energy Economics and Financial Analysis put out a press release, Fund trustees face growing fiduciary pressure to divest from fossil fuels:
A paper published today by the Institute for Energy Economics and Financial Analysis details the growing rationale for divesting from the fossil fuel industry.

The paper—“The Financial Case for Fossil Fuel Divestment”—is aimed primarily at trustees of investment funds that continue to hold stakes in a sector that is freighted with risk and is not likely to perform nearly as well in the future as it has historically—regardless of whether oil prices rise or fall.

Kathy Hipple, an IEEFA financial analyst and co-author of the report, said fund trustees everywhere have a pressing fiduciary duty to re-examine their investment commitments to fossil fuel holdings.

“Given the sector’s lackluster rewards and daunting risks, responsible investors must ask: ‘Why are we in fossil fuels at all?’” Hipple said. “The sector is ill-prepared for a low-carbon future, based both on idiosyncratic factors affecting individual companies, as well as an industry-wide failure to acknowledge, and prepare for, an energy transition that is gaining momentum and changing the very nature of how energy is produced and consumed.”

This paper describes divestment “as a proper financial response by investment trustees to current market conditions and to the outlook facing the coal, oil and gas sectors.” It concludes that “future returns from the fossil fuel sector will not replicate past performance.”

It details how the global economy is shifting toward less energy-intensive models of growth, how fracking has driven down commodity and energy costs and prices, and how renewable energy and electric vehicles are gaining market share.

And it cautions that fossil fuel companies’ exposure to litigation on climate change and other environmental issues is expanding and notes that campaigns in opposition to fossil fuel industries have become increasingly sophisticated and potent.

Key points from the paper:
  • The fossil fuel sector is shrinking financially, and the rationale for investing in it is untenable. Over the past three and five years, respectively, global stock indexes without fossil fuel holdings have outperformed otherwise identical indexes that include fossil fuel companies. Fossil fuel companies once led the economy and world stock markets. They now lag.”
  • A cumulative set of risks undermines the viability of the fossil fuel sector. Climate change is hardly the only challenge facing the fossil fuel industry. The broader factors bedevilling balance sheets stem from political conflicts between producer nations, competition, innovation, and attendant cultural change. These risks can be grouped into a few broad categories, such as “pure” financial risk; technology and innovation risk; government regulation/oversight/policy risk, and litigation risk.”
  • Objections to the divestment thesis rely upon a series of assumptions unrelated to actual fossil fuel investment performance. Detractors raise a number of objections to divestment, mostly on financial grounds, arguing that it would cause institutional funds to lose money or that it would undermine their ability to meet their investment objectives, thus ultimately harming their social mandates. Such claims form a dangerous basis for forward-looking investment and are a breach of fiduciary standards.”
Arguments against divestment are rebutted in detail. An FAQ section provides a guide to divestment.

Tom Sanzillo, IEEFA’s director of finance and the lead author of the paper, said the fossil fuel industry is afflicted by what has now become a long-standing weakness in its investment thesis, “which assumed that a company’s value was determined by the number of barrels of oil (reserves) it owned.”

“In the new investment environment, cash is king, which creates a conundrum for the industry,” Sanzillo said. “Aggressive acquisition and drilling will likely lead to more losses for investors. If oil and gas companies pull back, on the other hand, and acknowledge the likelihood of lower future returns and more modest growth patterns, their actions will only confirm the industry is shrinking financially.”

“Historically, fossil fuel companies were drivers of the world economy and major contributors to the bottom line of institutional funds. This is no longer the case,” Sanzillo said. “Whether oil prices are rising or falling the investment thesis cannot replicate the sector’s strong past performance.”

“In the new investment thesis, fossil fuel stocks are now increasingly speculative. Current financial stresses — volatile revenues, limited growth opportunities, and a negative outlook — will not merely linger, they will likely intensify. Structural headwinds will place increasing pressure on the industry, causing fossil fuel investments to become far riskier.”

The paper, published jointly with Sightline Institute was co-authored also by Sightline’s director of energy finance, Clark Williams-Derry.
The full report, The Financial Case for Fossil Fuel Divestment, is available here.

Let me begin by admitting my bias against divestment of any sort, except maybe cigarettes which OPTrust and Dr. Bronwyn King sold me on but I'm still not comfortable with in a financial and fiduciary sense, only in a moral sense as I detest tobacco and think it's a global health scourge.

What about Big Oil and climate change? Don't I care about the environment? Of course I do but I don't get emotional when analyzing the oil & gas sector as I understand the world still relies on fossil fuels and that isn't going to change any time soon:
The federal government's latest international energy projections are out, and there’s no question we’re living in a time of enormous change—and perhaps remarkably little progress.

The International Energy Outlook from the U.S. Energy Information Administration tries to identify the big trends and projections affecting the energy world through 2040. Some of the trends include:
  • The world is getting hungrier and hungrier for energy, but that’s mostly about China, India and the rest of the developing world. Energy consumption in countries that belong to the Organization for Economic Cooperation and Development (basically the industrialized world) is expected to go up 17 percent by 2040. Consumption in countries outside the OECD is projected to nearly double.
  • Renewable energy and nuclear power are projected to be the fastest-growing energy sources, increasing by 2.5 percent per year. Thanks to new sources opened by fracking, natural gas is projected to be the fastest-growing of the fossil fuels, and by 2040 half of all the natural gas produced in the U.S. will be shale gas.
  • Because of improving technology, the world will continue to get more efficient in energy use, and that will have an impact on greenhouse gases.
Yet for all that, the EIA projects the world’s overall energy mix won’t change much at all by 2040 (click on image).

Yes, renewables and nuclear are the fastest-growing sources. But overall, the percent of energy produced by fossil fuels will only drop from 84 percent today to 78 percent in 2040. Renewables only grow from 11 percent to 15 percent, and nuclear rises from 5 percent to 7 percent. Liquid fuels drop by 6 percent, largely because of rising prices. And despite all the debate about the decline of coal and rise of natural gas, the overall percentage of those two fuels barely changes at all. Given that picture, we still be pumping out plenty of greenhouse gases. EIA is predicting a 46 percent increase in global warming emissions during the study’s time frame.

There are important differences in what’s happening in developed nations versus emerging ones. For example, even though the EIA is projecting a small 1 percent drop in the share of coal used by 2040, it expects a dramatic increase in coal consumption between now and 2020, most of it coming from the developing countries that need cheap forms of energy to house and feed their growing populations and to industrialize.

Projections aren’t karmic. They depend on taking current trends and best estimates of what will happen if those trends continue. But it’s a fair question: if there’s so much activity around new energy sources, then why don’t the projections look different? Why don’t the changes have more traction?

The answer may lie in the fact that we haven’t, globally speaking, really reached consensus on the fundamentals: What kind of energy sources should we be using? What economic changes are we willing to make to back up those choices? What are developed nations willing to do to help poorer countries improve their citizens’ lives without depending so heavily on fossil fuels? Those of us living in the developed world have already reaped the benefits of industrialization based on cheap coal. It’s not surprising that developing nations would be tempted to follow the same path—and harder for us to preach to nations that are still building their economies.

The fact is that the changes we’re making on energy are working on the margins, and that’s why the long-term projections only show marginal shifts. If you want big shifts, you have to start making big changes—and that means persuading the public that those changes are worth making.
Admittedly, this article above was published five years ago and the public is more keenly aware of the need to do something to tackle climate change but it doesn't change the fact that the developing world is hungrier for energy and is looking at all cheap sources of energy to industrialize and grow.

More importantly, I'm a skeptic in regards to whether we can quit fossil fuels because whether we like it or not, our societies run on fossil fuels.

Sure, renewable energy is growing fast, there has been a lot of improvement at the margins but the keyword is margins, not in overall global energy consumption.

It's also true that China and India are very aware of the risks of climate change and they are doing something about it but their economies still rely heavily on fossil fuels to grow.

If I really want to be cynical, there are too many people living on this planet and if you really want to reduce your carbon footprint, you should have fewer kids and ditch your car.

Yes, forget McDonald's and cow 'emissions', the real problem driving climate change is your car and those diaper wearing babies which will grow up and contribute a lot more to global warming over their life.

So stop blaming the fossil fuel industry, look in their mirror, stop driving and procreating!

In all seriousness, people get so emotional on climate change, "we must do something about it", but in their emotional frenzy, they throw out all logic and rational thought.

And to my amazement and shock, pensions are jumping on board on this trend to divest from fossil fuels.

Nina Chestney of Reuters reports, Ireland commits to divesting public funds from fossil fuel companies:
Ireland committed to divesting public funds from fossil fuel companies on Thursday after parliament passed a bill forcing the 8.9 billion euro ($10.4 billion) Ireland Strategic Investment Fund (ISIF) to withdraw money invested in oil, gas and coal.

Members of Ireland’s Dail (Parliament) passed the Fossil Fuel Divestment Bill, which requires the fund to divest direct investments in fossil fuel undertakings within five years and not to make future investments in the industry.

In an amendment, the bill describes “fossil fuel undertakings” as those “whose business is engaged, for the time being, in the exploration for or extraction or refinement of a fossil fuel where such activity accounts for 20 percent or more of the turnover of that undertaking.”

The bill also said indirect investments should not be made, unless there is unlikely to be more than 15 percent of an asset invested in a fossil fuel undertaking.

The ISIF is managed by Ireland’s National Treasury Management Agency. As of June last year, the fund’s investments in the global fossil fuel industry were estimated at 318 million euros across 150 companies.

“This (bill) will make Ireland the first country to commit to divest (public money) from the fossil fuel industry,” said independent member of parliament Thomas Pringle who introduced the bill to parliament in 2016.

“With this bill we are leading the way at state level ... but we are lagging seriously behind on our EU and international climate commitments,” he told lawmakers.

Ireland was ranked the second-worst performing European Union country, in front of Poland, in terms of climate change action in June by environmental campaign group Climate Action Network (CAN) Europe.

The world’s top oil, gas and coal companies face rising pressure from investors to shift to cleaner energy and renewables to meet international greenhouse gas emissions cut targets.

Fossil fuel divestment has gained traction over the past few years as pension funds, sovereign wealth funds and universities, have sold oil, gas and coal stocks, especially after the 195-nation Paris climate agreement set a goal in 2015 of phasing out the use of fossil fuels this century.

Norway’s $1 trillion sovereign wealth fund, the world’s largest, is barred from investing in firms that get more than 30 percent of their business from coal and it has also proposed to drop its investments in oil and gas.

The government will give its opinion about that broader divestment in October.

In the United States, New York City announced a goal earlier this year to divest its $189 billion public pension funds from fossil fuel companies in five years.
Now, I understand pensions which want to reduce their carbon footprint and think this makes a lot of sense over the long run.

The Caisse has set targets to reduce its portfolio's carbon footprint 25% by 2025 and others are not setting public targets but necessarily moving in that direction because laws are changing and they're taking climate change seriously.

In fact, the Caisse and Ontario Teachers' Pension Plan are leading the G7 global investor initiative to unite global investors and focus is on three initiatives:
  1. Enhancing expertise in infrastructure financing and development in emerging and frontier economies;
  2. Opening opportunities for women in finance and investment worldwide; and
  3. Speeding up the implementation of uniform and comparable climate-related disclosures under the FSB-TCFD framework.
One of the pensions which is part of this global initiative is OPTrust and it's taking climate change seriously, delving deep into its portfolio to see the impact of climate change across all asset classes.

OPTrust's approach to climate change is rooted in its investment beliefs and strategy, which recognize that environmental, social and governance (ESG) factors will impact the fund's investment risk and return, decades in the future.

But it's important to note all of Canada's large pensions are taking climate change seriously, they don't have a choice. The world is changing, consumers are demanding it and laws are changing too which puts pressure on pensions to reduce their carbon footprint.

Still, it's one thing being cognizant about climate change and how is poses real long-term risks across all portfolios and another blindly divesting out of fossil fuels.

OPTrust and other large Canadian pensions take responsible investing seriously but none of them are openly talking about divesting out of fossil fuels.

Why? Because their fiduciary duty is such that they need to put their members' best interests first, lowering the cost of the plan. I articulated this point in a comment comparing BCI to OPTrust on climate change but I admit I was a bit irritated by the topic and may have done a lousy job.

I sent the article at the top of this comment to a blog reader out in Vancouver who was kind enough to share this with me:
Trustees have a fiduciary duty to act in the economic best interests of the beneficiaries – full stop. They have no fiduciary duty to “re-examine their commitments to” any particular holdings, except to the extent such re-examination is required to discharge their fiduciary duty. It’s a subtle but important point: the fiduciary duty is a macro duty, and there are all sorts of micro actions that are taken to discharge that duty, but the duty itself does not dictate any particular micro action.

If the trustees judge energy investments to be inconsistent with the best economic interests of the beneficiaries, they must divest. Environmental considerations are irrelevant except to the extent, and only to the extent, that they bear on the economics of the investment. A trustee that places his or her environmental preferences ahead of the economic interests of beneficiaries is surely in breach of his or her fiduciary duty.

Some of the arguments cited in the note (above) are therefore breathtaking. If the law is that in discharging their fiduciary duties trustees must comply, or may comply, with their own subjective view of what’s ethical (which is what the arguments imply), how could courts ever determine whether they are in breach? The fiduciary standard would become potentially unenforceable by virtue of having become subjective.

As for the argument that divestment is recommended by the fact that the fossil fuel industry is dying, witness the attached chart showing the performance of Altria (MO) while its industry was dying (click on image).

Now, he showed me a chart of Altria to prove a point, not because he's personally invested in tobacco stocks.

The point is this, pension trustees have a fiduciary duty to properly diversify their holdings across many sectors in order to improve their portfolio's overall risk-ajusted returns.

HOOPP's CEO, Jim Keohane, was telling me how in the 1990s, a lot of pensions were divesting out of sectors and it forced them to overweight the tech sector and when that crashed, they realized they made a huge blunder (too late).

More recently, have a look at the returns of the S&P 500 Energy sector (XLE) since bottoming in early 2016 (click on image):

Not too shabby and even though I'm not bullish on energy and other cyclicals in the near term (read my comment on the flattening yield curve for details), I'm not recommending any pension divest out of fosssil fuels. That would be a breach of their fiduciary duty in my opinion.

What about the report, The Financial Case for Fossil Fuel Divestment, which is available here? It's alright but it’s heavily biased and has many holes in it and lots of data mining going on there to make their biased case for divesting from fossil fuels.

I don't know, call me a skeptic but in a low rate, low return environment, I'd rather pensions have more not less degrees of freedom to properly diversify across all sectors at all times.

Below, Jim Auck, treasurer of the Corona Police Officers Association told CalPERS' board in a meeting last year that his union opposes divesting out of certain industries like tobacco and fossil fuels.

Indeed, many public sector workers in California are worried about their pensions being sustainable in the future but there is increasing pressure on CalPERS and CalSTRS to divest from fossil fuels.

I'm against divestment, think it's a breach of fiduciary duty but we do need to take climate change seriously and lower the carbon footprint at all pensions while maintaining the focus on returns and lowering the cost of pension plans for all stakeholders.

Tuesday, July 17, 2018

Caisse Invests $250 Million In CRE Services?

The Canadian Press reports, Quebec's Caisse de depot pension fund investing $250 million in Avison Young:
The Caisse de depot et placement du Quebec pension fund has made a $250-million preferred equity investment in Avison Young, a commercial real estate services firm.

Avison Young says the money will help fund acquisitions and hiring as part of its global expansion, while a portion will also be used to buy back shares held by Parallel49 Equity and others.

The Caisse invested in a newly authorized class of non-voting preferred shares of the firm, though the terms of the transaction were not disclosed.

As part of the deal, the Caisse will be entitled to choose three of the nine members of Avison Young's board of directors.

Avison Young says the deal will help its international expansion as it gives it access to a wide network of expertise, deal flow and market intelligence.

The pension fund says it looks forward to supporting Avison Young's growth, which has already seen it expand to 84 offices across North America and Europe.
Don Wilcox of the Real Estate News Exchange also reports, Caisse de dépôt invests $250M in Avison Young:
Avison Young CEO Mark E. Rose says a $250-million preferred equity investment from the Caisse de dépôt et placement du Québec (CDPQ) provides his growing firm funds to accelerate its expansion plans, leaves decision-making entirely with its senior management group and allows it to remain a “disruptive force” in the industry.

The investment, announced Monday, creates a new class of non-voting Avison Young shares for the CDPQ. A portion of the proceeds will be used by the commercial real estate services firm to purchase outstanding common (voting) stock from its current private equity partner, Parallel49 Equity (formerly Tricor Pacific Capital) as well as other “non-management founders and principals,” the company said.

“The common shares, the (voting shares) of this company 100 per cent are back in the hands of only people who work at Avison Young,” Rose told RENX during an interview Monday following the announcement.

CDPQ will be entitled to designate three members of Avison Young’s nine-member board of directors.

Rose said to have a partner such as CDPQ, “to allow us to keep the culture and the structure we have built as a privately held, principal-led organization is exactly what we were looking for. To have a company with the brand elevation, and the gravitas, and the case to be that partner, and with the belief to the tune of $250 million, we are just beyond excited.”

Acquisitions and talent recruitment

In addition to the share purchases, proceeds will also be used for acquisitions and to help Toronto-based Avison Young recruit additional talent as it continues to execute its strategic plan.

Rose, who has been CEO of Avison Young for almost 10 years, has already managed its growth from $40M in annual revenues to about $650M in revenues. When he joined Avison Young after leaving JLL, the company had 11 offices in Canada. It now has 84 offices across North America and Europe and has expanded into investment management.

In fact, Avison Young bills itself as the world’s fastest growing private and principal-led, global CRE services firm.

Rose said the key to Avison Young’s rapid growth has been its status as a privately held firm.

“It is so important to the company that we have built, especially against a competitive set that’s all public and structured,” he said, speaking of Avison Young’s major competitors. “We set out nine-and-a-half years ago to build something very different and very special. We wanted it to be very disruptive and we wanted it to differentiate itself.

“(As a private company) we believe you can move quicker, you can outsource more, you don’t need to worry about what you are saying to anybody on a quarterly basis. You can spend your time solving the needs of clients because if a client pays us in Years One, Three, Five, Seven and Nine, that’s fine.”

CDPQ large-scale investor

Rose said bringing the CDPQ on board was necessary for another reason. A large-scale investor, the CDPQ can better accommodate Avison Young’s expanding needs. He lauded Parallel49 as “the greatest partner anybody could ask for” as the company expanded both its service lines and geographical reach.

Financial terms of the transaction have not been disclosed.

“Avison Young’s track record and experienced team speak for themselves: through a well-defined and executed business strategy, the company has grown considerably in recent years, particularly by entering international markets with strong potential,” said Stéphane Etroy, executive vice-president and head of private equity at CDPQ, in a prepared statement.

“With its unique corporate culture and its long-term vision, Avison Young is an ideal partner for CDPQ, and we look forward to supporting the company as it continues to grow over the coming years.”

As for where Avison Young intends to grow, Rose didn’t get into specifics but did offer a broad outline.

“More of the same . . .”

“What you are gonna see is more of the same. More North America, because we can. More Europe, because we can. And, you’ll see us in Asia,” he said. “And, by the way, more in investment management. We have an investment management group which we started from scratch and we have every intention of growing that business.”

Armed with the new funding, Rose said Avison Young plans to move quickly on the acquisition front.

“That’s why we’re doing this, and I think you will see many announcements over the next year or year-and-a-half.”

Rose said having Avison Young’s business backed by a major investor like the CDPQ is both gratifying and energizing.

“(For) this next very large leg up in growth, to have confirmation from an entity like the Caisse that this disruptive, differentiated approach is right and they believe in it with us, it just feels very good to all of our partners here at Avison Young.

“We’re going to go have some fun.”

About Caisse de dépôt et placement du Québec

CDPQ is a long-term institutional investor which manages funds primarily for public and parapublic pension and insurance plans. As of Dec. 31, 2017, it held $298.5 billion in net assets. As one of Canada’s leading institutional fund managers, CDPQ invests globally in major financial markets, private equity, infrastructure, real estate and private debt.

About Avison Young

Headquartered in Toronto, Avison Young is a collaborative, global firm owned and operated by its principals. Founded in 1978, the company comprises 2,600 real estate professionals in 84 offices, providing value-added, client-centric investment sales, leasing, advisory, management, financing and mortgage placement services to owners and occupiers of office, retail, industrial, multi-family and hospitality properties.
IPE also reports, Québec’s Caisse invests C$250m in Avison Young:
Caisse de dépôt et placement du Québec (CDPQ) has invested C$250m (€162.2m) in Avison Young to enable the commercial real estate services firm to buy back its shares from a current private equity partner and accelerate its growth plan.

CDPQ, an investor that manages C$298.5bn funds primarily from public and parapublic pension plans, has made the preferred equity investment in Avison Young.

As part of the investment, Avison Young said CDPQ will be entitled to designate three members of Avison Young’s nine-member Board of Directors. The full terms of the transaction were undisclosed.

Avison Young said it will use the proceeds to invest in acquisitions and the recruitment of key professionals, fuelling the company’s ongoing growth of its global footprint and service-line capabilities.

In addition, a portion of the proceeds will be used to repurchase the shares held by the firm’s current private equity partner, Parallel49 Equity, as well as shares of certain other non-management founders and former Principals of Avison Young. As a result, the principals of Avison Young will own 100% of the common shares of the company.

Mark Rose, the chair and CEO of Avison Young, said: “We look forward to a collaborative relationship with CDPQ and its large global network, and benefit from the ability to share expertise, deal flow, market intelligence and resources as we continue to grow our business across the spectrum of commercial real estate services in North America and other key markets globally.

“We are gratified by CDPQ’s support of our growth strategy, which we launched from a base of 11 offices in Canada and expanded to 84 offices across North America and Europe in just under 10 years – and growing revenue more than 15 times during that period.”

Stéphane Etroy, an executive vice-president and head of private equity at CDPQ, said: “Avison Young’s track record and experienced team speak for themselves: through a well defined and executed business strategy, the company has grown considerably in recent years, particularly by entering international markets with strong potential.”
You can read the Caisse's press release on this deal here.

It's worth noting this isn't a real estate deal, it's an equity stake through the Caisse's private equity group in a fast-growing commercial real estate services firm based in Toronto, Avison Young.

A profile of the company is available here. The image below captures its profile and focus (click on image):

And an  overview of the company is available here:

Avison Young is the world’s fastest-growing commercial real estate services firm. Headquartered in Toronto, Canada, Avison Young is a collaborative, global firm owned and operated by its principals. Founded in 1978, the company comprises 2,600 real estate professionals in 84 offices, providing value-added, client-centric investment sales, leasing, advisory, management, financing and mortgage placement services to owners and occupiers of office, retail, industrial, multi-family and hospitality properties.

Formed by the union of Graeme Young & Associates of Alberta (1978) and Avison & Associates of Ontario (1989) and British Columbia (1994), Avison Young was created in 1996 to provide clients with more comprehensive real estate services at the local, national and international level. Over the next decade, new offices opened in Toronto West (1997), Montreal (2002), Winnipeg and Regina (2004), Halifax (2006) and Ottawa (2007). 

In fall 2008, the shareholders merged the operations to create a single national entity: Avison Young (Canada) Inc. As a result, Avison Young became Canada’s largest independently-owned commercial real estate services company.

In early 2009, Avison Young opened its first office outside of Canada in Chicago, followed by new offices in Washington DC, Lethbridge AB, Toronto North (2009); Atlanta, Houston, Tysons VA, Boston, Waterloo Region (2010); Dallas, Los Angeles, Las Vegas (2011); Reno, Suburban Maryland, San Francisco, New York City, Charleston, Pittsburgh, New Jersey, Fort Lauderdale, Boca Raton, Miami, Detroit, Raleigh-Durham, Orange County, Denver (2012); San Diego, Charlotte, Sacramento, West Palm Beach, San Mateo, Long Island, Greenville, Tampa, Philadelphia (2013); Columbus OH, London U.K., Thames Valley U.K., Austin, Fairfield/Westchester, Oakland, Cleveland, Orlando, Frankfurt (2014); Munich, Moncton, Minneapolis, Indianapolis, Duesseldorf, Hamburg, Nashville, Knoxville, Hartford, San Antonio, Mexico City, Memphis (2015); Coventry, Jacksonville, Phoenix, Berlin, St. Louis (2016); Bucharest, Manchester, San Jose/Silicon Valley (2017); Inland Empire (2018).

The company also acquired Toronto-based Darton Property Advisors and Managers in 2008; Virginia-based Appian Realty Advisors, LLC, Atlanta-based Hodges Management and Leasing Company in 2010; Virginia-based Millennium Realty Advisors, LLC, Los Angeles-based Ramsey-Shilling Commercial Real Estate Services, Inc. in 2011; Maryland-based Realty Management Company, Las Vegas-based Landry & Associates, Los Angeles-based Starrpoint Commercial Partners, Inc., New Jersey-based The Walsh Company, LLC, Raleigh, NC-based Thomas Linderman Graham Inc. in 2012; Houston-based Mason Partners, Florida-based WG Compass Realty Companies, Torrance, CA-based R7 Real Estate Inc., Tampa, FL-based Lane Witherspoon & Carswell Commercial Real Estate Advisors, (partnered with) Greenville, SC-based Colonial Commercial, Dallas-based Dillon Corporate Services, Inc., Maryland-based McShea & Company, Inc. in 2013; Atlanta-based The Eidson Group, LLC, Columbus OH-based PSB Realty Advisors, LLC, London U.K.-based Haywards LLP, Austin-based Commercial Texas, LLC, Montreal-based Roy et Tremblay Inc., Sacramento-based Aguer Havelock Associates, Inc., New Jersey-based Kwartler Associates, Orlando-based MCRE, LLC, Miami-based Abood Wood-Fay Real Estate Group, LLC in 2014; Calgary-based Peregrin Inc., Chicago-based Mesa Development, LLC, Philadelphia-based Remington Group, Inc. in 2015; Toronto-based Metrix Realty Group (Ontario) Inc., U.K.-based North Rae Sanders, Phoenix-based The GPE Companies, Calgary-based Linnell Taylor Lipman and Associates Ltd. in 2016; Atlanta-based Hotel Assets Group, LLC, Atlanta-based Rich Real Estate Services, Inc., Rutherford, NJ-based Cresa NJ-North/Central, LLC, Raleigh-based Hunter & Associates, LLC, Manchester U.K.-based WHR Property Consultants LLP in 2017; Vancouver-based Alcor Commercial Realty Inc. in 2018.

In 2018, Avison Young achieved Platinum status with the Canada’s Best Managed Companies program by retaining its Best Managed designation for seven consecutive years. The program is sponsored by Deloitte, CIBC, Canadian Business, Smith School of Business, TMX Group and MacKay CEO Forums.

Today, Avison Young has offices in Toronto (HQ) (2), Atlanta, Austin, Berlin, Boca Raton, Boston, Bucharest, Calgary, Charleston, Charlotte, Chicago (2), Cleveland, Columbus OH, Coventry, Dallas, Denver, Detroit, Duesseldorf, Edmonton, Fairfield/Westchester, Fort Lauderdale, Frankfurt, Greenville, Halifax, Hamburg, Hartford,  Houston, Indianapolis, Inland Empire, Jacksonville, Knoxville, Las Vegas, Lethbridge, London U.K. (2), Long Island, Los Angeles (4), Manchester, Memphis, Mexico City, Miami, Minneapolis, Moncton, Montreal, Munich, Nashville, New Jersey (2), New York City, Oakland, Orange County, Orlando, Ottawa, Philadelphia (2), Phoenix, Pittsburgh, Raleigh-Durham (2), Regina, Reno, Sacramento, San Antonio, San Diego, San Francisco, San Jose/Silicon Valley, San Mateo, St. Louis, Suburban Maryland, Tampa, Thames Valley U.K., Toronto North, Toronto West, Tysons, Vancouver, Washington DC, Waterloo Region, West Palm Beach and Winnipeg. The company's advisory personnel, licensed brokers, commercial property managers, financial analysts, research professionals, marketing specialists and property accountants serve clients ranging from leading multinational investors and occupiers to smaller firms and sole proprietorships.
I must admit, I've never heard of this company before but commercial real estate services isn't my area of expertise.

Still, I do know some of the top commercial real estate services companies like the usual suspects:
1. Cushman & Wakefield

With 300 offices in over 70 countries, Cushman & Wakefield is a real force to be reckoned with. C & W is truly a comprehensive company, with brokerage services, leasing, sustainability enhancement, consulting for portfolios or properties, tax management and escrow, and more. Their reputation is equally strong among investors and tenants, and they are definitely here to stay as one of the largest commercial property management companies worldwide.


2. Eastdil Secured

Since the 1960s, Eastdil Secured has been one of the most respected names in real estate investment banking. They have used their expertise in real estate fundamentals to become a leader in commercial real estate for private investors and institutions both. Their range of properties includes hospitality, multifamily, retail, and industrial holdings.


3. Simon Property Group

With properties across 37 U.S. states, Asia and Europe, Simon Property Group is the premier name in retail properties and property management. Flagship locations like The Forum Shops at Caesars in Las Vegas, Sawgrass Mills in Sunrise, FL and Woodbury Common Premium Outlets in Central Valley, NY are all proud parts of the Simon family of properties. Simon is a S & P 100 company, formed in 1993, and owns or has part interest in more than 325 properties, including international properties, The Mills, Premium Outlet Centers, community/lifestyle centers, and regional malls.


4. Colliers International

Based in Canada, Colliers International has a presence in 68 countries and provides services for investors, owners, developers, and tenants in the commercial real estate arena.

Serving the hotel, residential property, mixed-use, retail, and office sectors, Colliers International provides project management, investment services, landlord/tenant representation, asset management, valuation/advisory services, and property management.

With more than 40 years in the business, the firm’s 2015 revenues were over $2.6 billion. In recent years, Colliers International has acquired other commercial real estate firms in Cincinnati, Nashville, New York City, Grand Rapids, MI, Columbus, OH, and other markets.


5. CBRE Group

Based in Los Angeles, CBRE Group has been around for over a century and is the world’s largest firm specializing in commercial real estate services and investment. Their suite of services includes property management and facilities management for tenants of commercial real estate, appraisal, brokerage, and leasing. In addition, the company’s Global Investors division facilitates real estate investment through investment funds, direct investment, and other vehicles. CBRE Group’s Global Investors division has over $100 billion in assets currently under management. The company currently stands at #214 in Fortune 500 rankings – it has been included in the Fortune 500 every year, beginning in 2008.


6. JLL

Founded as Jones Lang LaSalle, Inc., JLL’s roots go back to 1783, when it was founded as Jones Lang Wootton. Based in Chicago, JLL has about 70,000 employees and over 230 offices in 80 different countries. In 2014, JLL’s global revenue was $4 billion, with interests in investment, leasing, property management, and development. JLL’s in-depth knowledge of LEED compliance makes them a go-to consultant for energy and sustainability services, including smart building solutions, alternative energy designs, and energy-efficient retrofits for existing properties. JLL’s size and assets are second only to CBRE in the commercial real estate field.


7. Newmark Knight Frank

Newmark Knight Frank (NKF) is a market leader among commercial real estate advisory firms. NKF is a fully integrated firm with services that include investment, consulting, property management, facilities management, valuation and appraisal, facilities and property management, and tenant/landlord representation. NKF’s portfolio includes industrial and retail properties that include landmarks like 666 Fifth Avenue and 34 W. 34th Street in NYC, The Wrigley Building in Chicago, The Confluence in Denver, and Thomas Place in Boston.

As you can see, commercial real estate services are big business ranging from everything from leasing, property management, advising to asset management.

I know CBRE well because it partnered up with Caledon Capital in Toronto to create CBRE Caledon, a firm which offers customized private market solutions for institutional clients.

What do I think of the Caisse $250 equity investment in Avison Young? I think it's a great long-term investment in a fast-growing company which is already a global player and should be part of the list of top commercial real estate services firms.

One thing I noticed, the company really grew fast after the 2008 crisis, which tells me they know what they're doing and have executed well on their growth strategy.

And judging by its more recent tweets, it's already putting the Caisse's investment to good use, buying a European real estate services company:

I also noticed it inevitably wants to get into the asset management game, which is very lucrative but could present some conflicts of interests with clients or maybe not since CBRE and Simon Property Group also do it.

Anyway, this is a good private equity deal for the Caisse, one that will benefit both parties over the long run.

Below, Avison Young is a different kind of commercial real estate company, where principals own the company -- and drive results for clients. “Providing a full range of integrated services for real estate owners and occupiers around the globe, we are growing rapidly to help clients solve their most complex challenges.”

I also embedded a second clip, the Avison Young Elevator Speech with CEO Mark Rose, updated August 2015.

Quite an impressive company and I like the fact it's owned by its principals, tells me they have the right long-term focus and alignment of interests. As their website states: "And because of the value we deliver, our culture and our unique approach, clients and talent are joining us every day."

Monday, July 16, 2018

Beware of the Flattening Yield Curve?

Neel Kashkari, President of the Minneapolis Fed, wrote a new essay on the flattening yield curve:
This time is different. I consider those the four most dangerous words in economics.

Today, policymakers are paying increased attention to the so-called flattening yield curve — the difference in yields between long-term and short-term Treasury bonds. For the past 50 years, an inverted yield curve, where short rates are higher than long rates, has been an excellent predictor of a U.S. recession. In fact, during this half-century period, each time the yield curve has inverted, a recession has followed. Over the past two-and-a-half years, as the Federal Reserve has raised short-term interest rates, the yield curve has flattened dramatically, with the difference between 10-year and two-year Treasuries down from 134 basis points in December 2016 to 25 basis points today, a 10-year low.

Is the flattening yield curve telling us a recession is around the corner?

Some say, “No. This time is different,” and that the flattening yield curve is not a concern. The truth is we don’t know for sure. But we do know the bond market is telling us that inflation expectations appear well-anchored, the economy is not showing signs of overheating and rates are already close to neutral. This suggests that there is little reason to raise rates much further, invert the yield curve, put the brakes on the economy and risk that it does, in fact, trigger a recession.

If inflation expectations or real growth prospects pick up, the Fed can always raise rates then.

The primary reason some policymakers argue that this time is different is because the “term premium” is low today, and so they argue that comparisons to past yield curve inversions are misplaced. If the term premium were at its historical average, these policymakers say, the yield curve would be steeper and an inversion would be further off. This is the same argument some policymakers made in late 2006 to explain why they didn’t worry about the then-inverted yield curve. We now know the Great Recession followed that inversion.

So what is the term premium?

It is the extra returns investors often demand to hold a long-term bond versus a series of short-term bonds. While we’ve given it a technical-sounding name, the truth is we don’t fully understand it. It’s just a residual of the various factors embedded in market prices that we can’t explain.

Why is the term premium low?

Maybe because the Fed’s expanded balance sheet is holding it down. Maybe investors are nervous about trade tensions and are buying Treasuries to hedge those risks. Maybe there is an excess of savings around the world. We don’t know. If I said this time is different because the residual is low, would you be willing to risk a recession on that hunch without clear evidence that inflation expectations are rising above target? I sure wouldn’t.

In the past year, Congress has enacted both a major increase in spending and a large tax cut, and the Federal Reserve has begun winding down its balance sheet. All of these factors increase the supply of Treasury bonds that the private markets must hold. For example, the private sector’s holdings of Treasury securities with remaining maturity of at least 10 years has increased at a rate of $14.2 billion per month so far in 2018 versus a rate of $7.5 billion per month in 2014.

This additional supply should be putting downward pressure on Treasury prices, driving yields up. Yet the 10-year yield has increased remarkably little, to 2.83 percent today. The fact that the 10-year yield is, so far, staying around 3 percent suggests that monetary policy, with a federal funds rate of 1.75 percent to 2.0 percent, is near neutral today. If the markets were expecting higher inflation or stronger real economic growth, that should be showing up as higher long-term bond yields.

If the Fed continues raising rates, we risk not only inverting the yield curve, but also moving to a contractionary policy stance and putting the brakes on the economy, which the markets are indicating is at this point unnecessary.

Deciphering the many signals from financial markets is not an exact science. But declarations that “this time is different” should be a warning that history might be about to repeat itself.
It's Monday, I wasn't in the mood to blog today until I read this gem from Neel Kashkari on my Twitter feed.

Admittedly, Kaskari is an unapologetic dove and he won't be a voting member of the Fed until 2020. By that time, the US recession will be entrenched and if it's really bad, don't be surprised if Trump feels the Bern and loses his bid for reelection.

I'm dead serious, a lot of things can happen over the next two years and if the US economy tanks, it's game over for Trump's reelection bid. He knows it, the Republicans know it and so do the Democrats, many of which are terrified at the prospect of a President Sanders (the US power elite made up of Dems and Republicans are desperately trying to maintain the status quo but Trump and Sanders are trying to shake it up for good).

Anyway, I'm not here to discuss politics, I'm here to focus on the economy and the flattening yield curve.

I began with Kashkari's comment because it's well written, short and to the point. This time isn't different and any pundit, economist or strategist who thinks otherwise is in for a very rude awakening.

On Friday, I explained why it's time to get defensive, noting the following:
The downturn is part of the cumulative effect of Fed rate hikes which is why I keep warning my readers not to ignore the yield curve.

I know, the media will tell you not to fear the flat yield curve and financial websites will tell you the yield curve panic is overdone, but I'm telling you the US and global slowdown is already here and you need to pay very close attention to the yield curve and ignore those who tell you otherwise.

It doesn't mean that markets are going to tank the minute the yield curve inverts, it means risks are rising and allocating risk wisely is going to become harder and harder in an already brutal environment.

And what happened on Monday? Financial shares (XLF) took off as big banks bounced back (click on image):

Let me be very clear here, use any rally in US banks to sell them and go underweight or outright short them.

Look at the daily chart of JP Morgan (JPM) going back one year (click on image)

Some technician is going to tell you it bounced off its 200-day, the MACD is crossing up and it's bullish but the stock is rolling over, incapable of sustaining momentum and making new 52-week highs, so the smart technician is going to tell you what I'm going to tell you: stick a fork in it, it's done.

If you don't believe me, have a look at the 5-year weekly chart of (JPM) which shows you a huge run-up, it’s still bullish as it's above its 50-week moving average but momentum is waning of late and downside risks are mounting as it's as good as it gets for the unstoppable US economy which is unable to generate sustainable wage gains (click on image):

More importantly, a flattening US yield curve doesn't portend well for financials (XLF), undustrials (XLI), energy (XLE) and metal and mining (XME) shares.

These are all cyclical sectors which are leveraged to the US and global economy, so when they roll over, it's typically a bad omen for the economy.

This is why I told you now is a good time to get defensive and focus on more stable sectors like healthcare (XLV), utilities (XLU), consumer staples (XLP), REITs (IYR) and telecoms (IYZ) and hedge that equity risk with good old US long bonds (TLT)

If you don't want to buy sector ETFs, just buy the S&P low volatility index (SPLV) and hedge (up to 50% or more) that equity risk with US long bonds (TLT)

I know I sound ultra bearish and I'm not, but it's worth pointing out we are living the calm before the storm.

What storm? Any storm can come from emerging markets (EEM) to Europe which is still a mess to the US junk bond market (HYG) where some fear a crash is imminent but so far, it's holding on nicely (click on image):

Of course, this can change fast, especially if the yield curve keeps flattening and then inverts which is why I keep warning you not to ignore the yield curve.

Still, others take a more benign view. In his recent blog comment, Is the Yield Curve Bearish for Stocks?, Dr. Ed Yardeni admits the yield curve was a great predictor of recessions in the past but then dismisses it in the current context noting the following:

(5) Bond Vigilantes. In other words, the US bond market has become more globalized, and is no longer driven exclusively by the US business cycle and Fed policies. In my book, I discuss the close correlation between the 10-year Treasury bond yield and the growth rate of nominal GDP, on a year-over-year basis (Fig. 13 and Fig. 14). The former has always traded in the same neighborhood as the latter. I call this relationship the “Bond Vigilantes Model.” The challenge is to explain why the two variables aren’t identical at any point in time or for a period of time. Nominal GDP rose 4.7% during the first quarter of 2018 and is likely to be around 5.0% during the second quarter, on a year-over-year basis. Yet the US bond yield is below 3.00%.

During the 1960s and 1970s, bond investors weren’t very vigilant about inflation and consistently purchased bonds at yields below the nominal GDP growth rate. They suffered significant losses. During the 1980s and 1990s, they turned into inflation-fighting Bond Vigilantes, keeping bond yields above nominal GDP growth. Since the Great Recession of 2008, the Wild Bunch has been held in check by the major central banks, which have had near-zero interest-rate policies and massive quantitative easing programs that have swelled their balance sheets with bonds. Meanwhile, powerful structural forces have kept a lid on inflation—all the more reason for the Bond Vigilantes to have relaxed their guard.

As noted above, a global perspective certainly helps to explain why the US bond yield is well below nominal GDP growth. So this time may be different than in the past for the bond market, which has become more globalized and influenced by the monetary policies not only of the Fed but also of the other major central banks.
This time is different in the sense that global deflation, not inflation, remains the ultimate threat ten years after the great recession and there are structural forces at play which is why the US is trying everything in its power to avoid the global deflation tsunami headed its way.

Why do you think Trump passed huge tax cuts AND is now implementing silly protectionist policies? He wants inflation, he needs inflation.

The problem, of course, is a higher US dollar from protectionist policies will only reinforce deflation once it strikes because it will lower import prices so Trump needs a rethink on his trade policies.

But as far as the flattening yield curve, pay close attention to it, no reason to worry yet even if it inverts but it might a huge warning sign that the US economy is stalling and getting set to roll over.

I've said it before and I will say it again, a slowdown is coming, the Fed needs to heed the warnings of smart economists like Larry Summers and it needs to proceed cautiously here.

Below, Michael Purves of Weeden & Co. says while historically recessions have followed the flattening and inversion of the yield curve, there are stark differences this time around.

Notice how he dismisses the flattening yield curve saying there a 'substantial distortions' influencing the back end of the curve.

I respectfully disagree, there are structural deflationary factors impacting the long end of the curve which Mr. Purves is ignoring or unaware of and as always, the bond market will get the final say.