"Dream as if you'll live forever. Live as if you you'll die today."
We've sent Keith to Scotland for the week to get some rest, smoke a few cigars, and hopefully improve his golf game. As a result, different members of our research team are going to take turns writing the Early Look this week, and applying our own unique individual lens to the interconnected world of global macro risk management.
Ironically, Keith and I have very different modus operandi when it comes to approaching every research day. He operates under a strict regimen that incorporates getting into the office at exactly the same time. My daily process is more based on chaos theory, or is at least chaotic. I get in every day at a different time, take a different route, and read a different collection of articles every morning (my girlfriend calls me the anti-type A).
Despite these differences, Keith and I have worked together effectively for many years, starting on the hockey rink at Yale, working together at a major hedge fund in New York, and finally building a business that, we believe, is reinventing a broken sell side research model. We sell our research for a simple fee, produce it real time, and have no conflicts of interests that are ever-present in banking, trading, or a prop desk.
In terms of how we operate on our Macro Research Team, Keith focuses on the day-to-day grind of the market, while I spend more time thinking and writing about the longer term trends. As the James Dean quote above implies, Keith manages risk like every day is the last, while I dream about the investment trends of the future. We call these longer term trends TAILs, and it's my job to chase them.
A TAIL, to us, is a theme and price that has duration of up to 3 years. Often ideas with longer duration are less obvious, hence the term tail, which is a statistical term that is used to refer to the extreme area of a distribution.
When we look at the global investment landscape, we see a number of themes that are sitting there out there on the TAIL, these include:
1. Demographic share taking - Globally, we are seeing the Middle East and Asia take massive population share and this will only accelerate in the coming years (these regions are growing at 2.0% per annum), as the former Soviet Union and Europe have stagnant population growth patterns (growing at less than 0.5% per annum). Domestically, we are seeing the emergence of a powerful demographic know as the Millennials (those born between 1), which will be much larger than the cohort before them, Gen X, given that live births in the U.S. reached 4MM for first time since 1965 in 1985, and have stayed at that level since. Companies that are positioned for age groups and regions that are taking population share, will inevitably have higher organic growth rates than their peers.
2. Scarcity of resources - When we think of scarcity of resources, we are referring primarily to oil. According to the BP Statistical Review of World Energy, from 2004 - 2008 global supply of oil grew at a CAGR of 0.5% and demand for oil grew at CAGR of 0.8%. Despite massive investment in exploration and production from 2004 - 2008, the supply of oil globally barely budged. If it were not for the global recession of late 2008 / early 2009, which will lead to an estimated decline of -2.9% in oil demand in 2009, the global oil market would be incredibly tight. The reality is that the recession has only prolonged the inevitable tightness of world oil supply and demand. Oil speculators aside, the reality remains that with any economic recovery we will see a tight oil market for years to come with the potential for exponential increases in the price of oil in the foreseeable future.
3. Potential loss of American dominance - President Obama is approaching foreign policy with a very unique strategy versus his predecessors. He is reaching out to our perceived enemies such as Iran and militant Islam broadly, and owning up to historical transgressions of the U.S. government. This policy has the potential to make us look weak and embolden our enemies, or alternatively encourage them to engage in diplomacy, which could hasten the spread of peace. To date his strategies appear to have mixed results. On the economic front, China and Russia continue to publicly denigrate the U.S. dollar and questions its dominance. While on the national security front, North Korea, as of this weekend, is threatening to send missiles towards Hawaii. Additionally, Iran continues forward with its nuclear program and appears to be suppressing the popular support for Mir Hossein Mousavi despite pleas from President Obama to do otherwise. The U.S. currently represents roughly 25% of global GDP, therefore any major shift in U.S. economic or foreign policy dominance will have a material impact on the global investment landscape.
Themes on the TAIL are not always actionable, but often accelerate into a closer time frame sooner than we expect. Chasing the TAILs should be part of any proactive risk management process.
Keep your head up and eyes on the tail,
Daryl G. Jones
EWZ - iShares Brazil-President Lula da Silva is the most economically effective of the populist Latin American leaders; on his watch policy makers have kept inflation at bay with a high rate policy and serviced debt -leading to an investment grade credit rating. Brazil has managed its interest rate to promote stimulus. Brazil is a major producer of commodities. We believe the country's profile matches up well with our re-flation theme.
QQQQ - PowerShares NASDAQ 100 - We bought Qs on 6/10 to be long the US market. The index includes companies with better balance sheets that don't need as much financial leverage.
EWC - iShares Canada - We want to own what THE client (China) needs, namely commodities, as China builds out its infrastructure. Canada will benefit from commodity reflation, especially as the USD breaks down. We're net positive Harper's leadership, which diverges from Canada's large government recent history, and believe next year's Olympics in resource rich British Columbia should provide a positive catalyst for investors to get long the country.
XLE - SPDR Energy - We think Energy works higher if the Buck breaks down.
CAF - Morgan Stanley China Fund - A closed-end fund providing exposure to the Shanghai A share market, we use CAF tactically to ride the wave of returning confidence among domestic Chinese investors fed by the stimulus package. To date the Chinese have shown leadership and a proactive response to the global recession, and now their number one priority is to offset contracting external demand with domestic growth.
TIP- iShares TIPS - The iShares etf, TIP, which is 90% invested in the inflation protected sector of the US Treasury Market currently offers a compelling yield on TTM basis of 5.89%. We believe that future inflation expectations are currently mispriced and that TIPS are a compelling way to own yield on an inflation protected basis, especially in the context of our re-flation thesis.
EWI - iShares Italy - Italian Prime Minister Silvio Berlusconi has made headlines for his private escapades, and not for his leadership in turning around the struggling economy. Like its European peers, Italian unemployment is on the rise and despite improved confidence indices, industrial production is depressed and there are faint signs at best that the consumer is spending. From a quantitative set-up, the Italian ETF holds a substantial amount Financials (43.10%), leverage we don't want to be long of.
XLY - SPDR Consumer Discretionary - We shorted XLY on 6/19 as our team has turned negative on consumer in the last week.
XLP - SPDR Consumer Staples - We shorted XLP on the bounce on 6/17.
SHY - iShares 1-3 Year Treasury Bonds - If you pull up a three year chart of 2-Year Treasuries you'll see the massive macro Trend of interest rates starting to move in the opposite direction. We call this chart the "Queen Mary" and its new-found positive slope means that America's cost of capital will start to go up, implying that access to capital will tighten. Yields are going to continue to make higher-highs and higher lows until consensus gets realistic.
UUP - U.S. Dollar Index - We believe that the US Dollar is the leading indicator for the US stock market. In the immediate term, what is bad for the US Dollar should be good for the stock market. Longer term, the burgeoning U.S. government debt balance will be negative for the greenback.
EWW - iShares Mexico - We're short Mexico due in part to the repercussions of the media's manic Swine flu fear. The country's dependence on export revenues is decidedly bearish due to volatility of crude prices and when considering that the country's main oil producer, PEMEX, has substantial debt to pay down and its production capacity has declined since 2004. Additionally, the potential geo-political risks associated with the burgeoning power of regional drug lords signals that the country's economy is under serious duress.