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Editor's Note: Below is a brief excerpt and chart from today's Early Look written by Hedgeye CEO Keith McCullough. Click here to learn more.
"... Looking a little deeper into how the latest all-time high in SPY has become:
During the post-convention plunge in Trump’s poll ratings, many of his closest associates (including RNC Chairman Prince Priebus and campaign chairman Paul Manafort, Jr.) urged Trump to try to exercise self-discipline and be more “presidential.” Last Wednesday, in appointing Steve Bannon as campaign chairman while demoting Manafort and elevating Kellyanne Conway as campaign manager, Trump decisively rejected their advice. He did so after coming to the opposite conclusion—that the reason he was losing was precisely because he was trying to stifle the reckless, uncouth, and anti-PC abandon which served him so well during the primaries.
Trump’s hard-core supporters were delighted: “Let Trump be Trump” has long been their battle cry. The GOP leadership and doctrinal conservatives were aghast, since Trump was apparently giving up on any effort to unify the party. Bannon in particular (as head of Breitbart News) leads a crusade of “alt conservative” populists and nativists who have directed at least as much rage against the “Republican establishment” as against Clinton and the Democrats. Pollsters and political forecasters, meanwhile, simply rolled their eyes. Almost without exception, these professionals have been saying that Trump’s only hope was to cement party unity, pull back the sharp edges, and reach out earnestly to independents in the middle. Trump to the pros: Like hell I will.
My own reaction is mixed. I actually know Steve Bannon fairly well. He’s a big Fourth Turning fan. He once directed a movie called Generation Zero about the 2008 GFC which borrowed heavily from my work. Before he became head of Breitbart he was a film director, and before that he worked for a decade at Goldman Sachs. He’s deeply knowledgeable about economics and history, tuned-in culturally (he runs a business that sells digital paraphernalia to World of Warcraft players)—and, no question, a total firebrand.
Like so many Boomers, he doesn’t mind contemplating the apocalypse. Like the Joker in Dark Knight Rising, he bills himself as an agent of chaos. In a Washington Post interview earlier this year, Bannon explained that, “We think of ourselves as virulently anti-establishment, particularly ‘anti-' the permanent political class.” According to a 2015 Bloomberg Businessweek cover story headline: “This Man is the Most Dangerous Political Operative in America.”
By any conventional calculus, it’s hard to see how the Bannon and Conway makeover improves Trump’s odds of winning. On the other hand, it’s also hard to see how, in a strictly conventional campaign, Trump was ever going to win anyway. In an era of deep voter skepticism, maybe his best chance is to go for the edge, take some risks, hope he can (for once) put Hillary off balance, and go into the debates with gusto. As a candidate, Trump may be ignorant on the issues. But his political instincts have always been pretty good.
Trump’s national poll deficit, by the way, has closed slightly over the last week, from about 7-8% to about 5-6%. (A recent LA Times/USC national poll anomalously gave Trump a 1% lead.) He is gaining mainly by keeping his mouth shut. By most estimates, clearly, Trump still has a very long way to go.
If you see a man walking across a frozen lake during spring thaw, two questions may go through your mind. Is he going to fall in? And, am I going to have to risk my life trying to save him? You may want to ask similar questions about your local public pension system.
On paper, the typical U.S. state or county pension system is 26% underfunded (that’s $1.1 trillion of red ink in aggregate). But even this number is hopelessly optimistic, since it is based on patently unrealistic projections. Most systems assume an indefinite real rate of return of around 7.5%: That’s inflation-adjusted and forever, to pay for benefit obligations that pension boards claim are contractual. Apparently, they still think it’s 1955—and have not woken up to the current global demographic (and productivity) outlook. Plug in a more reasonable RROR, like 4%, and their unfundedness rises to 55% (and their unfunded liabilities mount to around $4 trillion).
Why do public pension systems persist in making these outlandish discount assumptions, even in the face of so many howling critics (like me)? Well, it’s pretty simple: They do so because they can. Almost everywhere in the world, both in the private and public sector, funded DB pension plans are required to set their discount rate at the rate for long-term sovereign debt or for high-grade, secured corporate debt. This is true, for example, in Canada, Australia, the U.K., and the Netherlands. It’s also true for the U.S. private sector. But it’s not true in the U.S. public sector, where GASB accounting rules allows pensions to set their discount rate at the “reasonable” rate of return for whatever asset class they choose to invest in.
A cynic (again, like me) might suspect that these plans have been pushing their assets into higher-risk asset classes just to reduce their future liabilities. Sounds perverse, but is there any evidence to support this claim? Well, now there is. A brilliant new paper by Aleksandar Andonov, Rob Bauer, and Martijn Cremers, an international team of economists which analyzed 850 pension plans over 22 years (1), throws new light on why plans choose their discount rates.
First of all, Andonov et al. show that since 1990 discount rates for nearly all non-U.S. public funds have declined steadily along with the declining yields on sovereign debt. Meanwhile, the discount rate on U.S. public funds has hardly dropped at all (from 8.0% to 7.5%). How did they manage this? By moving steadily into riskier asset classes, including equities, high-yield bonds, emerging market debt, and alternative assets. Back in the 1970s, an estimated 75% of public-fund assets were in safe fixed-income instruments. By 1990 (see below), it was about 50%. Today, it’s about 25%.
The researchers show that the change in U.S. Treasury yield has been highly and inversely correlated, year by year, with the change in the risky asset share. Looks suspiciously like causation to me. They also find that the speed at which these funds have moved into risky assets is positively correlated with the maturity of the fund (i.e., the ratio of retirees to workers in the system). In other words, the closer they are to big payouts, the more risks they take—which is exactly the opposite of the behavior of all the other systems the researchers examined. Ordinarily, of course, you are supposed to steer away from volatility as your due date approaches.
But that’s not all. When Andonov et al. look at the governance of the U.S. plans, they find another strong link. They reveal a strong and positive correlation between the share of pension board members who are political appointees or plan-member representatives (as opposed to general-public appointees) and the tendency to go for riskier assets. Keep in mind that a lower discount rate threatens public employees or elected officials (through higher payroll deductions or the need to raise taxes). A higher discount rate and a riskier asset allocation, on the other hand, only threatens future taxpayers.
Finally, and most revealingly, Andonov et al. find that the public funds aren’t really very good at investing in riskier asset classes. They underperform most of the benchmarks (especially for alternative assets) by at least 50 bp. This makes sense, when you consider that their main object is not so much to attain the higher RROR ex post, but rather raise their discount rate ex ante. That’s what eases the near-term political pressure. And sadly, for too many of these plans, it’s really all about the near term.
According to The Economist, which gave these authors a brief mention, “This paper demonstrates convincingly that American accounting regulations have created perverse incentives for public pension funds. And that can mean only one thing. The rules need to change.” Amen to that. I’ve talked to enough pension managers to know that it isn’t their fault. They're simply following instructions. The real problem is rooted in a political and regulatory system that doesn’t fully level with the public about unsustainable generational promises.
Millennials Cuckoo for Couponing. “Extreme couponing” may conjure up images of a middle-aged individual with plenty of time on their hands. (See: “What’s the Deal with Extreme Couponing?”) But as Bloomberg Business reports, many of today’s heaviest coupon users run with a younger crowd. Marketing firm Valassis reports that nearly nine in 10 Millennials use coupons. But how young shoppers find these coupons is changing. Although print coupons still enjoy record circulation, many of today’s bargain-hunters find their own deals through websites, Web extensions, and digital apps. As a result, avid 31-year-old couponer Heather Schisler says that she “[doesn’t have to] get three or four copies of the newspaper anymore.” Traditional coupon distributors are quickly adapting to this fragmented landscape. Firms such as News America Marketing and Quotient Technology have each acquired app-based discount companies in a play for Millennials. Even Valpak, famous for its blue envelopes stuffed with local deals, says that website and app users printed more than 2 million digital coupons last year.
Hosted by Hedgeye CEO Keith McCullough at 9:00am ET, this special online broadcast offers smart investors and traders of all stripes the sharpest insights and clearest market analysis available on Wall Street.
Takeaway: We will host a conference call Thursday August 25th at 1pm EDT to present P as a new Best Idea Long.
Takeaway: We are adding AHS to the short side today.
Editor's Note: Please note that Healthcare analyst Tom Tobin will send out a full report outlining our high-conviction short thesis. In the meantime, below is a brief summary written by Hedgeye CEO Keith McCullough earlier this afternoon.
I'm I afraid to short High Short Interest (in most cases low quality) US stocks?
After a big decline on accelerating volume, AMN Healthcare Services (AHS) has bounced to a lower-high and is signaling immediate-term TRADE overbought within Tom Tobin's bearish intermediate-term TREND view.
On the fundamentals (per Tom Tobin and Andrew Freedman):
"Organic growth slowed sequentially again at AHS from peaks over 30% in 2015 to 28% in 1Q16, to 19% now in 2Q16. The reasons presented by management that have led growth from negative territory in 1Q14 center on an aging and retiring nurse and healthcare workforce alongside a tight labor and macro factors generally. We've been much more specific in our analysis of demand drivers, showing a strong relationship between the increase in insured medical consumers caused by the Affordable Care Act (and to a lesser extent payroll growth), which increased patient volumes and demand for labor on a 2 quarter lag, and subsequently produced accelerating price and volume for AHS and other staffing companies. As the contribution from insured medical consumers has already slowed from a peak of +8% to its current level of +1.5% currently (and likely lower in 2017), we believe the deceleration in organic growth at AHS is on a programmed path to turn negative, taking consensus revenue and margins with it."
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