Portfolio Strategies 2015 for Investing in an Age of Divergence

By: John_Mauldin

With all the negative news out of Europe, how do you find a positive story? Is there a way to structure a portfolio that gives you permission to be more aggressive when there are danger signs all around? Everyone is worried about being blindsided by a significant downdraft in the markets when maybe we should be thinking about making sure we don’t miss a bull market somewhere. These and several dozen other topics were on the table when the Mauldin Economics writing team gathered here in Dallas for 3½ days of intensive talk, interviews, and planning. Today we’ll go over a few of the highlights of this last week, and I’ll share a few reasons to be optimistic about 2015.

2015 Strategic Investment Conference

But first, we are finally ready to take reservations for our 2015 Strategic Investment Conference, which will be in San Diego, California, April 29 through May 2. (Note that this year the conference is open to everyone and not just to accredited investors, which makes me very happy.) While I am still finalizing the last few speakers with my conference cohosts, Altegris Investments, we’ve already secured an outstanding lineup. The plan is for my old friend David Rosenberg to once again take the position of leadoff hitter. The last few years he has come up with surprises to share with the audience, and I suspect he will do the same this year. Then, I’m excited that we have been able to persuade Peter Briger, the head of $66 billion+ Fortress Investment Group, one of the largest private-credit groups in the world. In 2014, Fortress Investment Group was named "Hedge Fund Manager of the Year" by Institutional Investor and "Management Firm of the Year" by HFMWeek. Briger knows as much about credit around the world as anyone I know.

Longtime readers and conference attendees know how powerful Dr. Lacy Hunt’s presentations are. Then, I’ve persuaded Grant Williams and his partner in Real Vision TV, Raoul Pal, to join us. Raoul is not a household name to most investors, unless you are an elite hedge fund (and can afford his work), and then you know that he is an absolute treasure trove of ideas and insights. If you are looking for an edge, Raoul is at the very tip. Paul McCulley, now back with PIMCO, will be returning for his 12^th year. David Harding, who runs $25 billion Winton Capital Management, which trades on over 100 global futures markets, will tell us about the state of the commodity markets. My good friend Louis Gave will drop in from Hong Kong to help round out the first day. Louis never fails to come up with a few ideas that run against mainstream thinking. I can’t get enough of Louis.

The next day my fishing buddy Jim Bianco, one of the world’s best bond and market analysts, will join us. I have long wanted to have him at my conference. I get the benefit of his thinking every summer, and I’m excited to be able to share it with you. Larry Meyer, former Fed governor currently running the prestigious firm Macroeconomic Advisers, will be there to tell us when the Fed will actually raise rates. He is a true central bank insider and will be flying in from a just-concluded Fed meeting. He is the go-to guy on Fed policy and thinking for some of the world’s greatest and largest investors. Then the intrepid and never-shy-with-his-opinion Jeff Gundlach, maybe the hottest bond manager in the country, will regale us with his insights. Is anybody more on top of his game than Jeff has been lately?

They will be followed by Stephanie Pomboy, whom I have wanted to have at the conference for years. She is one of the truly elite macroeconomic analysts, known primarily in the institutional and hedge fund world, and over the last few years her insights have been a regular feature in Barron’s. My friend Ian Bremmer, the brilliant geopolitical analyst and founder of Eurasia Group, who is consistently one of the conference favorites (and whose latest book we will try to have for you if it is off the press in time), will join, us followed by David Zervos of Jefferies, former Fed economist and fearless prognosticator, who has an enviable track record since he joined Jefferies five years ago. He is currently quite bullish on Europe (for some of the same reasons I outline below).

The next day we will have Michael Pettis flying in from China to give us his views on how Asia rebalances and China manages its transition. Michael has been one of the most consistently on-target analysts on China and is wired into the thought leaders in the country. And what fun would the conference be without Kyle Bass of Hayman Advisors offering us his latest ideas? We are finalizing agreements with another four to five equally well-known speakers, which will include a few surprises, as well as rounding out the panels. I will share those names with you as we nail them down.

Since the first year of the Strategic Investment Conference, my one rule has been to create a conference that I want to attend. Unlike many conferences, there are no sponsors who pay to speak. Normal conferences have a few headliners to attract a crowd and then a lot of fill-ins. Everyone at my conference is an A-list speaker I want to hear, who would headline anywhere else. And because all the speakers know the quality of the lineup, they bring their A games.

Attendees routinely tell me that this is the best conference anywhere every year. And most of the speakers hang around to hear what is being said, which means you get to meet them at breaks and dinners. Plus, this year I am arranging for quite a number of writers and analysts to show up just to be there to talk with you. And I must say that the best part of the conference is mingling with fellow attendees. You will make new friends and be able to share ideas with other investors just like yourself. I really hope you can make it.

Registration is simple. Use this link: https://www.etouches.com/2015sicmauldin. While the conference is not cheap, the largest cost is your time, and I try to make it worth every minute. There are also two private breakfasts where hedge funds will be presenting. Altegris will contact you to let you know the details.

And now let’s think about investing in an age of divergence.

Don’t Miss the Melt-Up

Jared Dillian (who writes the free Mauldin Economics letter The 10^th Man and is the editor of Bull’s Eye Investing) really got me thinking this week as he argued that most people try to hedge for the downside, buying puts and other hedges to make sure they don’t lose money in a market meltdown.

But as he showed us, it is actually far cheaper to buy long-term out-of-the-money calls to make sure that you catch a “melt-up.” If you had bought long-term calls in 2010 on the possibility that the market would double, you would be up a lot more than 100%. For whatever reason, the cost of betting on a bull market is much lower than trying to protect from a bear market. You have to work a little bit more to find these plays and to make sure you get the right price. Getting my 10-year options on the yen took a little time, but they are starting to pay off. For whatever reason, the cost premium relative to the strike price and recent movement in the yen-dollar cross is actually cheaper than it was when I bought a year ago. I have no idea why that would be, but markets can get to be strangely priced. (And yes, I am tempted to add to my position because of that price structure, even though I have a reasonable position already.)

Jawad Mian argued that Europe is going to be the place to be over the next year. Long-term readers can guess that I was quite skeptical of that view, as I see nothing but problems in Europe; but as the days went on I began to see the trading wisdom in his thinking, especially relative to the US.

First off, the US market is simply looking “toppy” to me. That doesn’t mean there is a crash or a bear market in the future (although that is a real possibility), but the outsized returns of the last four or five years are unlikely to be repeated. Will Denyer and Tan Kai Xian of Gavekal have made the case that it no longer makes sense to overweight US equities, which had been the firm’s position for many years:

Our issue is that three key drivers of US equity outperformance are going into reverse:

1) In recent years the Federal Reserve was the most aggressive liquidity provider in the world — this is no longer the case. In fact, the Fed is making moves toward tightening, while everyone else is easing.

2) In recent years the US benefitted from an extraordinarily competitive currency — this is no longer the case. In a very short period, the US dollar has gone from being significantly undervalued against almost all currencies, to being fairly valued against most, to now being overvalued against the likes of the euro and the yen.

3) In recent years US equities were attractively priced — this is no longer the case. On a number of measures the market is stretched.

Even though the Federal Reserve rate hike has probably been pushed off into the third quarter, it will soon be priced into the market. Fed rate hikes usually lead to price-to-earnings (P/E) compression, whether or not there are strong earnings. But since almost half of S&P 500 earnings come from outside the US, a strong dollar is going to weigh heavily on those earnings. Procter & Gamble has said currency costs will reduce their earnings by $1.4 billion after-tax this year. They are not alone.

Further, more than half of S&P 500 companies have P/Es over 20; and, to put it bluntly, bull markets do not begin from valuations at this level. The Russell small-company index is down for the last year, quarter, month, week, and day. Small companies in general are in a bear market (though numerous small companies, typically ones that are tech-focused in some way, are having a banner year).

So, where do you go if you are taking money off the table from the US? Counterintuitively, the coming Greek crisis suggests that we might want to look to Europe. To understand why, let’s review what’s going on in Greece.

The Euro-Positive Greek Crisis?

As we read the headlines, it would appear that Europe is heading for a major confrontation over Greece. The Germans and other Europeans have made it very clear that there will be no haircut on Greece’s debt. Tsipras and his left-leaning coalition party, Syriza, were elected on the basis that there would have to be major haircuts in the Greek debt, as well as relief from the austerity requirements imposed by the Troika (the ECB, IMF, and European Commission) in the wake of the last Greek bailout.

Within a few weeks, Greece will need significant loans to make its debt payments and to pay its bills. The requirement for getting those loans is that Greece must adhere to the regime that was agreed to by the previous government. Tsipras and company have made it quite clear that they do not intend to do so. If they don’t, it is highly unlikely that they will get the Emergency Lending Assistance (ELA) from the European Central Bank that would be needed to bail out their banks. Money appears to be leaving Greece, and deposits are at their lowest levels since 2012.

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