Leen’s Lodge Labor Day Musings

Labor Day weekend at Leen’s Lodge in Grand Lake Stream, Maine, continues a quarter-century tradition, and the best parts of that tradition have been reaffirmed. Sure, we also discussed the world as we see it and debated scenarios. A great outline of issues was summarized in the opening paragraph of Sunday’s Politico Playbook:

“Good Sunday morning. ON TRUMP’S PLATE: A rogue North Korea, which he cannot convince to stop testing deadly weapons. The dual threat of a government shutdown and debt ceiling default, which needs to be solved by the end of the month. America’s fourth-largest city trying to recover from a historic storm, and a Congress that needs to spend billions of dollars to clean it up. A Republican leadership he’s been warring with. A stalled agenda. The nation’s longest war.” (source: politico.com/tipsheets/playbook/2017/09/03/)

We have some observations, but first a note about the new owners of Leen’s. Scott and Kris Weeks and their two kids are full of welcome and hospitality. They are upgrading the facilities, improving the IT side, and are determined to bring the century-old lodge into the 21st century while maintaining its charm. We recommend a visit and advise that Labor Day weekend in 2018 is open for booking. First come, first served. Leen’s phone is 207-796-2929.

Now to some bullets.

1. The test of wills with North Korea intensifies, as all observers of this news flow confirm. We don’t like the evolution, and we are maintaining a cash reserve.

2. The revisions in Friday’s employment report were disconcerting. There are mixed signals in labor data, but a thoughtful analysis has to conclude that the picture is not robust.

3. The central bank picture remains fuzzy as divergence in policy makes interest-rate forecasting more difficult. The Fed seems hell-bent on shrinking its balance sheet even though no inflation threat is apparent and even though the economy seems to be muddling along at a lower growth rate. The ECB and the BOJ remain on their respective stimulus-oriented paths. Meanwhile, next year’s Fed leadership remains the subject of political speculation. Our view is simple. We cannot project what policy will be if we don’t know who will be deciding it.

4. We are watching credit spreads closely. They are a high-frequency, real-time indicator of stresses. They are giving us some warnings, as are credit default swap (CDS) prices.

5. In the muni space a government shutdown and debt ceiling limit failure could threaten some BABs subsidies and inflict unnecessary costs on all levels of government. Maybe the Houston-Harvey support package will pressure Congress to behave more rationally.

6. Novel approaches to pension-deficit funding now include lottery proceeds as New Jersey dedicates money from the lottery to pay what the legislature refused to fund. Will other states follow?

7. Torsten Slok at Deutsche Bank Research offers an interesting observation. He notes that the worldwide household savings rate is about $1.8 trillion a year. That is about $150 billion a month flowing into stocks and bonds and other assets. He sources OECD data for 27 countries that report detailed information with full transparency. To derive that estimate, Torsten multiplied the household savings rate by household disposable income country by country and then converted all to US dollar equivalents. Brilliant! Torsten, come fishing with us again in Maine.

We expect a September of surprises and volatility. We favor high credit quality in the bond space and are holding some cash reserve in the ETFs space. Of course, changes in portfolios can come at any time.

8. Lastly, the Friday ruling of the US Senate parliamentarian that requires the 2017 budget continuing resolution (CR) vote to take place by the September 30 deadline for any Obamacare change means that the 60-vote rule will then take effect. Thus the Trump administration has likely lost one of the key CR strategies for advancing its legislative agenda. Hat tip Stan Collender: forbes.com/sites/stancollender/2017/09/04/.

We are presently scheduled to discuss some of these issues with Tom Keene on Bloomberg TV at 6 AM on Wednesday (September 6) and to continue on Bloomberg radio at 7:30 AM.

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Hurricane Harvey – Unprecedented Event?

Our thoughts go out to all those displaced or injured, those who had homes and businesses destroyed, and especially those who lost loved ones. Many of us have been glued to the TV, focused on the news surrounding the devastating damage that has occurred and is continuing to occur at the time of this writing. It is heartening to see the outpouring of support from around the country. It is also heartening to hear that lessons learned from past disasters have reduced what could have been an even more devastating disaster. Positive steps have included the early designation of a state of emergency, triggering early aid in money and other resources from the Federal Emergency Management Administration (FEMA); improved and more coordinated communication; the existence of disaster recovery plans at many institutions; and physical reinforcement of buildings including hospitals. Hopefully a formal request to Congress for disaster aid will be addressed and resolved quickly.

The estimates of damage continue to rise as the storm moves and stalls, moves and stalls, dropping record rainfall on Texas and now shifting to Louisiana and Mississippi. And there are predictions of more rain this week for already hard-hit areas. Early estimates of damages were in the range of $30 billion but have grown to $100 billion or more according to some news programs. Katrina cost estimates ranged from $105 to $118 billion. Another perspective is that the total cost of Hurricane Harvey and continued flooding is less than estimates of the cost of a standoff in Congress on the debt ceiling! See point 7 in David Kotok’s commentary “Debt Ceiling Part II,” dated 8/29/2017, available here: http://cumber.com/debt-ceiling-part-ii/. Hurricane season has months left, and we hope the remainder is benign.

The initial cost of a natural disaster can be great, and not all costs are covered by insurance and disaster recovery aid. However, usually after a natural disaster there is a surge in economic activity that continues for an extended period as people and communities rebuild and money and workers flow into the area – increasing income taxes, sales taxes, and fees. The City of Houston, Harris County, and environs is a large economic engine with important municipal and corporate assets. The Port of Houston moves not only oil but food and will reopen, although a date has not been set as of this writing.

Investors’ expectation of a bump in economic activity as the region recovers may be reflected in the lack of noticeable price changes for Texas municipal bonds – at least not yet. The price stability may also be a reflection of a flight to quality and lower Treasury bond yields. This protracted disaster may have different outcomes in the markets than previous disasters. Possibly, investors are becoming increasingly numb to such events. We have noted that geopolitical events here and abroad are not causing as much investment price volatility as one would think.

At Cumberland we have a conservative investment philosophy and invest only in high-quality municipal bonds. That applies to our Texas holdings as well. These are bonds issued by municipalities with strong and diverse economic bases, conservative financial management, and reasonable debt and pension obligations. They generally have reserves set aside to address changes in anticipated revenues and expenses as well as unanticipated events.

We invest in bonds guaranteed by Assured Guaranty Municipal (AGM), National Public Financial Guarantee (NPFG), and Build America Mutual (BAM). Please see our 2Q 2017 municipal credit commentary (http://cumber.com/2q-2017-municipal-credit/), which includes a discussion of the strength of the bond insurers. The bond insurers, also referred to as financial guarantors, have strong claims-paying resources. They insure a number of single-A and triple-B municipalities. These may be small entities or have a narrower economic base or thinner financial cushion than a double-A-rated credit. However, the overall municipal default rate is very low. According to Moody’s, the five-year average default rate for municipal bonds is 0.15%, compared with corporate bonds at 6.92%. Interestingly, the municipal triple-B 5-year default rate is 0.61%, lower than the single-A corporate default rate of 1.15%, while the triple-B corporate default rate is lower, too, at 0.97%. See more detail in http://cumber.com/2q-2017-municipal-credit/. The bond insurers’ exposure to Texas, a state with many highly rated municipalities, is 5% for AGM; 6.7% for NPFG, and 14.3% for BAM. The bond insurers can provide an important stopgap for smaller Texas municipalities that may be operationally challenged in this environment, by stepping in and making debt-service payments. This may not even be necessary, as trustee banks responsible for administering bond proceeds and payments to bondholders may have sufficient funds on hand to meet debt-service requirements.

We also invest in school district bonds guaranteed by the Texas Permanent School Fund (PSF). The use of the PSF guarantee results in less expensive access to the capital markets for the school districts because the bonds receive triple-A ratings. The strong rating of the PSF guarantee reflects substantial PSF assets compared with guarantee obligations, good credit quality of school districts and strong oversight. The Texas PSF was created by the Texas Legislature in 1854 with a $2 million appropriation, expressly for the benefit of the public schools of Texas; and at the end of 2016 the fund had $37 billion in assets.

Longer-term, with increasing weather variability and more-damaging storms, there may be changing trends to keep an eye on. Fewer people may want to live by the coast, while insurance coverage and federal relief funding may change to try to incentivize people to move to less-risk-prone areas. This being said, people so far seem to want to continue to live in areas that are prone to earthquake or flooding – and are intent on reinvesting in their communities and their heritage. However, more and more municipalities, companies, and investors are concerned with the resilience of infrastructure and business continuity.

Hurricane Harvey and its aftermath will provide yet another opportunity for us as a nation to hone our preparedness and to reflect upon addressing our infrastructure needs. At Cumberland we will continue to monitor developments and take action to increase opportunities and limit risk.

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Debt Ceiling Part II

Bullets on the debt-ceiling charade:

1. No one expects the US to default. So why has the credit default swap (CDS) on the US risen in price? Answer: Bond market agents want to add a little insurance just in case American politics deliver a negative surprise.

2. The short end of the US Treasury curve is distorted by the charade. Market agents seek Treasury bills that mature beyond the October crunch date, so they can avoid a whipsaw.

3. US Treasury normal year-end cash balance is expected to be $350–$400 billion. That is what it was in the previous year. Debt-ceiling politics are likely to take September cash under $100 billion and falling.

4. October is the crunch month. Will Treasury miss the October debt-service payment? No.

5. Will 50 million Social Security checks be delayed? No.

6. At the last minute Congress will come up with temporary extensions to avoid a default. All the political statements and posturing are just that and nothing more.

7. Total costs of this charade of debt-ceiling politics are estimated between $75 billion and $200 billion. We use the lower number by estimating the additional CDS cost effect on all US dollar-denominated debt including derivatives. Thus each basis-point rise equates to about $15 billion at an annualized rate based on a debt and derivatives aggregate estimate of $150 trillion. Note other methods use secondary effects to achieve a higher cost estimate.

So who pays and who gains? All governments at all levels from local school boards to US Treasury incur direct costs or opportunity costs. All savers using banks get paid less because banks receive the cash when Treasury runs down its balances, and therefore banks pay savers less interest on their savings because they have an abundance of deposits.

Who gains? No one. This a societal cost. Congressional Democrats and Republicans collectively impose the cost by their behavior. Don’t blame President Trump for this one; his Treasury Secretary, Mnuchin, is complying with the law and is asking for a clean debt-ceiling increase.

Our proposed political solution will never pass. It is that all members of the House and all Senators and all their staffs and committee staffs be the first to take cuts in pay. Furthermore, we would make such pay cuts permanently conditional. Any time US Treasury balances are below $100 billion, don’t pay the federal legislature or their staff.

Will this solution become law? No. They will never vote to discipline themselves.

Will there be bond market gyrations because of this charade? Yes. We already see them.

When the charade has run its course, will bond markets resume focus on central banks, inflation, growth, credit demand, etc? You bet.

But between now and then, for a few months, politics in the US Congress will impose higher volatility and higher costs on all of us.

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Inflation and the FOMC: Minutes of July 2017

For many years, the so-called Phillips curve has provided the inflation forecast framework underlying much of the FOMC’s policy discussions.  Yet both before and especially after the financial crisis, the Fed and FOMC members have consistently under-forecasted inflation.  A new working paper from the Federal Reserve Bank of Philadelphia adds to what is now a large and growing literature spanning the past 20 years, documenting the poor performance of the framework as a basis for policy.

Briefly, as Chair Yellen discussed in a speech at UMass-Amherst, the model posits that inflation is a function of real side variables, and most specifically that movements of inflation away from its trend value are a function of the deviation of the rate of unemployment from its natural rate (the rate of unemployment that would exist if the real economy were in a state of long-run equilibrium).  In other words, the model suggests that the current rate of unemployment, 4.3% ,which is arguably below the natural rate, should be causing a surge in inflation as employers bid up wages and pass them on in the form of higher prices.  But that isn’t happening and hasn’t happened in the US economy since the Great Recession.  In fact, as unemployment has dropped, inflation has also declined somewhat.

The problem of a bankrupt theory was highlighted in the most recent FOMC minutes but has gone largely unnoticed by economic commentators.  What did the minutes suggest was the nature of the discussion at the table?  First, participants argued that the unemployment rate was likely to decline further and potentially significantly overshoot the full employment level.  Despite this potential – and despite the Phillips curve theory – there has been a notable absence of wage pressure.  One rationale offered was that the lack of wage pressure could be due to compositional changes in the labor market, as most of the hiring has been for lower-wage workers.   On the inflation front, the minutes were vague in explaining the recent softness in inflation, referring to “idiosyncratic factors” that were unnamed but hypothesized to keep inflation low for the second half of the year.

But then the minutes get interesting, because they reflected doubt about the framework’s suggestion that for a given rate of “expected inflation, the degree of upward pressures on prices and wages rose as aggregate demand for goods and services and employment of resources increased above the long-run sustainable levels.” The minutes note that a “few” participants questioned the usefulness of the framework for inflation forecasting.  Nonetheless, “most” of the participants reaffirmed the “validity” of the model but then went on to attempt to rationalize why it might not be working.  The reasons given included a reduction in the responsiveness of inflation to low unemployment (a reduction in the coefficient on unemployment in the model), the problem of using the unemployment rate, which may be an imperfect measure of labor market slack in the model, lags in the model, the influence of international market conditions reducing the impacts of tight labor markets on pricing power, and the influence of technology.  Finally, it was noted that at least two participants argued that there may actually be a nonlinear relationship between unemployment and inflation, with the impact becoming increasingly strong as labor markets become increasingly tight.  However, other participants argued there was little or no empirical support for such a nonlinear relationship.

So, what we see is an FOMC increasingly uncomfortable with its inflation forecasting methodology but with little or no alternative to fall back on.  So right now the Committee seems to be increasingly at sea as it struggles to interpret the current inflation dynamic.  Strikingly absent from the discussion is any mention of the money supply or the size of the monetary base as an influence on inflation, perhaps in part due to the sterilizing effect of the ownership of excess reserves being heavily concentrated in the balance sheets of foreign institutions.  So, for now, the Phillips curve is their story, and they are sticking to it, regardless of the evidence.

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Emerging-Market Rally Has Further to Run

Emerging market equities are continuing to outperform remarkably this year. While a pullback seems overdue, there are a number of reasons to expect the trend to remain upward, perhaps for several years more. The iShares MSCI Emerging Markets ETF, EEM, is up 28.19% year-to-date August 24. The Vanguard FTSE Emerging Markets ETF, VWO, has gained somewhat less, 23.48%. The main reason for the difference is that VWO tracks an index that excludes South Korea, considering that country to have gained developed-country status, whereas the index tracked by EEM includes South Korea with a significant weight, 15.55%. Despite the geopolitical risk on the Korean peninsula, the iShares MSCI South Korea Capped ETF, EWY, has registered a gain of 29.37% year-to-date. The above gains compare favorably with the year-to-date gains of the global iShares MSCI All Countries ETF, ACWI, 14.14%, the iShares MSCI All Countries ex US ETF, ACWX, 18.59%, and the US market as measured by the SPDR S&P 500 ETF, SPY, 10.16%. All returns are on a total return basis.

The macroeconomic underpinnings of the equity market rally in emerging-market economies are strong. In its July 2017 World Economic Outlook, the IMF projects the growth of emerging-market and developing economies, measured as real GDP, to be 4.6% this year and 4.8% in 2018, compared with 4.3% in 2016. These calculations are dominated by the emerging-market economies, which are much larger than the developing economies. Indeed, the OECD’s June Economic Outlook includes growth estimates for 2017 and 2018 of 4.6% and 4.8% for the seven G20 countries that are not members of the OECD (Argentina, Brazil, China, India, Indonesia, Russia, South Africa, and Turkey).

China’s economy is expected to slow slightly in 2018, from 6.7% growth to 6.4%, due to a carefully managed monetary tightening designed to restrict non-bank lending through China’s “shadow” financial system. Offsetting this, the economies of India, Indonesia, Brazil, Argentina, Russia, South Africa, along with those of the OECD members Korea, Chile, and Mexico, are expected to register stronger growth next year.

Emerging-market economies have become stronger structurally over the past several years. Their exchange rates have become more flexible, thereby making the economies more resilient to external shocks. Levels of foreign exchange debt and current account deficits are lower, while foreign exchange reserves are higher. Reforms in India, China, and Indonesia have moved in the direction of better balancing those economies, while Brazil’s reforms are still very much a work in progress. Conditions for commodity exporters are gradually improving. The main risks to this positive outlook are adverse geopolitical developments, extended policy uncertainty in the US, Brexit-related developments in Europe, increased protectionism that impacts trade and global supply chains, and a more rapid than expected moderation of central bank stimulus.

The latest leading indicators are sending a mixed message. OECD’s Composite Leading Indicators for June, published August 8th, indicate “growth gaining momentum” for China and Brazil, “stable growth momentum” for India, and “tentative signs of easing growth” for Russia. The Caixin China Composite PMI Output Index for July also showed an improvement, reaching a four-month high at 51.9, while the PMI for Russia sank to a ten-month low. India’s PMI declined sharply, apparently due to a new sales tax, and Brazil’s PMI continued to show contraction (a reading below 50%).

Emerging-market valuations continue to have an edge over those of the developed markets, despite the price increases that have been registered. The price-to-book ratio for MSCI EM equities is 1.66, still below the long-run average of 1.8. Their price-to-earnings ratio is 16.06, compared to its average of 24.2 and those of developed markets (24.11 for the S&P 500 ETF, SPY, and 23.59 for the iShares MSCI Eurozone ETF, EZU).  Along with the positive growth outlook summarized above, an important reason for expecting this emerging-market rally to continue is that these markets are still recovering from their lows of early 2016.

We are favoring the Asia-Pacific and Latin American emerging markets in our International Portfolio. Together they account for 84% of the MSCI EM equity index, with Asia-Pacific and its very large equity markets alone amounting to over 72.6% of this capital-weighted measure. The iShares MSCI Emerging Markets Asia ETF, EEMA, is up 32.66% year-to date August 24. Within that region the iShares MSCI China ETF, MCHI, is up 41.27%. Even more remarkable, the PowerShares Golden Dragon China Portfolio ETF, PGJ, has gained 50.42% so far this year. It invests solely in US-listed companies that derive a majority of their revenues in China. This means its holdings are mainly in internet software and services, internet and direct marketing retail, and education services and not in the large banks found in other China large-cap ETFs. India also is an important market in the region. Its reform-oriented government is making much needed changes. The iShares MSCI India ETF, INDA, has gained 26.90% year-to-date.

The Latin America region’s equity markets are dominated by those of Brazil, Mexico, and Chile. The iShares Latin America 40 ETF, ILF, which tracks an index of 40 of the largest firms in the region, is up 27.26%. While the ETF for the largest LA equity market , the iShares MSCI Brazil Capped, EWZ, has gained a more modest 21.89% as the Brazilian economy slowly recovers from recession and continues to experience political turmoil, Mexico’s equity market, despite the threats from Trump, continues to impress, with the iShares MSCI Mexico Capped ETF, EWW, bouncing 31.73% so far this year. The smaller but robust Chilean market is rebounding from its June pullback, with the iShares MSCI Chile Capped ETF, ECH, still managing a 28.50% gain for the year to date.

Outside these two regions we are watching with interest the steady gains of the Polish market, as the Polish economy profits from its close relations with the Eurozone’s powerhouse, Germany. The iShares MSCI Poland Capped ETF, EPOL, is up an impressive 46.58% year-to-date.

In sum, equity investors who were positioned in the emerging markets at the beginning of 2017 should be seeing very attractive gains thus far this year. There are reasons to think this rally may still have some legs. Market pullbacks, therefore, may provide entry points. The historically higher volatility of these markets and their vulnerability to “risk-off” market swings should be kept in mind.

Sources: Ned Davis Research; ETF.com; IMF World Economic Outlook Update, July 24, 2017; OECD Composite Leading Indicators news release, August 8, 2017; OECD Economic Outlook, June 2017; Goldman Sachs Economic Research; Oxford Economics; the Financial Times; and markit.com/commentary/economics.

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Biggest Rainbow Trout

The biggest rainbow trout I ever caught lives at the Keystone (Colorado) Village Ice Rink, a five-acre lake at 9321 feet above sea level. Here is that wonderful fish, held by Matt Campanella, a skilled fly fishing guide.

David Kotok & Matthew Campanella of Cutthroat Anglers fishing in Keystone, Colorado
In Keystone, Colorado, David Kotok & Matthew Campanella of Cutthroat Anglers display their latest catch, a huge rainbow trout!

Keystone is best known for winter sports like skiing and for its eponymous conference center. The lake freezes over in winter and the ice gets a lot of skating use while trout hibernate below. These trout have no natural enemies and gorge on pellets thrown by summer tourists. That is why they are huge.

This unique fishing experience requires a reservation made directly with Keystone. Their website is keystoneresort.com/activitiesdetail/Key+-+Fly+Fishing.axd, and you can call them at (800) 328-1323. They set up a guided trip with Cutthroat Anglers, a fly-fishing shop and guide service in Silverthorne, Colorado, only a 15-minute ride from Keystone.

To reach Cutthroat Anglers call (970) 262-2878. Their website is http://www.fishcolorado.com/. To talk with Matthew Campanella of Cutthroat Anglers about a trip to Keystone or a float on the Colorado River, call (303) 514-5352.

The best fishing at Keystone is in the early morning before the resort paddleboaters crowd the lake by about 10 AM.

This large fish took a Chernobyl grasshopper imitation. Most of the dozen caught during the sunny mid-August morning were taken on a pellet imitation fly. The fish are not leader-shy, so 1x tippet is advised given their large size.

BTW, this is all catch and release with barbless hooks. That fish is still in the lake.

What is Camp Kotok???

What is Camp Kotok???

This is not a routine Cumberland Advisors Commentary!  Rather than offering commentary on issues and events of importance to the investment and advisory community, this Commentary reports on a very unique and special event for the investment and advisory community known as “Camp Kotok”, held annually at Leen’s Lodge in Grand Lake Stream, Maine, one of the State’s most remote venues (www.leenslodge.com). Many have asked about this event; here is an overview.

Camp Kotok  (“CK”) is a “by invitation” event for individuals associated either directly with Cumberland Advisors or with the financial industry, generally. Attendees convene in Washington County, Maine under “Chatham House Rules” (what is heard and/or exchanged among the attendees is on a “non-attribution” basis unless expressly authorized to the contrary). General thoughts, ideas, forecasts and comments, however, can be discussed and published outside of CK.

This annual early August event evolved after David Kotok invited several other 9/11 “survivors” to relax, fish and reflect almost one year after the World Trade tragedy, from which many CK attendees escaped and where many lost friends. Fishing together on the pristine Maine lakes helped the attendees to form a bond in this restorative environment. Those who attended in the first year decided to return and invite others – thus “Camp Kotok” was established.

Several weeks ago 49 people met in West Grand Lake – some “old timers” and some “newbies”. What a great experience this year!  We had attendees from both North and South America as well as a new participant from Scotland. It was a particularly congenial and accomplished group.

We fished each day and enjoyed daily lunches of freshly-caught fireside grilled fish on several of the many small picturesque islands in the middle of the “grand” lakes. Abundant breakfasts and delicious dinners were prepared by the Lodge. The new owner, Scott Weeks and his lovely family, together with the former owner, Charles Driza, welcomed us warmly and went out of their way to meet the needs of every “camper”.

A highlight this year – a special surprise guest joined us for Friday evening’s annual Maine style “lobstah” dinner.  Senator Susan Collins joined us for drinks on the deck and stayed thru dinner.  She graciously spoke directly with almost everyone. Senator Collins addressed the attendees sharing her personal experience regarding the “skinny” healthcare bill vote and other current political issues. She was fabulous and despite the many political views among CK attendees, she won virtually everyone’s heart with her graciousness, charm, direct talk, warmth and openness. It was a very special memorable treat for everyone to have Senator Collins join us.

Camp Kotok Maine 2017 - David Kotok, Susan Collins and Sharon Prizant
David Kotok, Senator Susan Collins and Sharon Prizant

Beyond the special visit of Senator Collins, highlights included:
•    Intense and probing pre and post-dinner conversations about the economy and the world on the deck (along with wonderful wine and hors d’oeuvres – part of the tradition is that each participant ships several bottles of excellent wine to share with others)
•    Participation in a financial forecast survey of key factors for the upcoming 12 months as well as a review of the prior year’s financial forecast survey – including distribution of funds that the prior year’s attendees “bet” on the accuracy of the forecasts.
•    Participation in an anonymous survey of “camper” opinions regarding “current events” such as best (fake) news media, who they would vote for if they had it to do over, health care, tax code restructuring, immigration, etc.
•    An exciting and provocative five person panel discussion planned and prepared by veteran campers prior to arriving at CK.
•    As many members of the media are among CK “campers,” attached is a link to the articles these “campers” wrote after CK ended.  These views will help readers learn about the many issues discussed at CK.
•    In addition to the above, here is a link to some photos taken during the weekend.

We hope this “special” Commentary provides a glimpse into what has become a tradition at Cumberland Advisors. From this trip, other CK excursions have evolved. We spend a June weekend at Leen’s (including children) and a smaller group gathers there on Labor Day. (We have a few spaces left. If anyone out there is interested, contact the undersigned for details).

This weekend we head to CK/West at Hubbard’s Yellowstone Lodge in Montana where a small group will gather. It will for sure be another inspiring and fun experience!

Sharon Prizant
Managing Director and Director of Marketing
800-257-7013 ext. 335

Rats and Repatriation

“Rats have been said to be the first to sense an impending disaster, such as a sinking ship or a gas leak in a mine – so if rats are leaving, it’s a good idea to follow!”

“Early records of the expression [‘like rats deserting a sinking ship’] go back all the way to Pliny the Elder’s Natural History (77 AD): ‘When a building is about to fall down, all the mice desert it.’” (Source: bookbrowse.com)

It also appears in a form closer to the modern usage in Shakespeare’s The Tempest, Act I, Scene II (1610):

“Prospero: In few, they hurried us aboard a bark,
Bore us some leagues to sea; where they prepar’d
A rotten carcass of a boat, not rigg’d,
Nor tackle, sail, nor mast; the very rats
Instinctively had quit it.”

The exodus of White House-related folks runs the gamut from arts to economics to religious leaders to business CEOs, to staff. The list is huge. When the President’s Committee on the Arts and the Humanities resigned en masse, they sent a letter to President Trump in which the first letter of each paragraph spells out the word resist. See cnn.com/2017/08/19/entertainment/white-house-arts-committee-letter-resist-trnd/. The head of New York City’s largest evangelical church resigned from the president’s panel of evangelical advisers. See voanews.com/a/religious-leader-digital-economy-advisers-sever-ties-with-trump/3992975.html.

My adult or near-adult political memory starts with President Eisenhower. I cannot personally recall chaos in governance as we now see it. Maybe the end of Nixon’s time is a close second place, but that is a subject of debate. And we observe that our president’s approval ratings now rival the lowest ever for a president who has held the office for 30 weeks.

The debt-ceiling fight approaches with Republicans in disarray and Democrats smelling blood and a possible takeover of the House in next year’s midterm elections. Pelosi’s censure motion is designed to embarrass Republican congressional members regardless of their vote. A “yes” vote or a “no” vote puts members on the defensive in their respective districts. The failure of Speaker Ryan and his Republican House majority to accomplish anything puts the Republican caucus on the defensive, as would an agreement to do something instead. The president has trapped House members in a lose-lose position, the classic political Hobson’s choice.

But Republican members of the House do have a way to recover.

The House can pass an infrastructure bill funded by a repatriation tax code change. They can dynamically score it. They can send it to the Senate as a clean bill without muddying the process. This bill would allow the House Republican majority to demonstrate leadership that is independent of the president. And it would enable Senate Republicans to show independent leadership, too. Trump might claim the credit for the bill in the end, but the country would know that the leadership to get the job done originated with the Congress.

Such an initiative puts Democrats on the defensive. Do they vote ‘no’ to repatriate stale cash abroad? Do they vote ‘no’ to rebuild roads or schools? Or do they join Republican majorities who take this leadership path?

I’m not saying this option will be easy. But I’m suggesting that there is a way for Congress to lead without depending on a wounded White House. By the way, within that White House, as of this writing, we still have Cohn, Mnuchin, Kelly, and others who know the benefits of the repatriation-infrastructure linkage and can argue for it.

And with all the CEO advisers gone, it actually becomes harder for detractors to argue that the CEOs are supporting infrastructure-repatriation for their personal or corporate gain. Hat tip to Chuck Gabriel and his colleagues at Capital Alpha Partners for exquisitely dissecting this intricacy of American politics.

The case for infrastructure rebuilding is profound. Any citizen needs only to look around to see it.

A terrific macro summary was presented by Philippa Dunne and Doug Henwood in the August 14th Liscio Report. I will excerpt, starting on page 7:

“Public investment gets less attention for its contribution to productivity growth, but it’s hard to see why, since much of it is about infrastructure, which, as the dictionary tells us, is ‘the basic physical and organizational structures and facilities (e.g., buildings, roads, and power supplies) needed for the operation of society.’ Net civilian public investment was 0.5% of GDP in 2016, less than a third its 1950–2000 average. Recent levels are the lowest since World War II, when the civilian sector was squeezed to fund the military; they averaged 2.6% of GDP during the Great Depression.”

Dunne and Henwood argue strongly that letting the “basic physical and organizational structures and facilities … needed for the operation of a society” deteriorate and eventually “go to seed” is a horrible long-term strategy.

So the Republican House and Senate have a redemption opportunity without President Trump.

The infrastructure-repatriation ball is squarely in the Ryan–McConnell court. All they need to do is pick up that ball and take the shot.

Note that financing of this initiative is still available at very low interest rates and implementation can proceed at very low inflation rates. There is every reason to start now and no reason to wait.

A note to readers. We are regular readers of the Liscio Report. We receive no compensation for endorsing it. We think it ranks among the finest of regular subscription research. For details, call the subscriptions department at 877-324-1893.


This commentary was co-authored by Philippa Dunne (The Liscio Report) and David Kotok (Cumberland Advisors). It reflects their personal views.

A saga unfolds. First, snippets of online news, followed by TV images and “breaking news” reports. “Another one,” she thinks. “Ugh!” he exclaims, “madness! Why? What is the matter with these people?”

Two thousand miles apart, each in their own home, these two friends experience a similar aching angst over the futility of their efforts to try to improve a world that now seems to be rejecting their vision. After all, hate and anger triumphed in Charlottesville. Death arrived on scene, and innocents and innocence were among the casualties. Hate always seems to end that way.

Is hate learned, or is it embedded in some strand of DNA passed down through every human generation? Nazis hated, and Jews died. Then millions more died worldwide. Generations were seared and scarred. For what? To what end?

Geneticists who have decoded the human genome tell us that there is really only one human race, not multiple races within the species, yet the notion of a color scheme still grips some human imaginations, with disastrous results. White hated, and black and red died. And within this awful spectrum, each race’s history is replete with its own internecine murder and torture. Yellow on yellow, brown on brown. White on white. Red on red. That’s our history.

Bling! That little noise is now nearly continuous, announcing incoming mail in the wake of tragedy. A quick look. She has written:

“I am guessing you are sharing my grief today. I know grief isn’t much better than hope as a tactic – perhaps worse, but…”

Yes, he thinks. Grief, like regret, is an emotion that is not very effective, since it occurs after the damage is done.

He taps her cell number on his iPhone. They chat, just as if they are in the same room. How can his miracle of communications and the hate that ripped through Charlottesville occupy the same space and time? How can humanity have come so far and yet never seem to progress?

How can the many heroes who put their own lives on the line to shelter Jews and fleeing slaves people the same world as an individual who decides to plow his car into a group of people he has never met, or one who feels OK about walking down our streets wearing a T-shirt quoting Hitler. Quoting Hitler, you understand.

Pained, each recalls the writings of Joseph Conrad, and they share that sad understanding. Each feels the heaviness of this latest door opened into a “heart of darkness”.

Those of good will must not succumb, she and he agree, as futile as their efforts may seem at times. That is their closing pledge.

Conversations like ours must have taken place among friends all over the country, as we as a nation reckon with the events that unfolded in Charlottesville, Virginia, last week.

How do we brighten that dark heart? Platitudes abound, but first, we should take an honest look at our own motives. Listen to the stories we tell about why the economy is the way it is, why there is a growing number of disenfranchised citizens in our country.

If our theories are overly complicated, they are likely constructed to obscure basic truths. Think, by way of an analogy, of the tortuous paths the planets were said to follow in order to keep the Earth at the center of the old Ptolemaic view, obscuring for centuries the simple beauty of the heliocentric system.

Reality insists that we seek answers to life’s puzzles – and answer to ourselves. We’re forced to admit that we’re probably not up to sitting down and having a chat with someone who believes certain groups of people are subhuman. How do you shake hands with someone who was happy to call Sasha Obama a monkey on her sixteenth birthday? You don’t.

But we can do something about the decades of reckless neglect that are an integral part of our heritage. Targeting each other is clearly not working; targeting the neglect that drives the anger is, perhaps, the only way through.

Jobs are just one telling example: Yes, jobs are being generated by the sharing economy, but many of them are makeshift and do not make up for jobs lost to globalization and displacement of industry. The state of our workers is not an artifact of poor measurement. If that’s your argument, you aren’t looking at the facts on the ground.

There are many simple things to do. Someone recently suggested that PTAs in rich districts might take some of the money they raise to struggling sister schools. We’d add: Don’t mail it to them. Walk it over and tell the kids you are funding a specific project.

The US economic pie isn’t growing as it once did. Maybe we can do something about that through broader capital investment, especially in research & development.

Maybe we can’t… or maybe we won’t. We have to think about what it means that our workers are worse off today than they were in the 1950s. We need to recognize how easy it is for some to manipulate the anger that hardship generates. Set up a straw man, and by and by, someone succumbs to the urge to drive his car into a group of people he has never met. Wherever did those guys marching by eerie torchlight last Friday get the idea that Jews are out to “replace” them? Many of them are feeling shunted aside, that’s for sure.

We get to decide if the threat of manipulated anger is something we want our children to live with.  Yes, that’s right. We get to decide. Note indecision or do nothing is also a decision.

As it is, everyone loses. Though James Alex Fields, Jr., is innocent until proven guilty, if he took Heather Heyer’s life as alleged, it’s hard to believe he didn’t also ruin his own.

War Risk and Markets

“Geopolitical tensions reared up last week and eclipsed key fundamental data points. The escalating war of words between the US and North Korea resulted in a textbook flight to safety into bonds, and also provided an excuse to take profits on equities, especially after the Dow posted nine straight record highs. So far, the tensions between the US and North Korea have only impacted the financial markets. But, growth is likely to slow, particularly in Asia, if the uncertainties over a possible armed conflict cast a dark shadow across the region.” (Summary by Action Economics, August 14 – actioneconomics.com)

For a discussion of North Korea and geopolitical and war risk, see our commentary entitled “War?”: cumber.com/war/. We thank readers for their many and diverse emailed views.

Some asked if the market reaction was rational. Others wanted to know if we are “buying the dip.” Still others inquired if this war risk would change the outlook for the Fed and for interest rates.


We think it is too soon to buy the dip. There are too many scenarios, and all are uncertain as we write. They range from a coup that removes Kim, followed by North Korea’s opening dialogues (markets would soar), to a shooting war (markets would tank in a rapid sell-off). There would be no time to reposition in either case. Either is possible, but both are outliers to mainstream opinion.

Without an event as a catalyst, we believe the Fed stays its course of gradualism, which means announcing QT in the next month and starting implementation by year-end. They will advance by baby steps. And the Fed will pause its gradual rate hiking so as not to have two QT functions active simultaneously. At most, year-end 2017 short-term interest rates look to be a quarter point higher than they are today.

The more difficult issues to determine are how much slowing will occur due to war risk and where the cost pressures are. Example: Maritime insurance cost rises when military risk is heightened. So shipping rates increase, and those higher costs are passed through the supply chain. Note that this is a supply-chain inflation of price, but one imposed by elements that are not monetary or consumer demand-driven. Thus higher costs attributable to rising risk are a factor that reduces growth.

Readers may use their imaginations to identify many other aspects of the global economy that are affected by war risk.

Also note that defense expenditure increases are not capital investments. Money is raised through either taxation or borrowing. If borrowed, it is really a deferred form of taxation. Either way, the expense doesn’t raise productivity directly. It may do so indirectly with the passage of time as war-related technologies morph their way into societal benefits. But that process usually takes years.

So the initial phase for rising war risk is not conducive to growth outside the defense and materiel arena. Note, however, how modern war is highly beneficial to elements of the tech sector.

With so many unknowns, we are not buying the dip today except where we can seize opportunities in our quantitative accounts. Note that quant work is mathematically driven, without regard to why those numerical elements occurred. Quant work doesn’t attempt to answer “why?”

Today our US ETF accounts have a cash reserve. Our bond strategy is undergoing some realignment to take advantage of yield-curve shifts from the war-risk flight to quality. All this could change at any time.

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Cumberland Advisors Market Commentaries offer insights and analysis on upcoming, important economic issues that potentially impact global financial markets.  Our team shares their thinking on global economic developments, market news and other factors that often influence investment opportunities and strategies.