Sculpting Fog?

On Wednesday morning POLITICO’s Morning Money shared this quote from Bob Woodward’s new book, Fear, and opined on Trump’s intentions in the trade arena:

“I can stop this,” Cohn reportedly said. “I’ll just take the paper off his desk.”

Trump apparently never noticed. Still, those anecdotes – while not the most explosive tidbits in Woodward’s reporting – underscore the president’s level of seriousness in wanting to rip up trade deals as Canada negotiates with the administration on a new NAFTA. Trade tensions with China are also poised to heighten further as the administration prepares to put new tariffs on another $200 billion in Chinese goods. Strap in for a bumpy ride.

(https://www.politico.com/newsletters/morning-money)

When there is fog, a portfolio manager’s work gets hard

On Tuesday George Friedman weighed in with the following remarks on the significance of US trade relationships in a piece on the Geopolitical Futures site entitled “America’s Global Engagement”:

Take the renegotiation of NAFTA, for example. The United States is involved in discussions with Mexico and Canada over the future of continental trade. Lest this be regarded as a trivial relationship, the total population of North America is about 500 million, roughly the same as the European Union. The combined gross domestic product of these three countries is roughly that of the combined GDP of EU members. So the redefinition of this trade relationship is as complex and difficult as such a negotiation would be in Europe.

(https://geopoliticalfutures.com/americas-global-engagement/)

Finally, here’s a link to an excellent discussion of the secondary effects of the US-China trade war on global finance and the International Monetary Fund. This paper from the Petersen Institute warrants careful reading.

https://piie.com/blogs/realtime-economic-issues-watch/china-united-states-and-damage-imf

Let’s close with this investment notion: Portfolio management is a business of assessing risks, making estimates, admitting what you don’t know, and trying to be early on when you don’t know it. Markets generally look forward and discount the future.

I was asked a question along just these lines by Ramy Inocencio and Haidi Stroud-Watts on Bloomberg Daybreak: Australia the other day. You can watch here: http://www.cumber.com/took-position-in-canada-cumberland-advisors-kotok-says/

When there is fog, a portfolio manager’s work gets hard. The safe route is to slow down and recognize there are perils that are not visible. The other way is to try to sculpt the fog and plunge ahead. You may win – or you may hit a rock and sink the ship.

We are not fully invested. We have a cash reserve. Bonds are barbells, not bullets. Sculpting fog doesn’t work in the real world.

David R. Kotok
Chairman and Chief Investment Officer
Email | Bio


Links to other websites or electronic media controlled or offered by Third-Parties (non-affiliates of Cumberland Advisors) are provided only as a reference and courtesy to our users. Cumberland Advisors has no control over such websites, does not recommend or endorse any opinions, ideas, products, information, or content of such sites, and makes no warranties as to the accuracy, completeness, reliability or suitability of their content. Cumberland Advisors hereby disclaims liability for any information, materials, products or services posted or offered at any of the Third-Party websites. The Third-Party may have a privacy and/or security policy different from that of Cumberland Advisors. Therefore, please refer to the specific privacy and security policies of the Third-Party when accessing their websites.

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Report from Leen’s Lodge

We start September with a cash reserve in our US equity ETF portfolios. Some details of our thinking follow.

We wish our readers a Happy Post-Labor Day return to confront the 9-week run-up to the midterms. Other risk items include a possible government shutdown (not likely, in our view) and the effects of the continuing trade war.

The US-EU truce persists. We expect a deal to get done with Canada. The interests of all sides are served if there is not further ratcheting up. Mexico is done but, Trump tweets notwithstanding, it is questionable whether much has been accomplished.

Nothing has been accomplished with China, either. The response in Asia to US moves on trade seems to be entirely opposite to that predicted by Trump trade advisor Peter Navarro. In our view, risk is rising for US interests in Asia.

Opinions on US-China outcomes varied at our 27-person Labor Day gathering at Leen’s Lodge. Forecasts were as varied as the political views of the participants, who ranged from hard-core Trump supporters to Sanders socialists. All discussions were civil.

Some bond folks await the mid-September change in the taxation of corporate payments to defined-benefit pension plans that are underfunded. Most folks at Leen’s believed the Treasury yield curve will steepen after this one-time flattening pressure subsides. We will learn more from the results of the October Treasury auctions.

We benefited from three days of extensive and detailed conversation about central banking, with two former practitioners present. The investment bankers and commercial bankers and deal-analysis folks chimed in. Add a few economists and some money managers, and things got lively.

The headcount of 27 was our largest Labor Day ever at Leen’s Lodge. The weather cooperated; the fish did, too. Leen’s new owners are upgrading the facility and have excellent hospitality skills.

On Monday our friend Chris Whalen of The Institutional Risk Analyst published his usual insightful piece on the economy and markets, but with a difference: This one originated at Leen’s Lodge and grew out of our intensive discussion of the Fed’s manipulation of the yield curve, which led us to the question, Is the United States really an AAA credit? We think you’ll appreciate Chris’s analysis, and we thank him for it. Here’s the link to his commentary: https://www.theinstitutionalriskanalyst.com/single-post/2018/09/03/View-from-the-Lake-Is-the-United-States-a-“AAA”-Credit

We will close with a link to a Bloomberg editorial about the Trump trade war. We remind readers that trade war effects are sequential shocks. They are nonlinear. There are no Z-scores.

Here is the link: https://www.bloomberg.com/view/articles/2018-06-19/trump-s-self-defeating-trade-war-with-china

David R. Kotok
Chairman and Chief Investment Officer
Email | Bio

_____________________________________________________________________

Links to other websites or electronic media controlled or offered by Third-Parties (non-affiliates of Cumberland Advisors) are provided only as a reference and courtesy to our users. Cumberland Advisors has no control over such websites, does not recommend or endorse any opinions, ideas, products, information, or content of such sites, and makes no warranties as to the accuracy, completeness, reliability or suitability of their content. Cumberland Advisors hereby disclaims liability for any information, materials, products or services posted or offered at any of the Third-Party websites. The Third-Party may have a privacy and/or security policy different from that of Cumberland Advisors. Therefore, please refer to the specific privacy and security policies of the Third-Party when accessing their websites.

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Guest Commentary by Bob Bunting – It’s Getting Hotter

Bob Bunting, a friend, meteorologist, and accomplished professor, has offered his insight on climate change via this guest commentary, It’s Hot and Getting Hotter – The Case for Adaptive Strategies for a Warming Planet. We appreciate his perspective and invite you to join the conversation.

David R. Kotok
Chairman and Chief Investment Officer
Email | Bio


It’s Hot and Getting Hotter – The Case for Adaptive Strategies for a Warming Planet

By Bob Bunting

As humanity contends with a hotter planet, more volatile weather, and higher sea levels, adaptive strategies offer a win-win approach for now and for the future. Where climate change is concerned, to fail to act is to plan to fail; but by proactively implementing adaptive strategies we can spur economic activity in the present, preserve property values and lifestyles, and help to ensure a viable future.

Bob Bunting

Back in the late 1970s and 1980s I was fortunate to be a scientist and executive at both NOAA and the National Center for Atmospheric Research, NCAR. During this period the signal on manmade climate warming emerged from the noise. The first global atmospheric climate model went into use at NCAR. The early runs with and without the impulse of greenhouse gases put into the atmosphere by humans produced stunning contrasts. Without human greenhouse gas inputs, the model forecast little change in global temperatures; but with the impulse from mankind, the climate forecast indicated a troublesome warming during the 21st century. From that time onward, people fractured into climate-warming advocates and deniers. Led by remarkable consensus among scientists worldwide, the climate-warming forecast has seeped into the collective consciousness.

The NY Times Magazine recently featured a comprehensive review of what happened in Washington during the climate-warming realization period prior to 2000. The article detailed how and why the opportunity to limit climate warming was missed. At the time, many perceived a dramatic rollback of the carbon footprint of humans as hurting the US and other developed economies while simultaneously allowing developing counties to continue dirty development with old carbon-producing technologies.

Realizing that this difficult tradeoff was unlikely to be adopted, NCAR leadership began promoting the adaptive idea that climate warming presented a great economic opportunity for a technology-rich America and other advanced Western countries. Imagine developing India and China, whose goal was to turn the lights on for a few billion people, receiving cleaner-burning power plants and other more efficient technology from the West, thereby leapfrogging past their existing and soon-to-be-built dirty, high-carbon/high-sulfur coal power plants. Given the present state of affairs in 2018, it is clear this adaptive message fell on deaf ears! We can’t undo the past, and significant global warming is already baked into our future, so where can we go from here? Our message of 40 years ago is still the most effective one I have heard. Climate warming is not a theory but an unfolding reality. We estimate that the global temperature has increased about 1.1°C, or about 2°F, since 1880; and sea level has risen approximately 10 inches.

It’s Hot and Getting Hotter Graphic-2_1 - Sea Level Rise
Humankind can best deal with the consequences of climate change in an adaptive way that limits losers while maximizing winners. The imperative of slowing down, ending, and/or mitigating greenhouse emissions has received all the headlines. Meanwhile, unfortunately, the adaptive message has been lost. In addition to curbing emissions, we need to prepare for climate change that is already in the process of happening. I hope to move your thought in the direction of adaptive strategies because these strategies put us on the critical path to lasting solutions. But before we move forward, we need to grasp where we are now in the climate-warming scenario.

In the face of the rises in both global temperature and sea level, we continue to debate what is causing the global changes we have observed. The troublesome truth is that anthropogenic climate change is underway, and limiting additional greenhouse gas inputs from CO2, nitrous oxide, methane, etc. is critical to limiting the magnitude of the warming over the next few centuries. Even if miraculously the world could stop carbon emissions today, the Earth would continue to warm, and sea levels continue to rise until at least 2060. By then our children and grandchildren will be as old or older than we are now! It is in the best interest of our generation and the next few generations to focus on adaptive measures that can mitigate many of the impacts that we see now and that will increase over time. Humans must learn to address longer-term threats posed by climate change and act to protect future generations.

Adaptive strategies are at least part of the answer. For those of us living along the coast, managing sea level rise, for example, could well preserve our way of life now and for the next 50 years and probably beyond. We can, for example, preserve the value of our real estate, limit insurance premiums, and enhance the enjoyment of our adult and/or senior years. These and other benefits make adaptation personal and align with human instincts of self-interest and preservation.

Think, too, about the economic opportunities for small and large businesses that provide the adaptive solutions we need. Using the coastline as a continuing example, coastal engineers will design shoreline protection against additional sea level rise; providers will make or deliver materials to selectively harden and soften the shoreline to manage the rise and buffer more frequent and dangerous storm surges; consultants will help government on local, regional, and national levels to bridge the gap between need and implementation. We know that 80% of the world’s 7.5 billion people live close to the shore, and in Florida alone $6T of real estate is on the beach!

Moving inland, agriculture is likely to be an area where adaptation will pay large returns as the climate warms. The grain belts are located in many interior regions of the major continents. The US grain belts in the Midwest and plains, for example, will probably endure more frequent droughts and changes in the prime growing season. Drought, if not countered by adaptive strategies, could result in lower average crop yields. Adaptive strategies could include adjustments of planting and harvesting dates, changes in crop varieties, planting drought-resistant plants, separating fields with windbreaks, intermingling plots for grazing with those for planting, and developing alternatives for crop insurance.

I could go on, because there are hundreds of adaptive strategies in many economic segments that would mitigate the worst impacts of likely climate changes while enhancing economic activity. This is why I predict that adaptive climate change mitigation will become one of the fastest-growing and most lucrative business categories of the 21st century. We ought to help business see this opportunity and catalyze it for everyone, and the sooner the better!

So what is holding us back? One thought is that scientists necessarily present a range of outcomes and not precise forecasts, given the many uncertainties of making long-range predictions. The result has been a range of outcomes from 2°C to 6°C in temperature rise and 8 inches to 6.6 ft. of sea level rise by 2100. Given this large range, the impact could be quite manageable (but still significant) at the low end of the range and catastrophic at the upper end.

If you take away only one thing from this missive, it should be this. By 2100 the most likely range of temperature rise is, in my opinion, an additional 1.2–1.5°C rise in temperature and about 10–14 inches of further sea level rise. In order to reach these numbers, the current rate of sea level rise will have to advance from about 1 inch every 10 years to double that rate over the next 50 years. While these numbers are not pleasant, they portend real-world impacts that can be managed if we stop arguing about whether climate change is natural or manmade and start acknowledging that either way, the climate is warming and sea level is rising now.

It isn’t productive to wait for a 100% consensus as to the reasons for climate change. In the limited sense, who cares why? We all need to care about and address the adverse impacts no matter who or what is responsible. We buy insurance all the time for outcomes that are far less certain than climate warming and sea level rise. This is the message I have carried to business leaders, local government officials, and national congressional leaders in my sphere of influence. You can help by doing the same!

Bashing the media is not my intention, but the media becomes part of the problem when they hawk worst-case and least-probable scenarios. Sensationalizing promotes fear and creates a “deer in the headlights” syndrome that results in inaction. Showing, for example, how NYC could be underwater in 50 years without also classifying such an occurrence as about a 1% probability event is not helpful. Headlines presenting the worst-case and lowest-probability scenarios are both devastating and depressing because they tend to delay implementation of adaptive strategies. When people feel they have no options because they are going to be underwater, they are more likely to flee rather than to adapt. While climate warming has a fat-tail risk that should not be ignored, that risk also shouldn’t be the driver of paralysis that it has become.

If, however, the most likely scenario is presented, i.e., one with, say, an 80% chance of happening, society would be encouraged to move forward and to maintain our assets and lifestyle by taking adaptive measures. It is vitally important that we switch gears now while we still have affordable and viable options. It isn’t too late!

A final piece of the puzzle is quite encouraging. Knowledge is advancing at such a rapid pace that 50 years from now we may well have ways to sequester carbon and reverse climate warming. In my short lifetime, I have witnessed an incredible and increasing rate of change in human knowledge and technological progress, as I am sure you have. The knowledge tsunami is accelerating and is a cause for great hope and an affirmation that it isn’t too late.

Buckminster Fuller introduced his knowledge-doubling curve in 1982, about the same time as climate warming became a worldwide concern. With the help of IBM, the curve was modified and is shown below.

It’s Hot and Getting Hotter Graphic-3_1 - IBM Knowledge
I don’t have the data to show exactly where we are on the knowledge curve today, but I think the overall point is well made. Adaptation to climate warming and sea level rise is not a hopeless activity. It is as necessary part of a wider solution that is sure to come as our knowledge grows exponentially. We can and must give humankind the chance to solve the climate crisis. We need to get to work now on doing just that by implementing adaptive strategies! Please bring this message forward, and I hope you will!

Bob Bunting is a scientist, entrepreneur, educator and the author of a financial newsletter at bobsstocks.com.


Links to other websites or electronic media controlled or offered by Third-Parties (non-affiliates of Cumberland Advisors) are provided only as a reference and courtesy to our users. Cumberland Advisors has no control over such websites, does not recommend or endorse any opinions, ideas, products, information, or content of such sites, and makes no warranties as to the accuracy, completeness, reliability or suitability of their content. Cumberland Advisors hereby disclaims liability for any information, materials, products or services posted or offered at any of the Third-Party websites. The Third-Party may have a privacy and/or security policy different from that of Cumberland Advisors. Therefore, please refer to the specific privacy and security policies of the Third-Party when accessing their websites.

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Venezuela Implodes, Neighbors Suffer

Last week Venezuela devalued its currency, the bolivar, by 95%, cutting five zeros off the exchange rate. This measure was a desperate response to hyperinflation that reached an astonishing rate of 83,000% YoY in July, with prices doubling every 26 days.

Bandera_de_Venezuela_en_el_Waraira_Repano by Jonathan Alvarez C

The IMF has projected the rate could reach one million percent this year. Cash transactions had become almost impossible, with even restaurant tips being done as bank transfers. The new currency, the “sovereign bolivar,” is linked to the petro, a state-run cryptocurrency that can be manipulated. In other words there is no constraint on the ability of the government to issue this cryptocurrency and print further sovereign bolivars.

Despite Venezuela’s having the world’s largest proven oil reserves, the country’s economy is in a shambles due to the mismanagement since 1999 by the socialist governments of Presidents Hugo Chavez and Nicolás Maduro. The economy dropped by more than a third since 2013 and is now in freefall. Unwise price controls and exchange controls had unintended consequences. Expropriations, corruption, and serious mismanagement of the state-owned oil company further depressed the economy. The government goes on printing money, and the budget deficit now exceeds 30% of GDP. A further increase in the minimum wage to 34 times its previous level, another element of the government’s “magic formula” to counter the economy’s dire state, will likely add to that deficit, since the government will cover the greatly increased cost to private firms for 90 days.  Government borrowing to fill the financing gap has led to the issuance of some $60 billion in sovereign bonds and perhaps double that amount in loans.

Life in the country has become difficult, unbearable for many, with 2.3 million of the country’s population of 31.3 million leaving the country since 2014. There are major shortages of food, and child malnutrition is at a record high. In some cities there are water shortages and power cuts, which have been particularly hard for public hospitals, which also face serious shortages of medicine. It is not surprising that Venezuelans are voting with their feet.

The Venezuelan exodus, estimated to be one of the largest forced displacements ever in the Western Hemisphere, is creating increasingly difficult problems for Venezuela’s neighbors, Colombia, Ecuador, Peru, Chile, and Brazil. The first waves of migrants were largely middle class and met no resistance in the neighboring countries, which generally have relaxed immigration policies and governments that saw these migrants as a welcome rebuke to the Maduro regime. However, the flows have surged, and the more recent migrants have tended to be poor. Many exhaust their limited resources as they flee, and they often arrive on foot. Tensions have risen in Brazil, which had been handling the influx well, with some attacks by locals on migrant border camps, leading to extra security forces being sent to the border. Brazilian authorities indicate they have no intention of closing the border.

Both Ecuador and Peru will soon require Venezuelans who wish to enter their countries to have passports. Reportedly, getting a Venezuelan passport can take two years unless a substantial bribe is paid. Most migrants entering Ecuador have been heading to Peru, where the recent influx of Venezuelans has been 5000 a day. In contrast, Colombia continues to welcome Venezuelan migrants, recalling that Venezuela took in more than 700,000 Colombians during that country’s war with FARC guerrillas. In 2017 Colombia was the destination for 600,000 Venezuelan migrants, by far the largest volume among South American destinations. It is notable that the second largest number, 290,224, was taken in not by another South American country but by the United States.

The economic costs to neighboring countries of these inflows of migrants seem to be manageable. However, as the flows continue to increase, which seems likely, tensions could well increase, and the risk of political instability could grow. Rising risks would have negative effects on the region’s economies, raising investors’ concerns.

The economic situation in Venezuela does not look likely to improve under the present government’s policies. While the devaluation was inevitable, major changes in course are needed, including freeing up price controls, adopting responsible fiscal policies, and probably moving to a currency board or accepting dollarization, following the examples of Zimbabwe and Ecuador. Dealing with the external debt problem would require negotiating an adjustment agreement with the IMF and restructuring that debt. President Maduro appears unlikely to take such actions, and his government has already defaulted on some bonds. Maduro’s “Magic Formula” has little chance of ending the economy’s slide. International assistance from the United States and other wealthy countries could make a difference and be justified on humanitarian and regional-stability grounds but is unlikely as long as there is no change in the pro-Cuban, anti-democratic government.

Venezuela’s troubles have not yet had a significant effect on other financial markets in South America. Should the migrant flows eventually lead to political instability in one or more South American countries, investor attitudes toward the countries concerned and possibly toward the region would deteriorate. This is a medium-term risk that we will keep in mind as we adjust our investment strategies.

Bill Witherell, Ph.D.
Chief Global Economist & Portfolio Manager
Email | Bio

_____________________________________________________________________

Sources:  Financial Times, The Economist, BBC.com

_____________________________________________________________________

Links to other websites or electronic media controlled or offered by Third-Parties (non-affiliates of Cumberland Advisors) are provided only as a reference and courtesy to our users. Cumberland Advisors has no control over such websites, does not recommend or endorse any opinions, ideas, products, information, or content of such sites, and makes no warranties as to the accuracy, completeness, reliability or suitability of their content. Cumberland Advisors hereby disclaims liability for any information, materials, products or services posted or offered at any of the Third-Party websites. The Third-Party may have a privacy and/or security policy different from that of Cumberland Advisors. Therefore, please refer to the specific privacy and security policies of the Third-Party when accessing their websites.

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It’s in the Stars

As is the custom for Fed chairs, Chairman Powell provided the kickoff address to the Kansas City Fed’s annual Jackson Hole symposium, broadly attended by many of the world’s central bankers.

For those who are unfamiliar with the conference, the papers presented are generally conceptual economic policy documents with a distinctly longer-run, bigger-picture focus rather than a discussion and assessment of currently policy. In that vein, Chairman Powell provided an interesting and thoughtful discussion of the problems that he and the Fed face in setting policy going forward.

Some commentators on the speech focused on missing elements such as Powell’s failure to mention trade and tariff issues or the changing role that international economic integration has on the policy environment of changing policy regimes. These factors are clearly important but weren’t central to Chairman Powell’s thought piece, which really focused on the more abstract conceptual framework upon which the Fed’s current policy is depends.

Before discussing that framework however, Powell first provided a brief, but obligatory, overview of the current economic situation. It proved to be just a restatement of what was noted in the FOMC’s July/August policy statement and subsequent minutes. He noted that growth is strengthening, unemployment is at a 30-year low, and inflation is at the 2% objective. There was nothing new or noteworthy here.

Then Chairman Powell then turned to the more interesting part of the speech – interesting in part because it appears that he is revealing his own discomfort with the current policy framework. He first poses two disparate questions that observers and critics might ask any FOMC participant today, questions that encapsulate the policy conundrum the FOMC now faces. The questions are paraphrased below:

(1) With unemployment so low, why isn’t the FOMC tightening policy faster to head off potential overheating and a rise in inflation?

(2) Or, with inflation so low, why is the Fed tightening, thereby risking higher unemployment and a recession?

The first question is rooted in a Phillips-curve view of the world in which tight labor markets inevitably lead to inflation, while the second question ignores evidence on the lags of monetary policy and reflects the view that inflation isn’t a problem until it is. Powell has structured these questions as a policy problem of balancing two risks: the risk of being behind the curve versus the risk of being too aggressive.

Against this set of policy questions, Powell then goes on in a clear but oblique way to discuss how economists are currently framing policy in terms of (a) the desired rate of inflation, and (b) the two abstract concepts of the natural rate of unemployment and the natural rate of interest. Economists have dubbed the natural rate of unemployment u-star (u*) and defined it as the rate of unemployment that would prevail in an economy growing at its potential, where people would be unemployed only due to friction and structural reasons – that is, unemployed due to skill mismatches, mobility problems, or lack of information. The natural rate of real interest or r-star (r*) is the real rate that would exist in an economy operating at full employment and growing at its long-run potential.

Powell then proposes the simple, effective analogy that policy is like trying to navigate by the stars (u* and r*), where the course of policy is dictated by inferior instruments (ie. models) in which action depends upon the direction and magnitude of the deviations of actual unemployment from u* and of the estimated real rate of interest from r*. But the problem is that neither of the two stars nor the potential rate of growth of the economy are known with any degree of certainty.[1] Thus it is hard for policy makers to know exactly where the economy currently stands in terms of these conceptual anchors. The problem is doubly difficult because the anchors also have moved over time.[2] It is also important to note at this point in the discussion that Powell omits any mention of the policy tools that the FOMC has in its tool kit or how they are linked to changes in the deviations of the actual economy from u*, r*, or potential growth.

So, if policy makers don’t know exactly where the economy lies relative to these key variables, what are they to do? Put another way, a skeptic would say that the models aren’t working – and this is what Powell is indirectly saying. So, in the face of this conundrum, what does a practical policy maker like Chairman Powell do? His answer is to fall back on risk management, which says go slowly, be observant, and be prepared to act. In the current economic environment of steady growth, low inflation, and low unemployment, this means the FOMC should continue with gradual tightening, since policy is still accommodative, but be prepared to change if inflation and, importantly, inflation expectations change.

Overall, this was a speech that was clear, honest, and pragmatic. Some might have wanted more, especially since stargazing isn’t working too well, but Powell has laid out clearly what the conceptual problems are and how the Fed is proceeding.

Robert Eisenbeis, Ph.D.
Vice Chairman & Chief Monetary Economist
Email | Bio


[1] Indeed, the error bands around estimates of these parameters are quite wide.
[2] As an aside, this is part of the reason that President Bullard of the St Louis Fed has argued that regime shifts make policy formulation and forecasting very difficult.


Links to other websites or electronic media controlled or offered by Third-Parties (non-affiliates of Cumberland Advisors) are provided only as a reference and courtesy to our users. Cumberland Advisors has no control over such websites, does not recommend or endorse any opinions, ideas, products, information, or content of such sites, and makes no warranties as to the accuracy, completeness, reliability or suitability of their content. Cumberland Advisors hereby disclaims liability for any information, materials, products or services posted or offered at any of the Third-Party websites. The Third-Party may have a privacy and/or security policy different from that of Cumberland Advisors. Therefore, please refer to the specific privacy and security policies of the Third-Party when accessing their websites.

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Tariffs & Draining the Swamp?

Mr. David Malpass, at the US Treasury, will meet with Chinese Commerce Minister Wang Shouwen in late August. This is excellent news.

Dennis Gartman beat me to this on Thursday morning. I’m in complete agreement with Dennis’ assessment:

“Mr. Malpass, as everyone should remember, is an old Wall Street ‘hand,’ for he was at one time Bear Stearn’s Chief Economist. He served in the Reagan and Bush administrations in various positions of economic authority and has been a close economic advisor to President Trump before being given the position of Under Secretary of the Treasury for International Affairs. His are capable hands.”

Over the years I’ve spoken with David Malpass from time to time. He is and was always gracious. And his skill set is deep. He was a very early economist addition to candidate Trump’s team. He has made thoughtful policy arguments while carefully avoiding the political infighting.

While I personally do not agree with Peter Navarro’s broad tariff approach and believe it has done a disservice to POTUS and to the US, I have to confess some relief and new encouragement at seeing David Malpass now prominently added to the Kudlow and Lighthizer negotiating team which is now led by Treasury Secretary Mnuchin. The outlook is starting to offer hope for a positive turn in the US versus China trade war.

Why did I list the US first and not alphabetically in the previous sentence? Because we started the war, that’s why. We followed the Navarro script and now we have a mess which the new team must straighten out.

Below is a list of the top 20 countries ranked by GDP. Look at it and count all those involved in protectionism and tariffs that have been expanded or enlarged in 2018. Count the USA first, since we are now involved in tariffs and retaliatory tariffs with most of the globe (if we measure by GDP). Yes, some tariffs and trade barriers have been around for years. But, on the whole, the WTO had accomplished a global reduction. Until 2018.

Here is the chart, courtesy of Brent Donnelly of HSBC.

Chart, courtesy of Brent Donnelly of HSBC

Is the tariff war peaking? We don’t know. Is it starting to show up in anecdotal inflationary evidence? Yes. Is it slowing growth? Yes. Is it exacerbating credit risk? Maybe.

The important thing to know is that the Mnuchin-led team has the skills to see and understand the dangerous effects of growing protectionism, and we may begin to see damage control and a shift away from the harmful direction in which we’ve been headed.

Time will tell, as preparations and negotiations leading to a Trump-Xi November summit unfold.

Let’s move to an insightful post by Xi Sun, entitled “Will US-China trade war reshape global value chains?” We thank Lyric Hughes Hale for making it available via her EconVue site. Lyric is a longtime friend who has contributed economic and political affairs commentary to a broad range of publications and who, with her late husband, David Hale, coauthored the book What’s Next? Unconventional Wisdom on the Future of the World Economy, as well as the influential article “China Takes Off,” published in Foreign Affairs in 2003. She is a member of the Council on Foreign Relations and has served on numerous boards.

Here’s the link to her site: https://www.econvue.com/pulse/will-us-china-trade-war-reshape-global-value-chains.

Tariffs beget tariff exemption applications; and as the following article in the National Review states, “Their proliferation has empowered government bureaucrats ill-suited to the task to pick industry winners and losers.” https://www.nationalreview.com/2018/08/tariffs-bad-government-exemptions-worse/

The backlog of exemption applications has grown to over 20,000, and the swelling Dept. of Commerce bureaucracy must review and decide each one – but without the industry expertise necessary to balance the arguments being made (though they have plenty of input from Washington lawyers and lobbyists). What generally happens is that the players with the deepest pockets and most political clout prevail. The Wall Street Journal has remarked, “Far from draining the swamp, tariffs feed the swamp.”

Thus, the Navarro policy recommendations to POTUS have created an entire new, costly, and nonproductive government intervention into Americans’ businesses and lives. We can only hope the Mnuchin-led Kudlow, Malpass, & Lighthizer team can control and reverse this damage. We will close with a link to another instructive chart on the present and future global economy. Hat tip, Steve Blumenthal. Think about this trajectory and please consider how and where protectionism fits in. Or where it doesn’t. https://twitter.com/sblumenthalcmg/status/1031121108865622017




CDC Foundation President Dr. Judy Monroe

“Is there a vaccine now for Zika?” I asked Dr. Judy Monroe, president-CEO of the CDC Foundation. “Not yet, but we’re working on it,” she answered. For a YouTube of my interview with Judy when she visited Camp Kotok, see https://youtu.be/rge2tC74kSc.

CDC Foundation Dr Judy Monroe & David Kotok

Judy was a special guest this year when we gathered in Maine. She told the assembled 50 folks about the CDC Foundation, a congressionally authorized 501c3 that operates in close cooperation with the Centers for Disease Control. The foundation’s efforts are entirely supported by philanthropy, while the CDC is, of course, a federal organization funded by taxpayers.

Judy explained that the foundation has a well-defined global healthcare role and can be reactive in crisis. The foundation has programs in 130 countries. The Ebola effort was an example of rapid foundation response. Early this month, the foundation was honored by the Puerto Rico Department of Health for emergency response support in the wake of Hurricane Maria.

We discussed Zika and the Caribbean and specifically Puerto Rico. Our group at Camp Kotok probably has over a billion dollars invested in PR debt, property, hotels, etc. Judy shared her findings and the foundation’s and CDC’s ongoing efforts for Zika prevention, treatment, and research.

Judy’s presentation was enlightening, as many in our group did not know about this philanthropic ally of the CDC. Now they better appreciate how many lives are saved globally and how 300 million Americans gain health safety through the work of the CDC and CDC Foundation. We thank Judy for making the trip to Maine to share her information with us.

Another attendee at Camp Kotok, Katie Darden, also spoke one-on-one with Dr. Monroe and you can find the link to her interview here:


Katie Darden interviews Dr Judy Monroe

For CDC Foundation Zika updates and current status, see their blog which gives a closer look at how the CDC Foundation brings together resources, people and ideas to advance the CDC’s work, https://www.cdcfoundation.org/blog

For Dr. Judy Monroe’s bio, see https://buff.ly/2Mn0AZR

For our previous commentaries on Zika, see the following links:
“Zika Update” July 13, 2018 (http://www.cumber.com/zika-update-july-13-2018/)
“Zika Update: Brace for a Resurgence,” Nov 1, 2017 (http://www.cumber.com/zika-update-brace-for-resurgence/)
“Zika Update,” July 1, 2017 (http://www.cumber.com/zika-update-3/)
“Zika Update,” March 8, 2017 (http://www.cumber.com/zika-update-2/)
“Cuba & Zika,” October 16, 2016 (http://www.cumber.com/cuba-zika)
“Zika, Cuba, and American Politics,” October 4, 2016 (http://www.cumber.com/zika-cuba-american-politics/)
“Answering a FAQ on Zika Vote,” September 7, 2016 (http://www.cumber.com/answering-a-faq-on-zika-vote/)
“Zika, Congress, and Damaged Lives,” September 7, 2016 (http://www.cumber.com/zika-congress-and-damaged-lives/)
“Zika 4,” September 6, 2016 (http://www.cumber.com/zika-4/)
“More of the Costs of Political Failure on Zika,” Aug 12, 2016 (http://www.cumber.com/more-on-the-costs-of-political-failure-on-zika/)
“Zika Politics: Democrats & Republicans,” August 2, 2016 (http://www.cumber.com/zika-politics-democrats-republicans/)
“Zika Update,” July 19, 2016 (http://www.cumber.com/zika-update/)
“The Zika Virus and the US Congress,” May 23, 2016 (http://www.cumber.com/the-zika-virus-and-the-us-congress/)

David R. Kotok
Chairman & Chief Investment Officer
Email | Bio


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The Ball Is Rolling

August has brought welcome news for the Commonwealth of Puerto Rico and for creditors eager to see a resolution to the bankruptcy process that started more than two years ago with the passage of the Puerto Rico Oversight, Management, and Economic Stability Act (PROMESA).

Market Commentary Puerto RicoThere is now a restructuring agreement for Sales Tax (COFINA) bondholders and a court decision validating the powers of the Fiscal Oversight and Management Board (FOMB), as well as a restructuring proposal for the Puerto Rico Electric Power Authority (PREPA), all of which offer reason for optimism. These developments join the restructuring of the Government Development Bank (GDB), along with better-than-expected economic conditions.

When observers look back at the bankruptcy of Puerto Rico, they will point to the restructuring of COFINA as a major milestone. The formal agreement between the FOMB, the government of Puerto Rico, and both senior and junior creditors as well as monoline insurers marks a momentous step forward. It follows months of court-supervised mediation efforts. As part of the arrangement, COFINA bondholders have agreed to give up a portion of sales tax revenues to the Commonwealth: 53.65% of the Pledged Sales Tax Base Amount on a “first-dollar” basis would back new COFINA securities, while 46.35% would flow through to the Commonwealth. The disclosed term would see existing bondholders receive new senior lien bonds secured by the 5.50% sales-and-use tax (SUT), with recoveries of 93% for senior bondholders and 56% for subordinate bondholders. The accrued COFINA interest currently held in escrow will go to COFINA bondholders, with final disbursements between senior and junior bondholders still to be determined. In light of the circumstances, we believe this is a good outcome for bondholders as well as the Commonwealth, as the deal provides approximately $17.5 billion in debt-service savings. Execution risks do remain, and terms can change, so this is still far from a done deal.

In addition to the COFINA agreement there was Judge Swain’s August 7th decision affirming the authority of the FOMB over the Commonwealth’s budget and fiscal plan. The Commonwealth had challenged the powers of the FOMB for a number of reasons, including budgetary actions. As the judge wrote in her decision, “The power bestowed on the oversight board by Section 205(b)(1)(K) of PROMESA allows the oversight board to make binding policy choices for the Commonwealth, notwithstanding the governor’s rejection of Section 205 recommendations.” She held that while the board has the power to implement a budget or policy, it does not have the “power to affirmatively legislate.” The decision is a blow to the Commonwealth that will likely be challenged on appeal. The decision is significant, as it affirms the FOMB’s powers and will hopefully clear the road to the restructuring of the Commonwealth’s general-obligation debt at some point in the future.

Following congressional hearings and well-publicized turmoil involving PREPA’s top post, a tentative deal between the Commonwealth, the FOMB, and creditors holding roughly $3 billion of PREPA debt was also announced. Under the terms, creditors would receive two series of bonds. The first tranche would provide a recovery of 67.5%, and the second tranche would be a “hope” note at a recovery of 10%. Combined, this would be a total recovery of 77.5%, assuming the “hope” notes pay off. While not the 85% recovery outlined by the previous restructuring agreement that the FOMB scuttled, it is at least in the parking lot if not the ballpark. The terms have not been sufficient to entice monoline insurers on board, so we will wait to see how the situation develops.

Prices of both insured and uninsured debt have risen in accordance with these developments. Uninsured debt, specifically that of COFINA, has seen some of the most dramatic price increases. We still believe carefully selected insured paper offers value, and we continue to take advantage. As with most things in Puerto Rico, though, we view new developments with a grain of salt. Execution risks remain, but at least the ball is rolling. The path is now a little clearer, and the end is a little closer, but there is still a long journey ahead.

 

Shaun Burgess
Portfolio Manager & Fixed Income Analyst
Email | Bio


Links to other websites or electronic media controlled or offered by Third-Parties (non-affiliates of Cumberland Advisors) are provided only as a reference and courtesy to our users. Cumberland Advisors has no control over such websites, does not recommend or endorse any opinions, ideas, products, information, or content of such sites, and makes no warranties as to the accuracy, completeness, reliability or suitability of their content. Cumberland Advisors hereby disclaims liability for any information, materials, products or services posted or offered at any of the Third-Party websites. The Third-Party may have a privacy and/or security policy different from that of Cumberland Advisors. Therefore, please refer to the specific privacy and security policies of the Third-Party when accessing their websites.

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Something Fishy

Let’s see. An American company with American employees catches fish. It ships the fish to China. China imposes a tariff or retaliatory tariff when the fish arrives from America.

Market-Commentary-Cumberland-Advisors-Trade

A Chinese company processes the fish and creates frozen fish sticks. The company in China is an American investment, and the labor in China is available at low cost. The American company cannot find that labor force in America even if it is willing to pay a much higher wage cost than it pays to employ Chinese workers.

The frozen fish sticks are shipped back to America. The US imposes a tariff or retaliatory tariff.

You go to the supermarket and buy the frozen fish sticks. The price is higher. That is all that has changed in the fish stick business since the trade war began. Note that American fish exports approximate $1 billion a year.

Folks, tariffs and retaliatory tariffs like this amount to a sales tax imposed on the American consumer and a penalty imposed on American companies with American workers.

Peter Navarro, trade war adviser to POTUS, please explain this policy that you are scripting in the name of the national security of the United States.

Readers, ask your congressional representative and your Senator why they have delegated their congressional responsibilities to POTUS. Raising tariffs and taxes is a job that historically belongs to Congress. Letting a POTUS, any POTUS, impose tariffs unilaterally under a dubiously broad definition of “national security” seems a little fishy to me.

For details on the tariff impacts on the fish industry, see “Fish Caught in America, Processed in China Get Trapped by Trade Dispute” (https://www.wsj.com/articles/u-s-seafood-industry-vulnerable-to-tariffs-aimed-at-china-1533812400). The whole story of tariff impacts on food production and on consumers is, of course, much broader. As China Daily recently tweeted, “US farm sector will suffer greatly due to the loss of the huge Chinese market.” (See tweet and attached video report: https://twitter.com/chinadailyusa/status/1028090398160314368?s=11.

Trump is, of course, zapping the world with tariffs like a sorcerer’s apprentice, drawing upon powers he believed to be vested in him by the sorcerer’s hat of Section 232 of the Trade and Expansion Act of 1962. Section 232 “allows the president to adjust imports without a vote by Congress should the Department of Commerce find evidence of a national-security threat from foreign shipments.” (See https://www.bloomberg.com/news/articles/2018-05-24/trade-as-national-security-issue-here-s-the-u-s-law-quicktake.) Defining all sorts of things as matters of “national security” broadens the president’s powers far beyond the likely intentions of those who enacted the act in 1962, and it supplants the role of Congress.

There is at least one substantive effort afoot to ensure congressional oversight of the president’s use of Section 232: https://www.rollcall.com/news/politics/corker-unveils-plan-give-congress-power-stop-trump-trade-actions.

As the Trump–Navarro trade war heats up and its impacts widen, Bloomberg reports trouble on a different front: “Walt Disney confirms that its Winnie the Pooh movie Christopher Robin has been denied release in the world’s second-biggest film market” (https://bloom.bg/2MhiX1e). We leave it to readers to decide whether the banning of the film has to do with the trade war or perhaps with memes likening President Xi to Winnie the Pooh.

My point is that trade war has many dimensions. It is hurting American business and costing American jobs and raising America’s consumer prices. It is a failed policy crafted by POTUS’s trade adviser Peter Navarro, who is seen by many as a fringe and extreme economic professional. His early forecast and his promises for this Trump policy are being proven wrong by outcomes, as we now have the US facing growing dislocations.

But will Navarro have his way? Bloomberg reported that Mnuchin and Kudlow and Lighthizer were in the last negotiation with Chinese, and Navarro was not in the room. He was huffing loudly outside:

“Tired of the confusion, China asked the U.S. for one person with whom to negotiate economic matters. Trump designated Mnuchin to be the point person, which, according to multiple sources, was fine with Chinese officials, who preferred dealing with the moderate Treasury secretary. But in May, when Mnuchin traveled to Beijing for negotiations, Trump also dispatched Ross, Lighthizer, Navarro, and Kudlow to accompany him. (A Treasury spokesman says Mnuchin asked Ross and Lighthizer to join.) Predictably, there were tensions within the U.S. delegation. A White House official says Mnuchin and Navarro argued repeatedly, including in rooms where the Chinese could hear them.

“Their dispute, two sources say, escalated when Mnuchin insisted on meeting one-on-one with Chinese Vice Premier Liu He, President Xi Jinping’s chief economic adviser. Navarro wandered around outside sulking.” (https://www.bloomberg.com/news/features/2018-08-09/how-to-be-trump-s-treasury-secretary-starring-steven-mnuchin)

One senior official characterized the conflict between Mnuchin and Navarro over US trade policy with China as “a terrible mess,” according to a May report in Politico: https://www.politico.com/newsletters/morning-money/2018/05/17/navarro-situation-a-terrible-mess-221249.

These reports suggest that Navarro could soon prove a casualty of his own failed policy, and that Trump will soon alter the trade war bellicosity as he realizes that the collateral damage threatens the Republicans in the midterm elections. Meanwhile, trade war effects continue daily and will show up soon in macro numbers. Our hunch is that US GDP, profits and earnings growth rates peaked in Q2. We have a cash reserve in US ETF and US core ETF portfolios.

David R. Kotok
Chairman and Chief Investment Officer
Email | Bio


Links to other websites or electronic media controlled or offered by Third-Parties (non-affiliates of Cumberland Advisors) are provided only as a reference and courtesy to our users. Cumberland Advisors has no control over such websites, does not recommend or endorse any opinions, ideas, products, information, or content of such sites, and makes no warranties as to the accuracy, completeness, reliability or suitability of their content. Cumberland Advisors hereby disclaims liability for any information, materials, products or services posted or offered at any of the Third-Party websites. The Third-Party may have a privacy and/or security policy different from that of Cumberland Advisors. Therefore, please refer to the specific privacy and security policies of the Third-Party when accessing their websites.

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Turkey Tumbles, Financial Markets Are Unnerved

The Turkish lira is down more than 40% year to date, with Friday’s fall alone reaching 18.5% at one point and ending down 14.3% for the day. While Turkey’s economy is not large, some major European banks have big exposures in non-lira loans.

Market Commentary - Cumberland Advisors - Turkey Tumbles
The European Central Bank is reported to be concerned about the vulnerability of such banks, in particular, BBVA, Unicredit and BNP. Investors do not believe that the Turkish government under the strong-arm rule of President Erdogan is likely to take the actions needed to avoid a hard landing for the Turkish economy.

The unprecedented dispute between the Turkish and United States presidents, despite their being NATO allies, about the detention of a pastor from North Carolina has rattled markets in recent days. There are other elements in the dispute, including other Americans being held hostage and Turkish anger at American support for Kurdish rebels in Syria. Trump’s use of sanctions and tariffs risks hardening Turkey’s position.

The economic problems facing Turkey, however, are of a longer-term nature, evidenced by the dramatic fall in the lira over the past five years. The economy under Erdogan’s rule has binged on low-cost short-term foreign currency debt and is seriously out of balance. The country’s heavy consumption and construction orientation needs to be moderated. Up to the June election investors had been comforted by the technocratic managers of Turkey’s economy who were seen as a check on Erdogan’s lack of knowledge of economics. After the election, Erdogan appointed his son-in-law in charge of the finance ministry and increased the power of that ministry. Investor confidence understandably declined. Turkey’s nonfinancial institutions will have to pay or roll over some $66 billion in foreign currency debt during the next 12 months. Turkish banks will have to do the same for $76 billion, a formidable challenge.

The government announced a “new economic plan” Friday, but so far there have been few details released. Erdogan vowed to fight an “economic war” and asked Turkish citizens to sell dollar and other assets and buy lira to support the currency. We do not expect many will heed that call. Engaging in a tariff and sanctions battle with the US surely is not a solution. Turkey could raise interest rates, which are far too low in view of Turkey’s high rate of inflation, but Erdogan is adamantly against this move, arguing that high interest rates increase inflation. Turkey could go to the IMF and seek support. But asking for help would be counter to Erdogan’s pride, and more importantly the IMF would demand that Turkey agree to tight fiscal and monetary policies, just the policy moves Erdogan has been strongly opposing. Erdogan has ruled out this option. There are rumors that capital controls are being considered, but such a move would likely only cut off foreign lending to and investing in the country. The option that seems most likely is for the government to hope that its new economic policies, which may include some modest monetary and fiscal tightening, in conjunction with the slower economic growth that now is expected, will be sufficient and that the storm will pass. We fear a more negative outcome, a hard landing that eventually drives the country to the IMF.

Financial markets are concerned, rightly in our view, about the risks of contagion from this situation. Bank stocks in Europe are being hit, and this has led to losses in broad European market indexes. The iShares MSCI Eurozone ETF, EZU, lost 2.87% Friday and the iShares MSCI Germany ETF, EWG, dropped 3.03%. The iShares MSCI Turkey ETF, TUR, tumbled 15.53% on Friday and is down over 50% year to date. Fortunately, we do not hold the Turkey market ETF in our International and Global ETF portfolios.

Emerging markets around the globe have also been hit. The Vanguard FTSE Emerging Markets ETF, VWO, declined 1.99% Friday with some individual markets such as Mexico and Brazil declining more than 3%. The European banks that have heavy exposure to Turkey have also lent heavily to other emerging markets. Emerging markets can be hit severely when investors retreat from risky assets. Should the decline in emerging markets become substantial, even markets with good prospects can suffer as investors sell profitable investments to cover their losses. As Turkey’s crisis and its negative effects on emerging markets are not likely to be resolved quickly, we have reduced the weight of emerging markets in our International and Global ETF portfolios and increased cash positions.

Late Sunday, Turkey’s central bank reduced reserve requirements and modified banks’ liquidity management rules. Treasury and Finance Minister Albayrak ruled out exchange controls. There was no mention of raising interest rates. The lira declined further in early trading.

Bill Witherell, Ph.D.
Chief Global Economist & Portfolio Manager
Email | Bio

_____________________________________________________________________

Sources: Financial Times, BBH.com, The Economist, CNBC.com, Bloomberg.com


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