Congressional Panel Confirmed for February 22

We have now confirmed a bipartisan congressional panel for the February 22 “Cuba and the Caribbean: What Now?” event. Florida Congressman Carlos Curbelo, whose district includes the Keys, which bore the direct hurricane hit, is joined by Virgin Islands Congresswoman Stacey Plaskett. The moderator of this session is Ben White, journalist from Politico and CNBC political correspondent.

What now, Cuba - USF Sarasota-Manatee

The full program and registration information can be obtained with this link: https://www.wusf.usf.edu/cuba_and_the_caribbean_what_now.

This full day is designed to inform a broad range of people — tourists, travel agents, investors, policy wonks, and weather-forecasting folks. And those who wish to think about the government’s responsibility and actions in the hurricane-damaged parts of Florida or Texas or Virgin Islands or Puerto Rico or Cuba or elsewhere in the Caribbean, this program is for you.

The event costs only 50 bucks, and that covers lunch. This open forum is made possible by USF Sarasota-Manatee, the Atlanta Fed Americas Center, and the Global Interdependence Center. All media are welcome to cover the panel, and the entire community is invited.

Cumberland Advisors provided a grant to USF Sarasota-Manatee and to GIC to assist this event aimed at public education. Please come.

Cumberland Advisors is a proud sponsor of the Global Interdependence Center.




Inflation and Fed

Don Rissmiller is a Camp Kotok fishing pal, the new chair of the Global Interdependence Center, and a senior personality at Strategas. He is also one very thoughtful economist.

In his Weekly Economics Summary published last week, Don sets forth a serious analysis of inflation and the Fed’s 2% target. He outlines his arguments succinctly. And he ends with a series of questions about what the inflation target should be and whether there are options. Don captures the arguments that several members of the Fed’s FOMC have articulated. We expect this subject to be discussed this week. Clearly, the new Powell Federal Reserve will have to engage in this debate. We asked Don for permission to quote his piece extensively and share it with our readers, and we thank him for saying yes.

Don Rissmiller of Strategas follows:

“So, we continue to write about inflation, not because inflation is high (or likely to be high any time soon). Instead, we are moving from low levels to a little less low – and while there’s reason to believe that’s not a problem for the stock market (where nominal growth will boost revenue and earnings), there remain issues in the bond market.

“There’s also an opportunity for the Fed and other central banks to consider the recent past, and with the global economy now in pretty good shape (eg, U.S. real GDP 2.6% q/q annual rate in 4Q, and the tax cut coming), study if anything should be done differently. The topic of the inflation target is likely to continue to attract attention.

“Put bluntly, should the inflation target be precisely 2%? We have noted previously that the Fed’s goal of 2% inflation seems so familiar that it frequently goes without question that it is a ‘good’ target. But recent academic literature has continued to question whether that 2% number is correct. The 2% inflation target could be too low, and the push to achieve this ‘too-low’ target (over numerous decades) helps explain some of the unique issues in this business cycle.

“One key issue is that there is not a great reason for the inflation target to be precisely 2%. The Fed’s mandate is ‘price stability.’ If ‘price stability’ has to be translated into a number, one might pick 0%, rather than 2%. There has (for quite some time) been concern that inflation is not measured correctly, but the concern was (and is) that price indexes yield numbers that are too high rather than too low.

“Out-going Fed Chair Janet Yellen had a conversation with Alan Greenspan on this topic in the 1990s, where she argued against pushing inflation all the way to zero. Given the inability to measure inflation correctly, as well as the desire to have some cushion against deflation, 2% became the number. To make matters more complicated, this 2% number has caught on around the globe (central bankers frequently talk to each other, attend the same schools, attend the same conferences, etc).

“There has been some survey work suggesting that consumers are comfortable around a 2% inflation rate. But these surveys generally cover consumers’ experience with an inflationary past (eg, the 1970s). When inflation is already low, or deflation present, it is not clear that these results are robust. Even if ‘around 2%’ is the right answer, ‘exactly 2%’ or ‘2% as a ceiling’ could have unintended consequences.

“So, how could 2% be too low? Put simply, there still appear to be too many central banks that are stuck at the ‘zero-bound’ (or slightly below, based on recent experiments with negative interest rates). That’s a key piece of evidence that something is amiss. With a 2% inflation target, if policy rates are cut to zero, there’s a -2% real rate to help kick the economy out of its doldrums. If the inflation target were instead 4%, a zero nominal rate would equate to a -4% real rate (ie, a bigger kick). The fact that many central banks are still at (or close to) the zero bound suggests that the ‘kick’ given to the economy this cycle was simply not big enough initially. There are certainly costs and benefits, but it’s worth noting that the historical average of U.S. CPI inflation is 3.5% (ie, the economy has functioned adequately at creating wealth, etc. with inflation above 3%).

“There are alternatives like price level targeting or nominal GDP targeting which could also guide monetary policy. The idea that something needs to change seems to be gaining traction, regardless. Fiscal policy, of course, is an alternate solution but the recently passed U.S. tax bill means some of this stimulus is coming early.

“Given the maturing U.S. business cycle, rates may not stay in positive territory long – that is the consequence of starting out with a limited ability to pull the real economy back up (ie, an inflation target that’s too low). This final point helps explain why the Fed has been so focused on financial developments – the FOMC wants to know when the market is doing the tightening for them. For now, financial conditions remain easy, but this is likely to remain on the Fed’s radar for some time to come.”  Many thanks again to Don.

As for President Trump, SOTU, market volatility, and deploying the cash reserve, we will hold those words for another discussion.

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




Geography Matters

Strategas Research has compiled the year-to-date (through January 25) returns of major global equity markets. They point to Hong Kong and Brazil as the leaders, with returns YTD of around 10%. Of the others in the largest 20 markets, only two, Australia and the UK, were slightly negative. For reference, the United States was about 6% positive in the same time period. Strategas notes that this upward path occurred in the face of a rising trend in interest rates worldwide, US dollar pressure, and a rising gold price.

Strategas’ excellent research is a regular component of our reading list. They like the banks and the energy patch. So do we – both sectors are overweighted in our US ETF portfolios. We anticipate that will continue, but we must remind readers that our clients know our position can change at any time.

A geographical issue that was surfaced by Strategas caught our attention. They compared the returns of S&P 500 companies headquartered in Florida with those of S&P 500 companies headquartered in Illinois. They used the last decade as the reference period, so the starting time is January 1, 2008, in the thick of the financial crisis. In this piece of research brilliance, Strategas used equal weighting for performance measurement. The idea behind equal weighting is to look at the companies on a relative basis and not have a single dominant large company distort the comparison. Their surmise is that companies in states with “more favorable operating environments” will have relatively better share price performance (suggesting better earnings).

During the decade, Florida-based companies had a relative outperformance of about 50% over the companies in Illinois. That is a spectacular observation. We can argue about why the disparity occurred. Illinois critics point to budget failures, high taxation, and poor state debt management. But Florida’s critics talk about hurricane risk and major coastline issues, including rising sea levels. So the debate about the Illinois–Florida comparison is a multidimensional one.

Let’s set aside the debate over “why” and just draw an inference based on performance. Clearly Florida outperforms Illinois, suggesting that Florida is likely to be a preferred destination for businesses – and there is little likelihood that will change. The trend seems to be strongly embedded.

The new tax bill may work to widen the divide among states. The alteration of state and local income and real estate tax deductibility hits the executives of companies, their managers, and their employees. Over time, decisions will favor states that offer economic incentives. Thus we can expect an acceleration of migration from poorly performing states to the better-performing ones. It is not just Florida. For example, there are reasons that Utah is booming. And there are reasons that some states are barely staying even while the United States as a whole is undergoing an economic recovery.

That poor relative performance has implications for the creditworthiness of those states. Cumberland’s muni research team is tracking those states closely.

Yes, geography matters a lot. Whether globally or domestically, it is a factor in investment decisions or should be for any market agent willing to do the work. We congratulate Strategas Research for creating an index of corporate performance by state and using it to compare relative results.

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


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Trade, Dollar, Trump

“In the long run we are all dead” was John Maynard Keynes’ famous criticism of economic models. The rest of the quote goes, “Economists set themselves too easy, too useless a task, if in tempestuous seasons they can only tell us, that when the storm is long past, the ocean is flat again.” We thank Nick Colas and Jessica Rabe of Datatrek for the full quote of Lord Keynes. We find ourselves looking at Nick and Jessica’s daily missives with regularity. Here is their website: http://datatrekresearch.com.

So, is a dollar crisis coming? Are protectionist forces at work? Will that be the storm source described by Keynes? “Obviously a weaker dollar is good for us as it related to trade and opportunities.” Thus said US Treasury Secretary Mnuchin in Davos.

“The dollar is going to get stronger and stronger, and ultimately I want to see a strong dollar,” said President Donald Trump. Trump spoke right after Mnuchin made his remarks.

Peter Boockvar of Bleakley Advisory Group reminded readers that in April 2017 Trump said, “I think our dollar is getting too strong, and partially that’s my fault because people have confidence in me. But that’s hurting, that will hurt, ultimately.… It’s very, very hard to compete when you have a strong dollar and other countries are devaluing their currency.”

Is it any wonder that markets have been whipsawed by this mixed message about the world’s reserve currency from the president and the Treasury secretary of the United States? Is it any surprise that volatility measures rose?

Students of history are encouraged to focus on the dollar’s course since the collapse of the post-World War II, Bretton Woods fixed-exchange-rate regime. That collapse came in the 1970s during the Nixon presidency. History may not perfectly repeat, but it does rhyme, as the aphorism frequently attributed to Mark Twain goes. We think currency-related risk is now rising again.

Couple a mixed message on the dollar with rising protectionism, the imposition of tariffs, withdrawal from trade agreements, and threats made against our largest trading partners, Canada and Mexico, and the pot threatens to boil over.

Yes, there are tax-cut benefits coming; and, yes, global stock markets have been on a celebratory tear. We have been bullish and have participated in them.

But also yes to history as a guide that currency weakness and trade barriers work to raise inflation and to slow economic growth.

We suggest that readers take time to review the lessons from 1970–72. Specifically, read about comments made and policy originated by the French finance minister, Giscard d’Estaing, and US Treasury Secretary John Connally. I was a new and solo investment adviser in the years before Cumberland was founded (in 1973), and I recall vividly the negotiations and the volatility of the US dollar and other currencies and how they impacted markets. I specifically recall the fiery exchange between the two men in a Paris meeting.

Yes, history can guide those who take the time to learn from it. It does rhyme.

We have put a cash reserve in place. We are not fully invested in our US ETF portfolios. We are taking a pause in this bull market. We want to digest this anti-trade rhetoric and this dollar-value mixed message.

Of course, we could alter that position at any time. Trump’s speech this morning was presidential and well delivered. His Q&A excellent and he didn’t stray off message. Now if he doesn’t tweet away the gains, he may be able to build positively on this visit to Davos. We shall see. Meanwhile a little cash seems appropriate.

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 San Diego

Dear Readers,

We had the wonderful opportunity to present the Heldring Award to Boston Fed president Eric Rosengren at the GIC meeting in San Diego, held on Friday, January 12, at the Rady School of Management. This is GIC’s second year in San Diego but the first time in partnership with Rady, which provided a first-rate venue.

The conference theme was “Money, Models and Digital Innovation” and included cryptocurrency issues and discussion of the outlook for the economy and interest rates and volatilities. Speakers included President Rosengren, Dave Altig of the Federal Reserve Bank of Atlanta, Don Rissmiller of Strategas, and Nobel Prize winner Harry Markowitz, professor of finance at Rady.  Imagine the thrill; we had lunch Harry M.  He is super sharp, quick wit and does it at age 90.

We are sharing links below so that you can join, after the fact, the 75 or so of us who packed the Rady business school to enjoy the excellent presentations. Links include the presentations themselves, press coverage, the Rady business school blog post about the event, attendees’ comments, and a photo of the award presentation.

The presentations: https://www.interdependence.org/events/browse/programs/gic-frederick-heldring-award-global-leadership/.

The press coverage: https://www.interdependence.org/news/money-models-digital-innovation/.

The blog post that the Rady School shared on January 17: https://t.co/7VaTuMfmWr.

Feedback from the guests, collected here in PDF format: Attendee Feedback

Photo of the award presentation with GIC’s board/advisory council members: http://www.cumber.com/wp-content/uploads/2018/01/Award-to-Rosengren.jpg.

Note that all GIC events may be found at www.interdependence.org. Next up for us is the event in Sarasota on February 22, when we will examine the issues surrounding Cuba and the Caribbean. The detailed presentations will include commentary on hurricanes and geopolitics, energy, and recovery. For the detailed agenda and registration see http://usfsm.edu/event/cuba-and-the-caribbean-what-now/.

Note that all GIC events may be found at www.interdependence.org. Next up for GIC is the event in Sarasota on February 22, examining the issues surrounding Cuba and the Caribbean. The detailed presentations will include commentary on hurricanes and geopolitics, energy, and recovery. I will deliver the opening remarks and Jill Fornito whom many of you have come to know at Camp Kotok events will be in attendance. For the detailed agenda and registration see http://usfsm.edu/event/cuba-and-the-caribbean-what-now/. The small collage shown here was made from Sharon Prizant’s photos taken during a brief discovery trip to Cuba. She’ll be happy to share many more if you’re able to make this event in Sarasota.

Visit Cumberland Advisors website to see pictures documenting the struggles of the Florida Keys after Irma and a handful from inside Cuba.

Cumberland Advisors is a proud sponsor and member of the Global Interdependence Center.

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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Potential Fed Vice Chairman

Reports are that John Williams, president of the Federal Reserve Bank of San Francisco, has been targeted as a potential candidate for Fed vice chairman. President Williams is scheduled to vote as one of the five sitting reserve bank presidents on the FOMC in 2018. What would his appointment mean as far as the Fed and FOMC policy is concerned?

First and most importantly, John is a first-rate monetary economist who has been in the Federal Reserve System his entire career, spanning more than 20 years. He spent four years at the Board of Governors before returning to his native California. He held various research positions at the Federal Reserve Bank of San Francisco before transitioning from director of research to president in 2011. Unlike some reserve bank presidents, he has maintained an active research agenda in addition to authoring many communications on Fed policy via the Bank’s outreach publications.

Because of his background, he is intimately familiar with the system, the Board of Governors, the policy environment, and all that was involved in the financial crisis and subsequent recovery. In this sense, John might be viewed as an ultimate insider candidate, even more so than Marvin Goodfriend, who is awaiting confirmation as a governor. These two would address the departures of economists on the Board, but with people whose policy views are basically consistent with policies that have been pursued since the end of the crisis.

Former Chairman Bernanke suggested at a January 2018 Brookings meeting that incoming Chairman Powell would likely “commission” an internal study of alternatives to targeting a 2% inflation rate. To that point, President Williams commented at that same meeting that he would be open to other alternatives. One alternative he had been asked to comment on, presumably because of previous research and speeches he gave, was price-level targeting. His discussion at that Brookings conference points to two assets that President Williams would bring to the Board. First is a willingness to examine evidence and critically evaluate past polices. What has worked and what has not worked?  Second is an openness to new and alternative approaches to policy.

Some register concern that President Williams is an insider because they fear he may be subject to groupthink when it comes to FOMC policy which has become one criticism of policy lately. However, his speeches and writings evidence his willingness to dig into the data to better understand why the models are breaking down and why inflation has remained persistently below target. For example, in recent speeches he has focused on reasons why the economy may be likely to grow more slowly, such that the equilibrium real rate may be as low as 0.5%. Here he has conducted recent research that supports this view of the real rate rather than relying upon the work of others. With respect to the inflation objective, he and the staff of the San Francisco Fed have done a deep dive into the components of inflation to identify which components may be providing better signals about true underlying inflation trends and which may be clouding the measurement of inflation. They have concluded, for example, that component prices that tend to move in sync with movements in the economy have apparently recovered. Whereas prices for items less sensitive to general movements in the economy, such as cell phone services, airline tickets, and healthcare, etc., have either fallen or tended to remain low.(1)

As for where President Williams may stand on the issue of the desirability of continuing the FOMC’s 2% inflation objective, Chairman Powell might find in him a partner willing to reassess the FOMC’s 2% inflation objective, as part of both evaluating existing policy and preparing for the next policy crisis, if and when an abrupt change in policy may be appropriate. In both research and speeches John Williams has examined how a price-level target versus an inflation target might work going forward and/or how it might have performed in the past. To some, targeting the rate of growth in the price level as opposed to targeting the rate of inflation may seem like a distinction without a difference. After all, isn’t inflation just the rate of growth in the price level? However, the difference from a policy perspective is how one treats deviation from the target. A policy maker targeting inflation is willing to forget past misses of the target, whereas a policy maker targeting the growth rate in the price level commits to reversing past misses to ensure a long-run average rate of growth in the price level.(2)(3) Williams’ and his colleagues’ research argues that had price-level targeting been in place in the 1960s and 1970s, the inflation environment would have been much more stable than was realized.(4) President Williams’ evidenced and scientifically based approach would be a solid anchor for any work that might be done to modify or change FOMC policy approaches and how those might be communicated to the public.

One last observation regarding what President Williams might bring to the FOMC. In his work and speeches, he has continually emphasized the importance of Fed independence, accountability, and transparency. However, he has also expressed caution when discussing recent proposals mandating that the Fed follow a mechanical policy rule. He has emphasized issues that proponents often overlook. First, rules like the Taylor rule rely upon unobservables such as the natural rate of growth in the economy and the equilibrium interest rate. Would these estimated unobserved inputs change over time, and who would set them? There is, as yet, no one best-agreed-upon formulation of a policy rule, and many such proposals exist.(5)

In John Williams the Fed would get a vice chairman who has been comfortable with the present policy stance but who has also forecast slow growth for an economy at full employment and now sees a relatively low equilibrium real interest rate and hence a low policy rate for the foreseeable future. Williams would thus likely be cautious when it comes to the number of rate hikes for 2018 and likely favor at most three moves rather than the four implied in the latest Summary of Economic Projections. However, his elevation would create a vacancy at the San Francisco Bank just when its president is entitled to vote.  That vote would thus be exercised by the Bank’s first vice president.  A similar issue will exist when the New York Fed’s President Dudley retires mid-year.

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

(1) See John C. Williams, Remarks at the 54th Annual Economic Forecast Luncheon, Phoenix Arizona, November 29, 2017.
(2) See https://www.brookings.edu/blog/ben-bernanke/2017/10/12/temporary-price-level-targeting-an-alternative-framework-for-monetary-policy/
(3) Those who favor pure price stability would inflate if the price level decreased and force an actual decline in the price level if it had increased.
(4) See Orphanides, Athanasios, and John C. Williams. 2013. “Monetary Policy Mistakes and the Evolution of Inflation Expectations.” In The Great Inflation: The Rebirth of Modern Central Banking, eds. Michael D. Bordo and Athanasios Orphanides. Chicago: University of Chicago Press.
(5)  See https://www.frbsf.org/our-district/press/presidents-speeches/williams-speeches/2015/may/monetary-policy-independence-dilemma/


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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US Competitiveness – A Global Comparison

Next week the World Economic Forum (WEF) will host its 48th annual meeting in Davos, Switzerland, drawing together a large number of leaders from governments (including President Trump), international organizations, business, academia, and civil society. The title for this year’s meeting is “Creating a Shared Future in a Fractured World.” This global networking event will generate a lot of press but is not a forum for taking action. Trump will certainly be praising his own actions to reduce corporate tax rates and excessive regulations in order to improve the ability of US firms to compete internationally.

In this note we look at the WEF’s annual publication, The Global Competitiveness Report 2017–2018, a comprehensive analysis comparing the international competitiveness of some 137 economies.[1] The definition of competitiveness used in the World Economic Forum report is “the set of institutions, policies and factors that determine the level of productivity of an economy, which in turn sets the level of prosperity that the economy can achieve.” They look at some 114 indicators that are grouped under 12 headings: institutions, infrastructure, macroeconomic, environment, health and primary education, higher education and training, goods market efficiency, labor market efficiency, financial market development, technological readiness, market size, business sophistication, and innovation. This is indeed a wide range of factors said to affect competitiveness. This list and the above definition make clear that the WEF’s focus is on the productivity of an economy, its ability to generate economic growth and prosperity. This is central to the ability of an economy’s firms to compete in global markets.

The Global Competitiveness Index 2017–2018 Rankings, which were published September 26, 2017, indicate that among the 137 economies analyzed, the United States has the second-most competitive economy, behind that of Switzerland. The third through tenth rankings go to Singapore, Netherlands, Germany, Hong Kong, Sweden, United Kingdom, Japan, and Finland. The economies in this top ten list are not surprising – their overall scores are close. Some other interesting rankings are Taiwan’s (15), Israel’s (16), South Korea’s (26), China’s (27), Russian Federation’s (38) and India’s (40). The lowest-ranked economies – the bottom 20 out of 137 – are Haiti, Venezuela, and eighteen Sub-Saharan African economies.

Looking at details of the Global Competitiveness Index with regard to the United States[2] reveals the depth and complexity of the analysis that produces these rankings. We find that the US ranked first in just nine areas: inflation, venture capital availability, local equity market financing, international distribution, buyer sophistication, marketing, redundancy costs, cluster development, and airline seat miles per week. The US ranked second in the broad categories of business sophistication, innovation, market size, and financial market development. It ranked third for labor market efficiency and higher education and training. The quality of primary education earned a rank of 11. The US ranked 6 in technological readiness but achieved a rank of only 39 for internet users/population. The rank of 7 for goods market efficiency was understandably kept down by the rank of 95 for the total tax rate as a percentage of profits. The rank for female participation in the labor force was also low, 56.

The US’s burden of government regulation, another priority issue for the Trump administration, ranked 12th among the 137 economies, suggesting that we are already doing relatively well in this area. That category is included under the broad heading “institutions,” for which the US has an overall ranking of 20. As investors, we find it disturbing that under the same heading, the US managed only a ranking of 31 for strength of investor protection. Also troubling are the ratings of 34 for irregular payments and bribes, 61 for business costs of crime and violence, and 57 for organized crime. Thus, for example, 56 economies have less of a problem of organized crime than the United States does. An unsurprising reading is that 86 economies have lower business costs of dealing with the threat of terrorism.

Taken as a whole, the “competitiveness” of the United States economy – that is, its productive capacity to generate growth – is very high in comparison with other economies. Of course, there continue to be areas where improvements would be desirable, some of which are noted above. The recent corporate tax cuts in the US will register as a plus in the next global ranking. But the tax rate is just one of some 115 factors that enter into the WEF’s analysis. Moreover, the ability of US firms to compete in international markets is also affected by external factors such as exchange rates and the trade measures of other countries, including those determined by international trade agreements and global trade rules. Were the United States to impose significant trade restrictions and were other countries to respond in kind, as they surely would, the domestic economy’s competitive edge would not be sufficient to prevent serious harm to the country’s exports.

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


[1] Sources: The World Economic Forum, The Global Competitiveness Report 2017–2018, Geneva, September 26, 2017; available for download at http://www.weforum.org/gcr.
[2] The Global Competitiveness Report 2017–18, page 303


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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Value vs. Equal Investing: It’s More Than Just That Month

The US stock market had a marvelous year in 2017. The major benchmark S&P 500 returned 21.60%[1] including dividends. But savvy investors probably noticed that there were some significant discrepancies among the major indexes: If you chose the tech-heavy NASDAQ composite, you would have made 29.58%[2] last year, while if you invested in the small-cap Russell 2000, you would have profited only 14.52%[3].

It appears that volatility wasn’t the only number that was suppressed in the stock market last year: Stock correlations also remained low. So what does it mean to investors when stock correlations are low?

Simply put, stock correlations measure the contemporaneous movement among stocks and explain why stocks move in different directions. Stock correlations are particularly important statistics for portfolio weighting, while weighting is important for portfolio returns. For example, the large-cap S&P 500 is value-weighted, meaning that each stock makes up a portion of the index according to its market cap. Therefore, the mega-caps in the S&P 500 are capable of single-handedly driving up the index. However, if the S&P 500 were equal-weighted, then all the stocks would contribute in the same way to move the overall market.

How much does the weighting scheme matter to a portfolio? Let’s compare the value-weighted and equal-weighted S&P 500 performance history, as shown in Figure 1 below. Starting from the bottom of the financial crisis in March 2009, the equal-weighted ETF RSP outperformed the value-weighted ETF SPY by 30%, simply due to the weighting difference.

 


Figure 1. SPY vs. RSP since March 2009
Source: Yahoo! Finance
To form a comprehensive picture of the value vs. equal investing difference, we construct a 30-year portfolio starting from 1986. We include all stocks listed on the NYSE, NYSE American, NASDAQ, and ARCA markets, excluding ADRs. Both portfolios are monthly, including distributions. The difference between the two portfolios after 30 years is quite significant: While the value-weighted portfolio generated an 1,838.66% return, the equal-weighted portfolio returned 2,443.71%. We notice that value outperformed equal rather well during the tech-bubble period, when stock correlations were relatively low due to the crowded trade in the Technology sector. Nevertheless, during the following years, when stock correlations reverted to normal, the equal portfolio outperformed the value portfolio.

Figure 2. Value vs. Equal Since 1986
Source: Center for Research in Security Prices

Is there anything else that explains the equal weighting outperformance besides stock correlations? Yes. The answer is January. We notice that the equal-weighted portfolio averages a 3.98% return in January across the 30 years, 3.11% above the value-weighted portfolio, while there is no dramatic difference for the rest of the year. This pattern suggests that the difference between the value-weighted and equal-weighted portfolios comes mainly from just one month. In fact, this “January effect” has long been documented by academic research. Scholars find that while stocks generally rise in January, small-caps tend to be more affected than large-caps are. Generally, low stock correlation dictates the divergence between value and equal investing. Beyond that, low stock correlation signals a stock picker’s market – more specifically, one needs to choose the right sector to generate alpha.

Leo Chen, Ph.D.
Portfolio Manager & Quantitative Strategist
Email | Bio


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[1],[2],[3] – Source: Bloomberg



S&P 500 Index To Reach 3000?

We think that stocks in the US market will be fully valued when the S&P 500 Index hits the 3000 mark by the end of this decade. Here’s why.

A classic value method is to observe and estimate the equity risk premium (ERP). This method compares the earnings yield (earnings divided by price) to the riskless yield (US Treasury). Some use shorter-term Treasury yields; others use longer-term. Some modify for risk to adjustments in the corporate earnings outlook, while others add an expectations component. Over time, the way an estimate of ERP is derived has become complex.

We use a dozen methods in our shop. The key is either to decide on one method or to use many methods and adjust the mix by weighting them. In any case, take the earnings yield and subtract the selected riskless yield and the difference is the ERP.

The key to the ERP is to assume that it is the amount an investor is getting paid to take on the risk of owning stocks instead of choosing to buy a riskless bond or an interest-paying security.

Let’s just use one reference method for this commentary: the 10-year US Treasury note.

We have now seen enough to estimate 2019 earnings of $150–$160 for the S&P 500 Index. This is the range of estimates after analysts have had some time to revise their numbers and to consider the effects of the tax code changes. These estimates are based on static analysis. We think they are low because we expect some positive impact from repatriation, and we estimate that the US GDP growth rate will be close to 3%, rather than the current updated consensus estimates of 2.5%–2.6%. Remember that in the national accounting system after-tax profits are derived from the GDP with adjustments for foreign factors. Earnings of public companies that trade on the stock exchanges are a part of the profit picture in the GDP accounts. The tax code changes boost after-tax profits; hence they boost earnings.

So let’s use the high-end estimate of $160 for 2019. Now add the nominal GDP growth rate of 3% real plus 2% inflation. Also adjust for internal corporate leverage, because earnings grow faster than nominal GDP does. We have not adjusted for repatriation funds used in stock buybacks. That is going to happen, but we do not know to what extent. That adjustment will only raise earnings per share, but we will assume it is zero for the exercise.

So where are we now? About $160 for 2019 and about $170 for 2020.

The next step is to assume what the interest rate will be on riskless alternatives. We will use 3%. That is our best guess for the 10-year US Treasury note yield a year or so from now. Prices in the bond market today suggest that the 3% number is a bit high, but we will use it anyway.

History says that an ERP of about 3 is a fully priced market when using a 10-year riskless yield. We derive that result by looking at a century of data. So using the 3% number for riskless and adding 3% for our ERP, we get to a 6% earnings yield for a fully priced stock market. That equates to a 17 price-to-earnings (P/E) ratio.

Take the 17 P/E and multiply by the $170 estimate for 2020. The result of this exercise takes you to about 3000 on the S&P 500 – or, shall we say, close to it.

Close enough for our purpose. We could get a little extra earnings kick, and we could also get a weaker earnings picture. We could also get a lower US Treasury yield or a higher one. The key is not to try to guess the actual numbers – hitting them with a two-year forecast is nearly impossible.

For investment management purposes, however, the key is to guesstimate whether the market is richly priced (stay away), fairly priced (be careful but remain at least partially invested), or cheaply priced (raise the weight of stocks compared to bonds). We have been in a long period during which stocks have been favored over bonds. ERP helps explain the rise in stock prices.

Now we are approaching a time when the tailwind for stock prices will stop blowing. Rising interest rates, still-rising stock prices, and a refined earnings picture in the wake of the tax code changes make this wind shift clearer.

Our conclusion is to stay invested in the US stock market but to maintain heightened vigilance. We have not reached the end of this bull market, but we are getting close to the time when it will not pay for investors to overweight stocks.

Lastly, it is important to note that the stock market has often overshot. In the tech stock bubble of 1998–1999, the market had a massive overshoot. In the tech sector in 1999–2000, the ERP was actually a negative number. In other words, investors were paying a premium for the privilege of owning stocks. That is madness. It was madness then, and it will be again if this stock market overshoots. But we are not there yet.

We expect the stock market to experience an interim correction this year, but the trend is still toward higher stock prices as long as the ERP is as attractive as it is today.

We remain nearly fully invested. The last several years have been terrific for US stock market investors who could handle the risk required to be in it. The next two years will be okay but a lot harder. Still, the trend appears to be up.

We can send anyone who is interested the performance results for our ETF strategies over the last few years. Just email me for them.

January is off to a good start. It will be a fascinating year. And the politics of a midterm election year will certainly add to the entertainment, as we have already observed.

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


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Marijuana Discussion: A Follow-Up

We thank readers for their diverse and sometimes intense responses to our recent comments about marijuana legalization in California and about the reversal of a US policy.

The link to that piece is here: http://www.cumber.com/california-high-on-cannabinoid-wellness/.

Many good points and counterpoints were argued. Some of them are quoted below.

Our position of supporting change is rooted in the failure of policy over decades. When a substance is illegal and desired, the price rises in a black market. High prices attract criminal risk takers. Murder and mayhem follow, as we see in country after country confronting drug cartels.

With increasing legalization we now see price suppression with marijuana. The cost of criminality attached to marijuana usage and distribution has been reduced or eliminated. Those who want to be “high” can do so without stealing a car or snatching a purse. Meanwhile, those seeking a medical benefit from cannabinoids may obtain it.

Americans are often polled about marijuana legalization. The overwhelming majority support it. And nearly ALL AMERICANS support medical usage with supervision and prescription. That is why 8 states now permit recreational use and 29 permit medical applications. Both numbers seem destined to rise.

We recall that in 1933 Prohibition (of alcohol) was repealed and alcohol regulation was delegated to each state. Criminal activity associated with alcohol became a closed chapter in the history of whisky and wine. Today both are supervised and regulated and generate tax revenue for many levels of government.

Yes, there are still drunken drivers. Yes, there is abuse. And yes, things are much improved from the machine-gun era of US history, which is now just the subject of films that appear on the classic movie channels.

Why not repeat this with marijuana? Take out the crime. Remove the financial incentives for criminals. And deal with drug addiction and substance abuse with new approaches.

Who wins? Government does, because it spends less on prisons and more to help citizens have productive employment. Taxpayers also win, with reduced levels of violent and invasive crimes. Who loses? Contract prison operators and criminals who prey on habitual users. Also players in the marijuana business that cannot succeed when the price is low and only succeed when artificially induced scarcity raises the price and induces criminality.

Other views are below. We are glad to have triggered the debate.

Bill A. wrote:

“David, I guess that at age 89 I am just too old fashioned in rolling my eyeballs on this whole marijuana issue. We have spent billions of taxpayer dollars on “the war on drugs” and the war on cigarette smoking, and now we are promoting the use of a drug which can and will be smoked. I can see the use for medical purposes, but what makes us think that usage will be controlled any better than that of opioids???

“My opinion is that approval for recreational usage is insane and will create both medical and safety problems.

“The New York Times reported earlier this week that in Colorado traffic deaths among drivers who tested positive for marijuana had doubled from 2013 to 2016 and that visits to emergency rooms for marijuana users had increased by 35%. What is going on among young people in this country is bad enough without turning out a nation of legal hopheads.”

Michael W. wrote:

“I agree with legal use of pot for medical purposes. I agree that arresting people for pot is a waste of time.

“But, I have seen the effects of prolonged use to be high, a complete lack of drive and motivation follows, ask Tom Keene, he said he watched it destroy lives while in college.

“For me, I watched my older son progress from pot all the way to complete opioid addiction, for him it was a gateway drug.

“I can have a glass of wine and be fine, other than medical purposes to use pot is to be high.”

Marc G. wrote:

“I have no expertise with medical marijuana but appreciate its efficacy.

“I am antagonized by the wave of legalization for recreational use. The data from Colorado is highly disturbing to me as a parent and a grandfather. The Obama administration left us in a dangerous place in relation to drug usage.

“We need a national discussion; I support our AG but sense that you do not.”

Dr. John S. wrote:

“I notice you don’t quote any peer-reviewed medical studies regarding medical marijuana. I also notice that you blur the lines between the labels of recreational use and “medical” use. Why? You have “seen it work for seizures”? This is a silly statement. It’s not scientific. We have effective treatment for seizures. Perhaps what you saw was efficacy in the case of non-epileptic seizures? Poor.”

Lee D. wrote:

“ ‘[Kotok wrote:] By yearend, 8 states will have recreational Marijuana; 29 will have medical usage. Meanwhile a reversal of established policy gives an “in your face” to the majority of the country. That is the result of the latest gesture by the US Attorney General Jeff Sessions.

‘CNN summarized as follows: “In a seismic shift, Attorney General Jeff Sessions will announce (he subsequently did -Ed) Thursday that he is rescinding a trio of memos from the Obama administration that adopted a policy of non-interference with marijuana-friendly state laws.” CNN goes on to say, “While many states have decriminalized or legalized marijuana use, the drug is still illegal under federal law, creating a conflict between federal and state law.” ’

“CNN’s take misses the mark as usual. The responsibility for law resides in Congress. Congress can change the law any time they so decide. All Sessions did is bring the Justice Department back to enforcing existing law. Policies of the previous administration to circumvent and manipulate government in unconstitutional ways were always going to be temporary as long as no laws were changes to make them permanent. This is a key feature of the ‘Swamp’ that Trump supporters are so adamant about fixing.

“Thanks for the quoting of my response to a previous post. Glad your family has experienced the benefits of the rapidly progressing marijuana derivatives evolution. I assume you are familiar with the CBD (Cannabidiol) derivative which is virtually devoid of the psychoactive components and yet seems to have beneficial effects for pain management, and joint comfort (in my own experience). We live in a time a rapid change. Let’s do our best to support legal changes that enable further progress and definitively leave behind the manipulations used by weak leaders and timid legislators that failed to really address problems, swept too many things under the rug and repeatedly ‘kicked the can down the road’.

“PS – appreciate the link to CB1 Capital LLC Newsletter – had not come across them before.”

Frank M. wrote:

“I suspect one of the first Sessions targets will be a local credit union in Seattle that accepts deposits and has accounts with marijuana dealers licensed by the state.”

David B. wrote:

“My daughter lives in Colorado with three dogs. Her oldest dog has lived on for many years – he’s a big bull dog and 13 years – with various tumors that she has treated with a special kind of medical marijuana that they sell in Colorado dispensaries. To the surprise of the Vet the tumor has shrunk and gone away and the dog acts in many ways like a younger dog despite his size and weight. If you believe Rebecca the government has research confirming the cancer treating properties of special forms of cannabis and suppresses it.

“It is a shame that we are happy to have massive fire power on untrained individuals, beer and liquor openly available, but can’t let a rather benign drug be treated with the same understanding.”

Dale K. wrote:

“I live in Colorado part of the year. I’ve witnessed what you describe. And I’ve had personal experience and do charitable work to rescue folks. I just don’t write about it often. Criminalize any substance and we raise the price, incentive crime and impose high societal cost. That policy has failed in America after decades of trying. This legalization process is underway, as we know. It, too, has flaws. We shall see.”

David F. wrote:

“You people are all nuts. Although medical marijuana use may help some with pain relief this overall embrace of this drug is nonsense. Dope makes you stupid and increased use will make the majority of users dumber than wood. Dr Michael Savage knows of what he speaks and I suggest you learn more before jumping on this stupid horse. Jerry Brown and the rest of these lunies will ruin the country.”

(Kotok responded:

“Thank you. I guess you prefer murder and mayhem by making this substance illegal. That creates artificial scarcity value by raising the price and thereby incentivizing criminality.

“We tried that for decades in America. We incarcerated millions of folks. We created an entrenched taxpayer-funded special-interest business to operate the prisons.

“I wonder who is the nut.”)

Liz W. wrote:

“Thank you for taking the time to share your thoughts on Sessions’ rolling back the Cole memo deprioritizing marijuana crimes. This seems at first glance to be contrary to the wishes of many Americans including those of us who have seen marijuana’s medical benefits firsthand – or who voted for Gary Johnson in the last election. However, the action – casting aside a policy promulgated post legislation – seems more in line with the rule of law, whether or not that was Sessions’ intent. Perhaps a more ‘judicious’ action would be for Congress to rescind federal laws and regulations over areas best handled at the state level. Similarly, the practice of lowering charges, e.g., in drug cases, to avoid mandatory sentencing laws begs the question, ‘Why are we not changing the law rather than recasting the crime?’

“The Wired article linked below provides another view you might find of interest – and possibly comfort.” (https://www.wired.com/story/sessions-legal-weed-crackdown-startups)

Byron W. wrote:

“Sessions is out of touch and is missing the sweep of history. He will succeed in further reducing the respect for federal power, enhancing states rights. If not careful he will further empower civil disobedience. He’s missing what US denizens do in their daily lives, he missed the anthro 101 observation of man’s universal need for intoxicants, and he’s clueless to the real-time social agglomeration and reinforcement powers of the internet. On the opposite side, Congress is a bit more sensitive to the flow of power. And maybe, just might write legalizing legislation. Either checkmating Sessions or falling for the bait of the evil geniuses manipulative powers to get Congress to act.

“Yesterday Trump tossed yet another bizarre career-limiting (except for Trump) non-presidential bit of meat into the grinder.

“Trump’s defense of himself as ‘a very stable genius’ is an example of the perils of unchecked self-esteem (and he’s arguably neither stable nor a genius). Ironically, could the tipping point in the Republican voter revolt away from this president and the party may be from Sessions’ recast ganja policy? Too many have tried pot, find it helpful, and fear the ravages of cancer without it. Pocket book, medicine, relief from pain are powerful motivators. As is simply the recreational aspect. The public has been clear on this since 1968. We are retiring now, we tolerate alcohol a lot less. We like a quality spliff when we want one. No ambiguous street weed for us, we have standards, we have needs. We are gourmet not fast food. We are older, wiser, grumpier, less tolerant of hurdles to our well being, and we vote. #GoodGanjaMatters, #WeedWantsToBeFree, #MedicateMe, #EarlyOnsetCrankiness. First amendment, second amendment, smeckle amendment pale in our need to celebrate the sacraments of the blessed herb.

“A ramblin’ rant from a former Wall Street analyst. I appreciate your work and opinions, and not because they are always the same as mine. Keep on keepin’ on.”

Robert K. wrote:

“I also seek clarity and as much veracity as can be obtained from available, credible information.

“In other words, I try to align the strength of my beliefs with the quality of the supporting data.

“I fully recognize the distress involved in the circumstances surrounding a diagnosis of cancer. However, having administered cancer chemotherapy to thousands of patients, and in the process helped a few, I can assure you that chemotherapy does not cause ‘pain.’ It causes many side effects, some ugly, but not pain as the term is generally employed. Suffering, perhaps, when added to the suffering intrinsic to the underlying disease, unless a favorable effect is achieved, which still, regrettably, is not often enough.

“In the 1970s, as a trainee at the National Cancer Institute, NIH, I participated in a trial of delta 9-THC, purified from crops grown on US government farms, for Rx of nausea in childhood acute leukemia patients. They still vomited, but according to them, it was beautiful. In 1985, the drug MARINOL (dronabinol capsules, USP, synthetic delta-9¬ tetrahydrocannabinol [delta-9-THC] was approved in the US for Rx of nausea related to chemotherapy (and is still on the market). Older people, like us, do not do well on it – mental adverse reactions – however, it never did well because there are MUCH better, highly effective anti-nausea meds with much less side-effect problems available.

“In truth, we know almost nothing about cannabis – probably hundreds of unique chemicals within the multiple species.

“Personally, I expect the medicinal use of cannabis to dwindle as synthetic versions of the active ingredients are developed. Recreational uses, and ‘needs,’ probably will easily be addressed by the use and availability of the whole plant. The astute buyer will rapidly be ‘growing their own’ and won’t need ongoing purchases, except maybe for special events! I wish I knew enough of the commercialization being implemented to short these new ‘businesses.’

“Even more important, especially in the weed imported from south of the border, there are impressive levels of pesticides, DDT, etc. being consumed by the public – but, but ‘It’s organic – it’s NATURAL.’

“ ‘Caveat inhaler.’ ”

Joe Z. wrote:

“Regarding the Medical Use of any Medication, one of the most important things that I’ve learned as a licensed physician for the past 46 years: The patient is always right. If they say a drug works, then it works.”

Finally, Dennis Gartman wrote, in today’s Gartman Letter:

“We are openly opposed to the legalization of marijuana here at TGL, despite the fact that we are libertarians in almost all instances and libertarians on balance support legalization of it and many other drugs. But we have seen the dangers of drug usage and despite the arguments otherwise we are of the belief that marijuana usage is detrimental to health and welfare. Let the Millennials and others younger than we argue otherwise; we’ve seen what we’ve seen and it is rarely if ever benign.

“However, we are even more opposed to federal government trampling upon states’ rights, for we are even greater believers in the rights of the individual states to make their own decisions on these sorts of questions. It is up to the states to decide on alcohol consumption; it is up to the states to decide who can and who cannot drive in that state; it is up to the states to decide the questions regarding marriage; it is up to the states to decide how and where they will educate their children, these things are not up to Washington to decide. These are the things that the citizens of Virginia, or Massachusetts, or Ohio, or Iowa or California are to decide. These are state’s rights.

“Hence, although we would openly oppose any attempts by Virginia, where we live, to legalize the use of marijuana, for we do indeed believe that allowing it to be used widely by the states citizens and youths can be and will be deleterious to the state. However, it is up to the voters of Virginia or the legal elected legislature to make that decision, and if the “people” of Virginia make that bad decision it is up to us to either move to another state or to make our peace with that decision. The voters of Colorado, California, Oregon, Washington and Nevada have chosen to allow their citizens to imbibe in marijuana and that is the right of the citizens there to make that ill-advised decision. If the citizens of these states wish to expose themselves to “impaired” drivers or to expose themselves to “slacker” labor forces, then that is their right and it is our duty to defend that right. In the end, rest very much assured that Colorado, California, Oregon, Washington and Nevada will see their states deteriorate; businesses will fail; tax revenues will fall; deficits will rise and populations will fall… but again, that is their choice. It is not Washington’s choice to make and it is not the right or the obligation of the US Attorney General to intervene.

“We shall make enemies with this comment; so be it. It won’t be the first time and certainly it won’t be the last. But we know this: we won’t be investing in the drug culture. Others may get wealthy buying marijuana stocks. We wish them well. We pass.”

We thank all readers for their responses and especially Dennis for permission to quote his morning missive.

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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