David R. Kotok co-founded Cumberland Advisors in 1973 and has been its Chief Investment Officer since inception. He holds a B.S. in Economics from The Wharton School of the University of Pennsylvania, an M.S. in Organizational Dynamics from The School of Arts and Sciences at the University of Pennsylvania, and a Masters in Philosophy from the University of Pennsylvania. Mr. Kotok’s articles and financial market commentary have appeared in The New York Times, The Wall Street Journal, Barron’s, and other publications. He is a frequent contributor to CNBC programs. Mr. Kotok is also a member of the National Business Economics Issues Council (NBEIC), the National Association for Business Economics (NABE), the Philadelphia Council for Business Economics (PCBE), and the Philadelphia Financial Economists Group (PFEG).
November 26, 2009
We’ve spent two weeks traveling almost 20,000 miles and visiting three cities: Tokyo, Hanoi & Singapore. Meetings included quality time spent with central bankers, investors, pension fund managers, academics, commercial bankers, and others. It has been a whirlwind and well worth the fatigue.
We will summarize the observations with some key points.
Our trip confirms that the Asian emerging-market story is real and is likely to accelerate. This is not just a China story, and folks who view it that way are making a mistake. China is the largest player in the region, but the others need respect. This conclusion is true for newly emerging economies and markets like Vietnam (devaluation of currency notwithstanding) and for seasoned and established ones like Singapore.
At Cumberland, our global portfolio strategy maintains an overweighted position on non-Japan Asia. Asian emerging markets are a terrific story. This is true both for the fledgling ones and for the largest one, China. There are many in the region and they need to be examined separately. We will be going back to Shanghai and Hong Kong in January for another look at the region and to examine how US policy is playing out there. Or should I say, how US policy is failing miserably to play out there. More on that below, but first let’s wrap up the Japan report.
We are still not ready to take the Japan weight to a bullishly overweighted position. That may come after next summer’s Japanese elections, and if the new government is strong enough and determined enough to change policy. Both the electoral outcome and the willingness to change policy are open questions. It is the present policy that keeps the yen very strong and keeps deflationary forces at work in Japan. Government officials know it but are not yet compelled to change. Many there believe that a stable price level or a slightly falling price level is a better choice than an inflation-prone policy. Many reject the Bernanke approach of massive monetization. They heard his lecture many years ago and have taken a different view. We shall see what unfolds now that those in Japan have the opportunity to watch Bernanke apply the policy that they rejected. In sum, the final chapters of this book on Japan and deflation and on QE and inflation are not yet written.
Now to the regional takeaway from our trip
We believe that few trust the United States. This is obvious in private conversation. And it is clear to all that confidence in the dollar is low. This is mostly mentioned only in private.
In public there is quiet response when the Treasury Secretary of the United States utters words about a strong dollar. Asians have heard that for years and with the many different accents of the various Treasury Secretaries. Geithner would serve the country better by ceasing to mouth the same words that his predecessor Snow and others used. He is not believed. Frankly, in some circles he is actually seen as an incompetent political hack. He is blamed by some for the insufficiency of the New York Fed under his presidency to supervise the primary dealers that failed – Countrywide, Bear Stearns, and Lehman. And the ethics issues surrounding the NY Fed under his tenure are viewed as appalling; this continues to surface in private conversations. Some folks are puzzled about why Obama maintains his support for Geithner. Some just attribute it to the President’s inexperience as a leader.
My takeaway is that our present Secretary of the Treasury is seriously and sustainably injuring the image of the United States. He has lost credibility. His actions are real and they impact markets. My conversations with those who are attempting to market GSE securities to Asians and getting rebuffed are validation enough for me on this point. When the Fed stops buying GSE mortgage backed securities, this reality will hit the markets in a re-pricing of that asset class. Spreads are going to widen.
The American federal budget deficits are worrisome everywhere. Policy promises from Washington to reduce them are greeted with great skepticism. Often they are privately described as American arrogance. Publicly, Asians are very polite and do not often subject their guests to embarrassing criticism. Privately they are quite candid. In my view they are correct: America is arrogant and seems to pretend that it is still the best and most trustworthy financial and capital market in the world. There is no basis for the US to have such a view of itself. We have squandered our reputational capital as a financial center leader.
This recent financial crisis is quite different from its predecessors. In 1997-1998, the Asian currency crisis and Russian ruble collapse wasn’t viewed as America’s responsibility. We didn’t cause it. We didn’t cause the 1994 Mexican peso crisis either. And while we contributed to the tech-stock bubble, we weren’t the only ones to do so. But the last two years of Madoff scandal, federal agency failure, rating agency restatement, bond insurer demise, Fed primary dealer (Lehman) bankruptcy, and mortgage securitization deception (CDOs) are all Made in the USA. We led the world into crisis. We caused it. And we haven’t fixed it.
To Asian eyes it appears that this American-made tragedy continues to this day. Proposals for reforms in America are greeted abroad with skepticism and doubt. The political structure of America is seen as a weakness. And confidence abroad is falling, just as it is at home.
Some will view our conclusions as harsh. Maybe so. But the lists of American-made errors that have cost the world billions are factually correct. Say what you want, but Madoff WAS regulated by the SEC, Fannie IS a federal agency, and AAA used to be a respected rating that that has turned out to mean nothing.
This is not just a Democrat or Republican critique. Both political parties have failed the country miserably and both are seen as contributing to the mess, from the Asian perspective. Personally I agree. Our Washington leadership under this president and under the last one has proven to be impoverished. The money influence in politics seems to have overwhelmed any sense of centering ethics.
We come back from this trip more determined than ever that investors must protect themselves. The starting point for that defense is an old principle: diversification of risk. To do that they must take a global view. And Americans need to be very critical of US policy and distrusting of their politicians.
Cumberland’s recommendations include worldwide diversification of security risk and worldwide diversification of currency exposure. Favor spread product in the fixed-income area and avoid US Treasury securities. View all positions as subject to change in strategic ways. Require independent verification of credit rating opinions and do not depend solely on rating agencies. And be prepared to change course as events unfold. Act prospectively and preemptively and not reactively.
Lastly, separate the silos of investment approaches. This may seem self-serving to say, but we believe that the separation of investment management, brokerage, and custody is needed to insure safety. At Cumberland that has always been our view. Not one of our managed client’s accounts had any money exposed to Madoff, Sanford, or any others of their ilk. Separate silos prevent that risk and allow for audit trails.
Cumberland does not take custody of client’s assets; they are held by investment firms or banks. Cumberland believes that a separately managed bond account must be able to “trade away” from the firm where it is domiciled and in whose “wrap” program it is placed. We will not manage an account where we cannot trade independently.
We are finding this view acceptable worldwide. As the globe grows, investors and financial professionals are becoming more and more skilled at their work and less and less trusting of governments and policies. They have good reason, in our view. This approach works for Asians and needs to be the foundation of investing for Americans.
We are often asked if we are optimistic about the future. For the world as a whole the answer is yes. Most of the world is seeking growth and peaceful economic outcomes that enhance the quality of life.
We are less optimistic for the US. Our longer-term trends are working against us. We have squandered our political capital and are neglecting the education of our youth. We practice polices of subsidy and deceit instead of self-determination and transparency.
No, we are not about to abandon our country; we have deep respect for our entrenched American traditions of freedom. But we are directing the harshest of criticism against our politicians of both parties. They are equally accountable and responsible for the mess we have. If only we could limit them – but the citizens are not yet angry enough to do that.
When we Americans have had enough, the voters will throw many of the bums out and start over. That will be a great day of celebration in America. We expect that others in the world will join the celebration. I hope that day arrives sooner, not later. By the way, financial markets will anticipate this change and be moving higher before the votes are actually counted. Markets measure change with sensitivity and find the pulse of that change before events are widely known.
Speaking of events, we built a little cash reserve in the US stock market accounts in the run-up to the Thanksgiving holiday. The Dubai World debt crisis has contagion risk. Insolvency cannot be permanently papered over by excess liquidity, not in the Middle East nor, for that matter, in America. In our global portfolios we are underweight the UK and have zero ETF exposure to the Persian Gulf states. Readers are directed to the Gartman letter. Dennis Gartman identified this Dubai risk well in his Thanksgiving Day missive. At Cumberland, we want to see the market make the adjustment for this risk before we resume a fully invested posture.
In America we have much to be thankful for. Our great freedoms are our strength. Our ability to speak and write with openness and to articulate diverse views is a powerful force. Our press is permitted to investigate and disclose. Our courts are honest and our legal systems include entrenched respect for individual rights. World travel confirms that for me every trip. I worry for my country but I still love it.
Happy Thanksgiving. Stay safe.
David R. Kotok, Chairman and Chief Investment Officer, email: email@example.com
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