The Greatest Game


“Golf is deceptively simple and endlessly complicated; it satisfies the soul and frustrates the intellect. It is at the same time rewarding and maddening – and it is without a doubt the greatest game mankind has ever invented.” – Arnold Palmer


My great passions, besides my family, are golf and investing. They are very similar in their nature. As Mr. Palmer so eloquently stated both games are maddening but perhaps that is why they are so rewarding and satisfying. We enjoy that both games seem simple but are frustratingly complex and it is in conquering their complexity that we find such satisfaction.

The 3rd Quarter of 2016 was maddening as the entire quarter was spent watching and waiting for some sort of resolution to market direction. While investors and hedge fund managers went off to the beach, the market, with the exception of the first two weeks in July, looked like it went off to the beach as well. The S&P 500 was up 3.5% in the first two weeks of July and that is where it closed for the quarter.  Much like a duck it was about what was going on under the surface that counted.

The pressure in the market continues to build as the market stays range bound between 18,000 and 18,500 on the Dow Jones Industrials. The pressure, if you listen to the media, is increasingly blamed on the election but it is the course of central banker policy that should hold your attention. The election is merely a sideshow. Central bankers, while publicly stating that negative interest rates are working, are finding that negative interest rates in Japan and Europe are having serious consequences. The pressure is mounting on central bankers to claw back higher interest rates without disturbing the animal spirits of the market place which would knock down asset prices while hindering confidence in the recovery.

Deutsche Bank and Interest Rates

Of late, central bankers in Europe have also come face to face with another dilemma and that is the market is attacking the stock price of Germany’s largest bank, Deutsche Bank (DB). The market has begun speculating that Germany’s largest bank and perhaps the world’s most systemically important bank could be in trouble. While we don’ think Deutsche Bank is on the brink of failure attention must be paid. When Wall Street senses weakness they feed upon it. The market has a way of cleaving the weak antelope from the herd. Financial firms’ biggest asset is confidence in the institution itself. A bank is only as good as its promise that it will deliver on its obligations. If there is no confidence in the institution then it is no longer viable and money will flow away from it. A bank run is not always logical.

Markets are going to push Deutsche Bank, possibly to their limit. Markets have a way of fleshing out the weak players. Traders will get into to a position where they will profit from a fall in Deutsche Bank’s stock. It has been this way since the dawn of Wall Street. You could call them parasites but as speculators they perform a function. They keep the system honest and flesh out the weak hands. That is what capitalism is. We have seen it over and over again. This can be seen in the failure of Lehman Brothers, Bear Stearns and probably most clearly in the failure of Long Term Capital Management.

(In 1998, Long Term Capital Management was THE hot hedge fund full of famous Wall Street traders and Nobel Prize winners. They made increasingly larger bets that put them in hot water.  Traders around the Street got wind of their problems and garnered insights into Long Term’s worsening positions and bet against them until Long Term had to capitulate and be bailed out by the big banks.)

One of the biggest issues surrounding Deutsche Bank and the European banking system is the unintended consequences of negative interest rate policy. The current negative interest rate environment is curtailing bank profitability. By trying to save the European economy European Central Bank (ECB) officials are putting the solvency of their banking/insurance sectors and pension funds at risk.

From a macro perspective we see that not only can central banks no longer lower interest rates they must raise them to enable banks to make profits and heal their balance sheets. Danielle DiMartino Booth is a former advisor to Federal Reserve of Dallas President Richard Fisher and is now President of Money Strong and serves as a consultant on worldwide central banking. Here is what Danielle had to say on the current interest rate environment.

In a reversal of economic fortunes, today’s economy is in desperate need of higher rather than lower interest rates, of a normalization of policy to put a floor under the bloodletting in pensions, insurance companies and among retirees worldwide. – Danielle Martino Booth Fed

Central banks are currently trying to keep zombie companies and banks from failing. They are not allowing capitalism and its creative destruction component to function. The capitalist system is designed and needs to allow weaker hands to fail and the system to heal and become stronger. That has been what is missing since the dawn of this crisis – The allowance of failure. The politics of it are not palatable. The system is weakened because of it. At some point authorities must allow creative destruction or we will end up in an endless series of crises and become like Japan with low growth and stagnation for decades. The piper must be paid. Pain must be felt. Could we be at the beginning of that realization? Rates must be allowed to rise so banks can make money and repair their balance sheets. Central banks may be forced to raise rates.

Do we think that Deutsche Bank is going to fail? No. The legal settlements will not be as high as the headline grabbing amounts suggested so far. The bank does have sufficient liquidity at the moment but bank runs are bank runs and if one begins for Deutsche Bank there is never enough capital. Bank runs are panics and cannot be reasoned with.  We look at the macro risks and opportunities. We believe that there has to be a Plan B in effect and the German government will step in if Deutsche Bank begins to fail. A lack of confidence in Deutsche Bank and a lower stock price will deny them the ability to raise more capital. Either the governments will have to back off and allow them to operate under less stringent capital measures or Germany may have to step in and take a large stake in the world’s largest derivative dealer. The contagion risks are too high worldwide. What we see from a macro perspective is that the ECB will have to back off its pledge of negative interest rates as the unintended negative consequences are too high. Banks need positive rates and a steeper yield curve to make money. You cannot have your banks fail. They are the plumbing of the economic system. If Deutsche Bank fails then Credit Suisse is next and so on. The dominoes fall. Central bank leaders need to make it easier for banks to generate profits and negative rates are killing banks.

 Saudi Issues – Oil


The other issue that has had our attention all summer is the lingering dissension among OPEC members and talks to tighten oil supply. Saudi Arabia is the 800 lb gorilla in the oil markets and without a definitive commitment on Saudi Arabia’s part no supply cut will have any effect.  A younger generation has taken control in Saudi Arabia and has been attempting a different tack in managing its foreign policy and economy. This has led them to attempt a change in their oil policy. The Saudi’s have been trying to drive prices lower in order to maintain market share and perhaps drive Russian and United States policy in their favor. The continued oversupply of oil markets has had the effect of dragging down oil prices but the outcome may have been too painful for the Saudi’s to handle. Things in the Kingdom have gotten much worse for the rulers as social issues mount. The Saudi Arabian government was forced to tap the international bond market for the first time in decades in order to fund a large budget deficit approaching 16% of GDP.  Currently their stock market is tumbling and the default risk of Saudi Arabia is rising in world markets.

Efforts to manage the fallout from cheap oil gathered steam over the past two weeks. Policy makers have suspended bonuses and trimmed allowances for government employees. Ministers’ salaries were cut by 20 percent. The central bank also said it’s injecting about 20 billion riyals ($5.3 billion) into the banking system to ease a cash crunch.

Austerity will help Saudis reduce a budget deficit that reached 16 percent of gross domestic product last year


The benchmark Tadawul All Share Index is down 18.5 percent this year, the third-worst performer among more than 90 global indexes tracked by Bloomberg. The MSCI Emerging Markets Index has climbed 15.4 percent.

Current Saudi policy of over production is not working and the latest negotiations among OPEC nations may be the royal family admitting defeat and enabling a fundamental change in policy. The Saudi’s’ must constrict production in order to raise prices which will entail them taking the brunt of production cuts.  By agreeing to those terms perhaps they can elevate the price of oil. Higher oil prices will bring greater supply especially above $55 a barrel here in the United States but the capitulation of the Saudi’s could indicate a broader policy reform that over time will help support oil prices.

Bubble in Central Bank Policy

High interest rates are going to encourage savings, and I think we desperately need savings. Take a widow: they don’t know what to do with the money. There is no way they can do anything with it unless they go into stocks. I think forced equity investing creates the bubble.”

When asked who do you blame for this mess, the legendary hedge fund investor had one name: Janet Yellen, who Robertson says “is unwilling to see the American public taking pain at all and because of that I think she is creating a serious bubble where serious pain is going to come.”- Julian Robertson Bloomberg 9/28/2016


We could be on the cusp of real change in how investors are maneuvering especially in reaction to higher interest rates. Because of low interest rates investors, and in particular retirees, have been forced into buying ever higher priced income producers. Those income producers, such as real estate and utilities, have become overpriced in historical terms. We are looking to pull back from those areas of the market. In addition, low volatility strategies are seeing increased downside risk due to leverage, risk parity strategies and the current correlation of stocks and bonds.

The Saudi’s are indicating a change of heart on production numbers as things in the kingdom are getting rough. Whether or not they will be able to get production numbers down is another story. We think that the major gains for the 30 year bond market are behind us but we do not see interest rates heading much higher in the near future. The Fed is too afraid to rattle markets and they will raise rates even slower than most think.


While we can make the case for markets to fall the fact remains that we are in a binary environment and stocks could sharply rise as well. Although we think that risks continue to be tilted to the downside. In making the case for higher stock prices we note that professional investors are under invested and under performing. According to Goldman Sachs only 16% of Large Cap money managers are beating their benchmarks. There are some very high levels of cash at mutual funds and under performing managers will be looking to protect their jobs. Also, central bank policy may be forced into buying riskier assets to continue to forestall another crisis. That means they may be forced to buy equities as the Swiss and Japanese have already begun to do. If under invested under performing mutual funds begin to chase the market and inflation begins to move higher central banks will be reluctant to take away the punch bowl.

The election could roil markets but we think that a rate rise from the Federal Reserve in December is the more likely suspect to press markets. If that is the case we could be in for a replay of late 2015 and early 2016.

I think we aspire less to foresee the future and more to be a great contingency planner… you can respond very fast to what’s happening because you thought through all the possibilities, – Lloyd  Blankfein CEO of Goldman Sachs


5845 Ettington Drive

Suwanee, Georgia 30024



The URI to TrackBack this entry is:

RSS feed for comments on this post.

Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Google+ photo

You are commenting using your Google+ account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

%d bloggers like this: