Mr. Market Reveals His Secrets In 2015

    Mr. Market Reveals His Secrets In 2015

     “Luminous beings are we…not this crude matter.” - Yoda

    Both Stocks and Bonds were down in 2015

     Just how rare is it for both stocks and bonds to be down on a calendar year basis?

    Extremely rare apparently!

    Going back to 1928 there have only been 4 instances for an impressively small 4.5% of occurrences.


    The last time we experienced this phenomenon was in 1969 the year prior to the decade that saw stagflation and the Vietnam War.

    Moreover, 2015 was a much vaunted 3rd Year of a Presidential cycle where the S&P 500 had never suffered a loss since World War II2

    So excuse us for asking but what went wrong?


    Global Economic Slowdown Fueling Volatility


    The primary reasons behind poor equity performance last year was the ongoing and deeper slowdown in China.

    Agitated by draconian moves on behalf of the Chinese authorities which included a ban on short-selling, triggering circuit breakers and then abandoning them and ‘taking in for questioning’ high level executives, moves that exacerbated the drop further. Something we warned against in our February 2nd 2015 note entitled Shanghai Stock Exchange Index and The Long Game.

    The horrific terror instances in Paris on 13th November 2015, the Syrian refugee crisis and the rise of ISIS is reminiscent of social unrest in the 1930s and the rise of National Socialism. Is it not eerie that the world was then as it is now going through a deflationary period?

    With negative nominal policy interest rates in Switzerland, Sweden, Denmark and the European Central Bank itself, certain parts of Europe are no longer experiencing slow growth but negative growth! Financial hardship follows, a breeding ground for social unrest.

    Poor Mario Draghi the ECB President has presided over €60 billion Bond purchases a month since March 2015 only to find it is NOT enough and on October 22nd promised the market more. Heavens! Private lending has been picking up in Europe but just not quick enough.


    Viewing events on a continuum helps to understand what may happen next


    This bull market began in March 2009 as global equity markets bottomed from their 2008 epic financial crisis. At 81 months it is now the 2nd longest bull market in history with the average being 58.

    Trillions of Dollars of stimulus have been injected into the global economy since. The old adage is that central banks can create money out of thin air but they cannot dictate where it will flow to.

    We have seen potential asset bubbles forming in energy (now collapsed) and venture capital. Private companies which sport valuations north of $1 billion have become known as Unicorns and include names such as Uber and Airbnb.

    But stimulus has also postponed the cleansing of credit system.

    Stansberry research published an interesting research piece on credit cycles where they noted that the 1990-1993 recession saw defaults on high yield bonds peaking at 11% or $50b, the 2000-2002 recession peak defaults were 8.7% but the amount of capital was commensurately larger at $500b (10x). Fast forward 2008-2010, defaults rose to a peak of 10% featuring Trillions of Dollars in credit yet only $1 trillion went into default. The point – the debt burden is growing exponentially but bad debts were not cleansed fully during the 2008-2010 recession and hence the system became water-logged.

    A water-logged system is one where future growth is difficult because you are still servicing your ‘dead’ liabilities from the past.

    One uncleansed misallocation of capital was Chinese Real Estate – the now infamous Ghost Cities. The slowdown in construction admittedly slow to hit the headlines finally arrived and it was no surprise to us that China would feel further pain. The dominoes have been falling:

    • First in line were raw materials whose demand and prices have dropped precipitously as Chinese construction slowed.
    • As that glacier moved (at glacier pace) slower revenues began to impact the underlying collateral of Commodity based countries who saw currency devaluations;
    • Acute pain was felt in emerging markets particularity those who had gorged on issuing Dollar denominated Emerging Sovereign Debt and whose liabilities became bigger as the Dollar rallied;
    • Energy and Resource companies saw large selloffs. The poster child, Glencore, was down 67% on the year as they faced the prospect of a debt downgrade to junk.
    • High Yield fell initially as Energy credits repriced lower but then overall credit concerns caused spreads to widen.


    • The Euro and European markets moved lower as negative interest rates caused the currency to weaken and poor growth prospects combined with insufficient stimulus knocked equities down.
    • The standout winners for 2015 in what became the narrowest of rallies goes to the FANG’s – Facebook (+34%) , Amazon (+117%) , Netflix (+134%) and Google (+47%). Just how narrow was the rally? This quote from The Fred Repot is striking:

      "Through this past Friday December 11th, there are 2,154 stocks higher for the year and 4,587 lower with 64 stocks with no change. That means only 31.65% of stocks are higher year to date through last Friday. Of the stocks that are lower year to date, 1,413 are down between -0.10% and -9.90%. Meanwhile there are 3,169 names down more than -10%. Even more telling is that 1,889 names are down more than -25% for the year.


    Is there a pending Pension Fund Crisis?


    We pondered the effects of negative returns from both bonds and stocks on a most important area of our capital base - defined benefit pension plans. It is clear to see that when both stocks and bonds are lower it is even harder to achieve the actuarial rate of return of 6-8% going forward. The unfunded liabilities amount to what we perceive as a pending pension crisis.

    Anecdotally we expect pension boards to continue seeking returns from alternative investments, despite their lackluster performance. And we expect this to be an area of tremendous capital inflows –primarily low volatility arbitrage type strategies in 2016 and beyond.

    In addition, we expect to see more money from operating budgets (municipal as well as corporate) channeled into the pension black hole which of course crimps local government spending and corporate profits going forward.

    However, after numerous false alarms, the Federal Reserve finally raised short-term interest rates by 0.25% on December 16th - citing the ongoing strength in the labor market -- the first hike in 7 years.

    Savers including Pension funds finally got a minor reprieve and we wonder if the Fed was prompted to raise because of a pending pension fund disaster?


    2016 could be the year of Higher Interest Rates


    As of this writing the world looks to be in the grips of a deflation as Oil continues to careen down to $30 and the deflationist crescendo is getting louder.

    We do not hear of anyone asking about all those Trillions of Dollars that were created through stimulus programs that sit on bank balance sheets waiting to move into the economy.

    As noted in our 2016 Forecast a big surprise could be in store, for the second half of the year, if inflation unexpectedly emerges.

    Truthfully we are not sure where it could come from but we note that the inflation bar is set very low and markets have a nasty habit of obfuscating the consensus view. And we do find it eerie that the last down year for both stocks and bonds was prior to the last inflation outbreak in the 1970s.

    Ultimately we think the positive trend in ADP non-farm payrolls and lower unemployment rate – currently at 5% - continues. We noted with interest the leap in minimum wage increases in January 2016 up 38% from $7.25 to $10 and in some instances $153 (San Francisco, Seattle).

    The risk is that Jane Yellen may, surprisingly, face consumer prices rising more than the 2% target – believe it or not. Causing the Fed to raise interest rates, shifting the entire yield curve higher despite a slowing global economy. The worst of all worlds in our opinion.

    We have a forecast of 3.0% on the 10 Year U.S. Treasury note currently at 2.1% on 1/13/2016.

    We can’t help but wonder if the Bond market is sensing this and why Bonds did not rally in 2015 (and early 2016) in what was seemingly perfect conditions for lower interest rates.

     We remain honored and proud to be stewards of your hard earned capital

    Greg Silberman
    Chief Investment Officer
    Atlanta Capital Group


     Thank you for reading my post. I regularly write about private market opportunities and trends. Please sign-up to my mailing list to hear about investment opportunities at Atlanta Capital Group.

    Greg Silberman is the Chief Investment Officer of Atlanta Capital Group. Atlanta Capital Group specializes in creating custom private market solutions for RIA/Family Office clients and is an active acquirer of independent wealth management practices.

    Advisory Services offered through Atlanta Capital Group.

    Nothing in this article should be interpreted as a recommendation to buy or sell any security. Please conduct your own due diligence.                  



    1 - excludes dividends and coupons

    2         1937 was last time S&P500 was down in 3rd year of presidential cycle -

    3         Minimum wage 2016 -

    4         Main pic:

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    Is the Investment Consulting Industry Ethical?

    Is the Investment Consulting Industry Ethical?

    By Rex Macey, CFA, CIMA, CFP

    I recently enjoyed the movie adaptation of Michael Lewis’ The Big Short, the most recent of many movies to demonize Wall Street.   I think the last movie to portray the finance industry positively was It’s a Wonderful Life (1946). What puzzles me is that my financial colleagues wonder why public perception of our profession is so bad. They should go to the movies more often.

    The three organizations from which I have received a professional designations all have codes of ethics and/or standard of professional conduct (see CFA, IMCA, and CFP.   While I would describe the countless individuals I have worked with over the last thirty years as ethical, the industry as a whole does not hold itself to a high level of ethics. What surprises me most is that most people in the industry (I’m referring less to the stock and bond pickers and more to those who pick the pickers) are oblivious as to how our industry can be viewed with such disdain as we are lumped in with “greedy bankers”.   Here I will try to unravel the paradox that the industry can be less than the sum of all these ethical individuals. Mostly it comes down to systemic lapses in honest disclosure.

    Let me gloss over boring definitions of ethics except to say I’m referring to professionals who believe in the advice they are giving. Naturally there are instances of individuals and firms who do not behave ethically.

    The largest lapse is that active management is over-sold. As Nobel Laureate William Sharpe writes in the Arithmetic of Active Management, “after costs, the return on the average actively managed dollar will be less than the return on the average passively managed dollar”. It’s not that advisors shouldn’t recommend active management, it’s that their clients are not well informed by the advisory community. And Sharpe’s arithmetic holds even before taxes are considered.

    Another lapse is that taxable clients are treated too much like institutional clients. After taxes are considered, studies have found that taxes have a significant negative impact on returns averaging 1 to 3 percentage points per year for the typical active manager. In addition, asset location is often ignored. The CFA Institute has had an after-tax performance standard in effect since 2006, but I’ve yet to see it implemented. While there must be instances, it is not industry practice – and I emphasize that the opinion I am expressing is that the industry does not embrace high ethical standards. I am not saying every individual practitioner is evil.

    Disclosure is not necessarily honesty and it does not bestow ethical absolution. You’d have to be very young and sentenced for life to have time to read all the fine print in all the terms of agreements and so forth put before us in contracts and websites. Disclosure in a document you know won’t be read is not highly ethical. If we can’t scrap the mind-numbing contracts, I’d like agreements to have a page of normal size print in red requiring initials of the risk disclosures: Such as “active management on average across investors underperforms passive management” and “active management strategies are likely to result in higher tax payments and/or earlier payments than a passive or a strategy of tax loss harvesting”.

    The ubiquitous “past performance is no guarantee of future performance” is hardly an informative statement. It so borders on the obvious as to deter people from bothering to read further because they figure what’s the point of reading more if this is the most important point.

    And then there are the hidden fees. I am particularly alarmed by advisors who “sit on the same side of the table” with their clients and claim to be fee-based while their firms mark-up municipal bonds from their inventory. Or their firms get fees and trading revenue from the fund companies.

    We think of ourselves as professionals. In my mind, being a professional means putting the clients’ interests ahead of our own; informing them of risks including the likelihood of the outcome; and informing them of the pros and cons of alternatives.

    Many consultants require track records of the asset managers but have none of their own. They hide behind the fig leaf that the client makes the ultimate decision such as when several managers are presented. If a consultant is presenting several managers she thinks can do the job, then she should at least take the average of the managers. And be sure to include the transition costs of switching managers. Where is the performance standard for consultants?

    While I am being hard on the industry, let me be soft on the individuals. The individual VW salesperson who unknowingly sold a diesel vehicle which was less green than promised was not unethical in my book. Many professionals in the investment consulting business are not aware of many sins. In another sense, they are like individual doctors who prescribe antibiotics. Individually it’s not a problem, but when done too much, it is a problem (drug resistance).

    Statistics is a tricky subject and many are indeed tricked by it. An individual fund / manager / factor / model may look outstanding and appear to be statistically significant. It’s easy to be fooled by this. The significance doesn’t exist when one (or one’s research department) combs databases looking for excellent performance. There is roughly a 1 in a 1000 chance of my flipping 10 heads in a row. But if I examine a thousand coin flippers, odds are pretty good that I’ll find a perfect record. When the excellent coin flipper (or fund manager) is presented to the client, the client is usually unfamiliar with this process of arriving at the nomination and the track record looks more impressive than it should.

    Active management is good for the world. The research helps allocate assets efficiently. It’s a paradox that the entire economy benefits from efficient markets but those who pay for active management on average do not enjoy higher returns. Indexers “free ride” on active management. They enjoy the benefits of efficient markets and liquidity without paying for those benefits. Does that sound ethical?

    My objection is with active management is only that its record as a whole is not presented by those who know or should know the arithmetic. Thus clients are not making fully informed decisions.

    I think the industry as a whole is also reluctant to tell clients about how low expected returns over the next 7 to 10 years might be. There are a few (Jeremy Grantham/GMO, Rob Arnott/RAFI) who call it the way they see it. There’s a reason messengers beg not to be shot. Prospects do not shower assets on those who say the pickings will be slim. Still, silence is not honesty nor highly ethical.

    I’m not sure much of this can be addressed by the industry itself. Tobacco required a labelling law (e.g. active management can be dangerous to your wealth). The industry attracts those who believe in high fees – or rather the services they are delivering for high fees – and see themselves as ethical. They are unlikely to embrace a warning they don’t think applies to them.

    Clients are better off with their advisors than without because advisors perform better than the individuals would on their own.   DALBAR studies show how far dollar-weighted returns fall below time-weighted returns. The industry is not evil, but I would not give it a high mark on ethics and don’t think my fellow professionals should expect high marks from the public either.  

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