2016 Fall Grant’s Conference

On October 4, we attended the fall Grant’s Conference in New York City, hosted by Jim Grant, publisher of the influential newsletter Grant’s Interest Rate Observer. As we’ve noted in past dispatches, we consider this event of particular interest both for the intelligence and diversity of its presenters as well as the quality and influence of its audience.

It would be hard to identify an overarching theme in this year’s presentations, though, generally, the mood was one of apprehension if not outright bearishness. Managers for the most part alluded to what they saw as overheated equity markets, as well as perils facing bond investors. Uncertainty reigned: Geopolitical uncertainty, in the form of the coming U.S. election, as well as an increasingly fractious Eurozone, and economic uncertainty, as future Fed moves remain far from clear in either their substance or effect, while asset prices remain artificially high and interest rates artificially low. Highlights from the various presentations follow:

Lacy Hunt, chief economist for Hoisington Investment Management, a treasury specialist, kicked off the day with a presentation arguing that the nation’s huge deficits and growing debt would ensure low interest rates for the foreseeable future because they would inevitably (and to some degree paradoxically) produce ever-slower economic growth. Policymakers, Hunt argued, “accept a model that is 80 years out of date.” Rather than boosting economic activity, said Hunt, excessive government spending is depressing it, pointing to what he said was a negative government expenditure multiplier, in which every incremental dollar of government spending is presently producing a seven-dollar drop in private investment. He expects this ratio to become even more unfavorable as debt grows, producing a self-reinforcing downward economic spiral.  We would note that Dr. Hunt has been correct for 30 years, and Hoisington’s beliefs are implemented in a bond portfolio of pure Treasuries with a duration of 22 years!

Later in the day, conversely, fixed-income guru Jeffrey Gundlach, of DoubleLine Capital, expressed his own strong opinion that rates were headed up, perhaps dramatically. The Fed governors, and other central banks, if nothing else, face immense psychological pressure to “do something,” Gundlach argued, whether conditions justify it or not. Despite his pronouncement two years ago that “TIPS [Treasury Inflated-Protected Securities, which are indexed to inflation] are for losers,” so convinced is Gundlach now that higher rates are coming that he has moved all of his treasury holdings into TIPS. Uncertainty, indeed.

Julian Robertson, who co-founded the seminal hedge fund Tiger Management in 1980, joined the crowd in lamenting the present state of economic affairs. “We have come to the point where we are punishing saving and applauding spending,” he said. “It has created a large bubble and it will exaggerate any downward market movements that we may have.” Robertson agreed generally with Gundlach that “interest rates have to go up,” and argued that “it’s a long-term sure thing to go short the bond market,” though, in a nod to timing, he cautioned that “at the same time there are a lot of sharks in the water ready to eat us as we swim to shore…you don’t want to get your head taken off by going up against the central banks of the world.” In terms of specific investments, Robertson opined that the Mexican peso might be a good value and pointed to “certain stocks trading at 3-4x earnings—Air Canada for example.” Caveat emptor, of course.

Baupost’s Seth Klarman shared a similar disdain for the Fed’s easing. “It’s a giant experiment,” he said. “We should not be conducting giant experiments on the future of the nation’s health. Artificially low rates create a lot of fake economic activity and I am very concerned, given the nature of mean-reverting markets, that we will suffer huge consequences.” At the moment, Klarman favors distressed investing, along with “super-complicated things,” that most investors won’t take the time to understand, and “things that are hated by investors,” such as spin-offs that have proven initially disappointing. Klarman holds cash as a “buffer,” he says, “not as a market timing device.” His maxim: “Hold cash when there’s nothing great to do, because eventually, something great will come along.” His fund is presently 40% cash, “and if current trends continue, it will likely creep higher.”

Steven Bregman, of research firm Horizon Kinetics, presented a thought-provoking analysis of some of the liabilities of index-based ETFs, which he termed the “delivery agent of the great bubble” that present “massive systemic risk to everyone who thinks they are diversified in a conventional sense.” Among the chief problems (though not the only issues) with such vehicles are a lack of price discovery (especially in fixed-income ETFs), a lack of clarity among investors as to which markets they’re actually investing in (Bregman’s example: 6 of the 10 top holdings in the iShares MSCI Spain Index ETF derive 70% or more of their revenues from outside Spain), and potential liquidity problems should investors rush to the exits simultaneously.

Should you have questions or desire additional information, please contact your consultant.