Reading the Tea Leaves: Where Are Markets Headed?

Panel Composition and Premise:

• Moderated by Chris Ailman (CIO, CalSTRS), the panel featured Ann Cassells (Atos Alternative Investments), John Rogers (Ariel Capital), John Calamost (Atom/CalMOS), George Evans (Oppenheimer), and Todd Morley (G2 Investments).
• Ailman noted the panel's previous year's advice (betting against Greece) would have resulted in a 100% return if inverted, highlighting the necessity of contrarian views.
• The core debate centered on whether the U.S. economy has shifted to a "new normal" (slower growth) or is returning to an "old normal" (higher growth).

U.S. Economic Outlook: New Normal vs. Old Normal:

• Ann Cassells ("New Normal" View):
  • Projects U.S. GDP growth settling at 2% long-term, driven by demographic shifts (population growth down to 0.5% and stagnant productivity).
  • Cites a current 10-year "beautiful deleveraging" period; estimates Europe may be at 0% growth due to greater demographic and structural issues.
  • Argues the 2000s growth was artificially inflated by leverage, which is now unwinding.
• John Rogers ("Old Normal" View):
  • Predicts GDP growth will surprise to the upside, potentially exceeding 4%, and unemployment will fall below 5%.
  • Attributes growth potential to a housing recovery (creating supply chain jobs), lower energy prices revitalizing manufacturing, and historically low interest rates.
  • Notes that risk aversion has pushed capital into fixed income/hedge funds; he anticipates a return to equity investing as this "sideways" cash re-enters the market.

Monetary Policy and Interest Rates:

• John Rogers:
  • Views a moderate increase in interest rates as beneficial to stimulate small business lending, which is the primary engine of job growth.
  • Criticizes the current flat yield curve and quantitative easing as ineffective without consumer spending velocity.
  • Suggests 2-3% inflation is preferable to deflation and argues the Fed has better control over inflation.
• John Calamost & Todd Morley:
  • Describe the current market environment as "zombie markets" artificially sustained by "steroids" (Fed stimulus).
  • Warn of an inevitable "reflation" event where currency devaluation will occur due to insolvency risks in the U.S. and Eurozone.
  • Predict rates could spike violently (similar to 1973-1974) rather than rising gradually, citing massive money supply increases.

Global Perspectives and Investment Themes:

• George Evans (Oppenheimer):
  • Identifies "mass affluence" in developing markets as a primary growth driver, favoring Western and European consumer brands with exposure to this demographic.
  • Highlights the "information generation" boom (IoT, mobile networks) as a long-term secular growth theme.
  • Expresses caution on Japan due to endemic capital misallocation; notes only ~10% of Japan's top 300 firms generate returns above their cost of capital.
• Todd Morley (G2 Investments):
  • Focuses on "Omega moments" (forced liquidations/distress) as the primary source of alpha, specifically targeting Eurozone balance sheet imbalances.
  • Recommends a systematic rotation from paper assets (currencies, bonds) into hard assets (copper, iron ore, oil, water, food) which are currently undervalued.
  • Dismisses traditional asset allocation models (equity/bond splits) as irrelevant in a distorted market, preferring tactical, active management.

Risks and Market Structure Concerns:

• Catastrophic Risks: John Rogers cites long-term risks such as bioterrorism, nuclear terrorism (North Korea, Middle East), and grid attacks as potential market disruptors.
• European Fragility: Ann Cassells identifies Eurozone stagnation and high youth unemployment as immediate near-term risks over monetary policy side effects.
• Market Volatility and Liquidity: Todd Morley warns that the U.S. pension system's reliance on equity returns ($4.5 trillion deficit) is a fragile strategy; he argues the stock market is priced for deflation while the rest of the world is priced for inflation.
• Asset Class Distortion: Morley characterizes the current Treasury and equity markets as non-functional due to Fed manipulation ("Operation Strangle"), eliminating natural volatility and pricing mechanisms.

Investor Action and Asset Allocation (401k Context):

• John Rogers: Advocates for high equity exposure (90%) with low fixed income, emphasizing long-term holding periods (through age 80+) and the resilience of equities despite short-term volatility.
• Ann Cassells: Suggests institutional investors have an advantage; recommends broad global equity allocation (50-60%) but warns that traditional fixed income yields (approx. 1.7%) are insufficient for retirees, necessitating exposure to non-traditional income sources.
• Todd Morley: Advises extremely low equity exposure (approx. 5%) for most individuals, favoring inflation-protected hard assets and high-yield alternative strategies (e.g., senior secured loans at 15% yield).
• General Consensus: All panelists agreed that traditional 401(k) options (standard fixed income and broad equity) are inadequate for the current "new normal," urging investors to look beyond standard asset classes.

Forward-Looking Predictions for 2016:

• Inflation and Rates (Ann Cassells): Forecasts 2-3% inflation and a Fed funds rate of 3-4%, pushing the 10-year Treasury to 4.5-5.5%.
• Inflation Spike (John Rogers): Expects significantly higher inflation by 2016, but believes the market will have time to adjust without a collapse.
• Violent Inflation (Todd Morley): Predicts a sudden, violent reflation event driven by the inability to manage the money supply, potentially causing a rapid spike in rates.

Specific Long and Short Recommendations:

• John Rogers:
  • Long: KKR (Private Equity leader).
  • Short: Clorox (overvalued defensive consumer stock).
• Todd Morley:
  • Long: Natural resources (Oil and Gas).
  • Short: Paper assets/Currencies.
• George Evans:
  • Long: Diageo (Global consumer brand with emerging market exposure).
  • Short: Japanese equities (due to capital allocation) and European financials (due to regulatory uncertainty).
• Ann Cassells:
  • Long: Mid-market lending (filling the gap in capital for small businesses).
  • Short: Industry facing structural decline (e.g., traditional newspapers) or French sovereign debt (via CDS).
• John Calamost:
  • Long: Global consumer brands benefiting from middle-class growth.
  • Short: Long-dated government bonds (betting on rising rates).