Our view on global investment markets:

August 2013 The Miracle Belay

Keith Dicker, CFA Chief Investment Officer keithdicker@IceCapAssetManagement.com www.IceCapAssetManagement.com

August 2013
Becoming a legend

The Miracle Belay

In 2009, the Americans lead by Hank Paulson and Ben Bernanke threw unlimited amounts of money to the financial sector to self arrest the entire plant from spiraling out of financial control. These financial acts of bravery stabilized the system and so we were told would set the stage for a recovery. Alas, one year later in 2010 the same Ben Bernanke announced that the recovery had completely stalled and he would once again save the system by printing even more money. Of course in 2011 he repeated the same strategy and began yet another round of more money printing to save us again. And, then in 2012 the Europeans felt that everyone needed even more life saving, and told the World that just like the Americans, the Europeans too would watch your back. Those who disagree with history conveniently forget it was actually the US Federal Reserve who created the housing bubble, by creating the technology bubble, by bailing out a Wall Street hedge fund. To add more ice cream to this dish, lets not forget the central banks role in the Asian crisis, the Mexican crisis and the savings & loan crisis. As you can see, these are not one-hit wonders, and sadly the Feds Greatest Hits are anything but great. Certainly, the stock market has recovered and this is exactly what the US Federal Reserve wanted. At the time, they read somewhere that if people feel wealthier, theyll borrow and spend more. Simple

In mountaineering lore, summiting Everest, McKinley or even the Vinson Massif certainly warrants a notch in your ice axe. However, the mountain that always produces jaw-dropping admiration, respect and outright fear, has been and always will be K2. The Worlds second highest mountain, is rarely guided and attempted only by the most skilled, the most patient and the most determined climbers and for good reason, falls, slips and nasty tricks can happen in a moments notice. And when they occur, knowing how to swiftly execute a self arrest, or a belay can be the difference between a tragic fall and living to climb another day. Now, when it comes to belays, American Pete Schoening has become synonymous with not just any belay, but the miracle belay. In 1953 at 25,000 feet high in the clouds on K2, one precarious moment turned Mr. Schoening into a climbing legend when he single handedly saved five of his rope mates from plummeting off the mountain. Naturally the climbers were all shaken; yet they learned from this experience and enjoyed many more years of climbing. In 2009, 2010, 2011 and if you can believe it again in 2012, global financial markets were also hanging from a ledge. But each time, instead of having an experienced professional to save everyone involved, the World was dependent upon central banks whose entire legacy was smeared with economic and monetary failures.

www.IceCapAssetManagement.com

August 2013
Fair is fair

The Miracle Belay

cant buy happiness probably have never had a lot of money. Not only does the economy matter, it matters a lot. And this is one belief that our central banks got right. Except, theres just one thing wrong. Note chart 3. This picture has really befuddled the US Federal Reserve and Ben Bernanke who believe that if they throw trillions of dollars into the economy making the stock market rise, then the velocity of money, or the speed at which it zooms around the economy should skyrocket as well. While the official reason for the decline in velocity continues to confuse Bernake and company, the unofficial reason is loud and clear bad government policies and actions are scaring the pants off of private capital. President Obama wants the rich to pay their fair share of taxes. Considering the wealthiest 20% of Americans already pay 65% of all taxes one might ask What number is fair? 80%,? 90%?, 100%?. Maybe the rich can cover the deficit as well and pay the impossible rate of 120%. Dont underestimate the lack of logic in tax policy. If the Americans need help in suspending the laws of mathematics, just ask the Europeans for guidance. Worse still, many people are not aware that Obama Care has had an extreme impact on employment in the US. The new mandatory healthcare program makes it considerably more expensive for companies to have full-time workers. And so they simply hire parttime workers instead.

enough, all they had to do was to make people feel wealthier and when it comes to wealth in America, theres no better barometer than the stock market. Chart 1 next page shows the cumulative effect on the US stock market from all the various forms of quantitative easing, or money printing programs. One can see that as the Federal Reserve printed more and more money, the stock market increased more and more as well. This made Ben Bernanke a happy man. As demonstrated in chart 2, the household net worth of Americans has just hit its highest mark EVER. Yes, Americans are now wealthier and now all the world has to do is wait for them to start their borrowing and spending engines. Except this hasnt happened. While GDP loving economist are quick to point out that unlike Europe, America hasnt slipped back into any recession, they conveniently fail to mention that +1.5% GDP growth is hardly the stuff of legendary recoveries. Instead America, and the World continues to slowly grind lower. At any time, cracks in the system appear. Fractured governments in Italy and Greece, massive protests in Turkey and Brazil, and outright civil war and coups in Syria and Egypt are all symptoms of a weak global economy. Lets face it, those who disagree and say money

www.IceCapAssetManagement.com

August 2013

The Miracle Belay

Chart 1: S&P 500 and Quantitative Easing

Money MoneyPrinting 5

Money Printing 2 Money Printing 1

Money Printing 3

Printing 4

www.IceCapAssetManagement.com

August 2013

The Miracle Belay

Chart 2: US Household Net Worth

Wealth Effect Step 1: A SUCCESS Individuals and companies are wealthier today than at any other time in history

www.IceCapAssetManagement.com

August 2013

The Miracle Belay

Chart 3: US Velocity of Money

Wealth Effect Step 2: A FAILURE Despite being wealthier, individuals and companies are not borrowing & spending, which means money has basically stopped sloshing around the economy

www.IceCapAssetManagement.com

August 2013
A breath of fresh air

The Miracle Belay

summer hypnotizes everyone in financial markets, we remind you that it was only a few short weeks ago when the financial World was rocked: a seemingly innocent Ben Bernanke announced that later this year the Federal Reserve might actually begin to print less money. While this isnt exactly the same as taking away the punch bowl; it is the same as watering it down to say the least. Markets of all shapes and sizes ran for the hills and left Wall Street wondering what the heck just happened. Not to be outdone Ben Bernanke and the Federal Reserve asked the very same question. One thing that became crystal clear was the fact that the Federal Reserve does not control markets as much as they initially believed. Naturally, what proceeded next was a series of speeches, interviews and memos that would have made Abbot & Costello proud. Apparently, the Federal Reserve didnt exactly mean what they meant after all. The Federal Reserve has finally come around to admitting that yes, perhaps all of their post-2008 market saving adventures actually created yet another bubble. Not wanting to create any loud noises, Bernankes May 2013 tapering announcement was meant to create a small hissing sound. Instead, he received a lot of angry phone calls from the JP Morgans, Goldman Sachs and Morgan Stanleys of the world.

As for the Republicans, they are not exactly showering the country with innovative solutions either. Senator John McCain is leading the charge to tax the internet claiming it is providing an unfair playing field for the mom & pop stores on main street. Technology is one area where America still has a competitive advantage. McCain and other career politicians should understand that allowing businesses and consumers to embrace technology may actually help the economy escape the stalled recovery. If they are going to further stifle innovation, dont be surprised if they next devise taxes for fresh air and sunlight. Meanwhile in France, President Hollande also ponders how much he should tax the rich. Of course, this shouldnt be surprising. After all, while campaigning Mr. Hollande frequently called finance his greatest adversary. And if that wasnt enough he also declared he didnt like the rich that much either. Yes, this is the person entrusted to lead the Euro-zones second largest economy out of recession. Similar views, moves and laws have also been sighted in Italy, Spain, Greece, and Cyprus. And since we live in a global world, lets not forget Japans newest super duper money printing attempt, nor Chinas now regular participation in their liquidity markets. All of which brings us to 2013 and the irony that inevitably follows any Holy Grail plans devised by our central banks. As the lull of

www.IceCapAssetManagement.com

August 2013
Head-locked

The Miracle Belay

clearly head-locked people into driving with their rearview mirror. Instead, we urge investors everywhere to analyse their portfolios for sensitivities to a rising US Dollar. Its no secret that most financial and monetary data write a gruesome story for the US. After all, unfunded liabilities will never be funded; Fiscal deficits will never become surpluses; and evidently debt loads will always increase. When the US is viewed in this light run for the hills, get out of Dodge, or prepare to live off-grid for a while. However, the missing pieces from this puzzle show Europe and Japan to be significantly worse off than our American friends. Its imperative to view the World from a Worldly perspective isolated analysis will lead to erroneous conclusions. Its our view that as economic, political and social lives experience very little progress, governments and central banks will not only continue with their same failing policies, but they will actually implement more of these same failing policies. Yes, people should prepare for more austerity and then less austerity, followed by more. The same will be true for money printing. One thing that wont change however is the trend of higher taxes and the trend for increasingly more regulation and tax reporting. It is this continuation of failed policies that will become the driver behind a stronger US Dollar. Private capital will leave Europe, leave Japan and any other country that becomes an auxiliary victim of www.IceCapAssetManagement.com 7

Unfortunately, this rather awkward situation now leaves the financial World in a rather uncomfortable place Will central banks continue to print money and therefore blow even more air into the bubbles they have created? Or alternatively, will the Americans begin to print less money in an attempt to slowly deflate the bubbles. This is a tough spot thats for sure. But correctly understanding the dynamics of the global financial system and the ongoing proactive moves by private capital will help you better position your investment strategies for what is about to happen next. The Next Big Thing When it comes to the next big thing, we are not talking about Bieber, Kaepernick, or Baby George were much cooler than that. Instead, investors everywhere should begin preparing for the effects of a significantly stronger US Dollar. In November 2011, we clearly stated our view that the US Dollar would once again return to prominence and strengthen considerably against most currencies. Yes, the days of the Loonie & the Aussie at par would be fodder for camp fire stories. The Euro would break-up altogether, and yes, even the mighty British Pound would shed some weight. In short the next 10 years in the currency World is going to look a lot different than the previous 10 years. The challenge of course is that human beings fail time and time again to correctly anticipate major turning points. Cognitive dissonance has

August 2013
The paradox

The Miracle Belay

be a complete shock if Merkels coalition doesnt win the most votes. At this point, the only risk is whether her coalition can win a majority. Either way, the current seemingly innocuous Euro debt crisis will rise its head again once the election dust settles. Once markets have digested these bumps, the real fun will begin. There will still be bumps in the night, and pot holes during the day yet as the World approaches 2014, the possibility of sustained strength in both the US Dollar and stock markets becomes very real. Now, we absolutely appreciate the paradox of a strengthening US Dollar and stock market, all while the global economy continues to grind lower but this is the World the central banks have created.

these global policies gone wrong. Of course, as the US Dollar strengthens and its stock market rises the talking heads will be talking about the miracle economic recovery - we advise that this reasoning will be proven wrong. Global private capital is fluid, and just as people become comfortable with the next new paradigm of a super duper America, another bubble will have formed right before them. Eventually of course, this global capital will flow away from the US and back to where it came, meaning after the rise of the USD, investors should prepare for a decline, as well as the opposite reaction a rising Asia. For a reference point to this view, consider the 1987-90 Japanese market. Chart 4 on the next page details the surge in the Nikkei over a very short period of time. While Sony, Cannon and Fujitsu gave investors easy to understand stories for dinner and drinks, many forget the 1987 US market crash which was the precursor to nonAmericans yanking their money out of the US. As for the near-near-term, the Federal Reserve boondoggle in Jackson Hole, Wyoming will stir up the buzz surrounding Ben Bernankes replacement. At present, it seems like a two-horse race between the usual socially inappropriate Larry Summers and the career public servant Janet Yellen. Careful throwing a dart to pick the winner, apparently this very political decision changes by the day. The near-term has the September 22, 2013 German election. It will

www.IceCapAssetManagement.com

August 2013

The Miracle Belay

Chart 4: Japanese Stock Market 1987-1990

After the 1987 US Stock Market Crash, international capital left the USA and flowed to Japan causing the Japanese Stock Market to surge by almost 100% over 2 years

The US stock market could emulate the 1988-1990 Japanese stock market and double very quickly

www.IceCapAssetManagement.com

August 2013
Hero vs Villain

The Miracle Belay

Our Strategy The difference between Pete Schoenings Miracle Belay and the various market saving feats of the central banks is very clear; Mr. Schoenings act saved his friends from certain death and his act did not put them into any further danger. Petes a hero. On the other hand, while in 2009 the central banks initially did try to save the day, their repeated attempts have time and time again severely distorted financial markets, putting investors back into even more danger. Over the past three years, the real risk in financial markets has been in global stock markets. Each time stock markets teetered and tottered, central bank stepped in to save it. Ben Bernankes June 2013 speech has completely changed the dynamics of financial markets by significantly increasing the risk associated with bonds and interest rate sensitive strategies. Considering the confusion caused by the US Federal Reserve and the ongoing sluggishness of global growth, our portfolios are reducing exposure to interest rate sensitive strategies and increasing exposure to USD markets. Stock market sentiment has once again crept up towards the non-reward zone and this allows us to remain patient as we enter into the upcoming events in Jackson Hole and Germany.

As always, wed be pleased to speak with anyone about our investment management capabilities. As well, we encourage you to share our global market outlook with those who you think may find it of interest. Please feel to contact: John Corney at johncorney@IceCapAssetManagement.com or Keith Dicker at keithdicker@IceCapAssetManagement.com. Thank you for sharing your time with us.

www.IceCapAssetManagement.com

10