Investment Strategy Conference - October 21, 2017

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It was the best of times, it was the worst of times, it was

the age of wisdom, it was the age of foolishness, it was the
epoch of belief, it was the epoch of incredulity, it was a
season of light, it was a season of darkness, it was the
spring of hope, it was the winter of despair, we had
everything before us, we had nothing before us.
~Charles Dickens, A Tale of Two Cities
 4

The Age of Turbulence

Past Crises & Fed Tightening Cycles
5

83-84 Penn Square & Continental Illinois

82 Latin banks and Drysdale Securities collapse
American Debt &
Farm Belt Crisis
87 & 89 Stock Market crashes

90 Junk Bond crisis, Real Estate

74 Franklin and Savings & Loans collapse
Natl bankruptcy
97 Asian Currency, Russian Debt
70 Penn Central default, Long-Term Capital Management
bankruptcy 00 Tech Bubble bursts

Subprime Credit Crisis

11 PIG/Debt Ceiling
94 Mexican Peso crisis &
15 China/Global Stall
Orange County bankruptcy
 6

Richard Sylla

Someone alive today who remembers the last

40 to 50 years can feel theyve been a part of a
special period for history, from the extreme
highs to the extreme lows in US history.
~Richard Sylla, FSN Sept. 2, 2017
 A History of Interest Rates
7

It took 5,000 years to

reach 20%
5,000 Years
In a 40-year time span
rates went from the
highest to lowest
interest rates recorded
in human history

Thought human
history average rates
6-8%, today 0-2%
 8

Before There Was Money,

There Was Credit
Grain Loans
Countryside 33 1/3%

Silver Loans
City 20%

Credit Loans
The Code of Hammurabi 6-8-12%
 9

What Has
Changed
10
The Debt Supercycle
11

Source: DougBriefcase.com
Monetary Policy Under New Normal
12
 Where We Stand Today 13

Yields
U.S. 2 yr note 1.36
U.S. 10 yr note 2.18
Germany 2 yr note -0.72
Germany 10 yr note 0.41
Italy 2 yr note -0.14
Italy 1 yr note 2.05
Switzerland 2 yr note -0.93
Switzerland 10 yr note -0.13
Japan 2 yr note -0.14
Japan 10 yr note 0.03
U.K. 2 yr note 0.275
U.K. 10 yr 1.145
Source: Barry Bannister, March 2017 presentation
As of 10/17
Yield Curve Distortion
14

Global QE still
in effect

$9 trillion
negative rate
sovereign
bonds

Inverted yield
curve -
Source: Bloomberg recession
indicator?
Financial Repression 15

$20T
Debt Consequences
Caps or ceilings on
interest rates

Government control
or ownership of
domestic banks and
financial institutions

Capture domestic
market for
Source: St. Louis Fed
government debt
 How the Debt Supercycle Unfolds 16

Source: St. Louis Fed

Decades-long growth of debt
Debt levels grow in each
business cycle
Debt build up leads to long-term Bond markets rebel and debt has
decline in balance sheet liquidity to be reduced or restructured
Debt finally reaches levels where
it impacts economic growth
 How We Got Here 17

Source: Bloomberg

Each recession / business The fed would lower Economy prevented from
cycle added more debt interest rates cleansing itself of
to stimulate economy excesses
Debt Free Hall Pass 18

U.S. Govt Debt Annual Interest

(Trillions) Expense
$10,024 2008 $451,154
$11,910 2009 $383,971
$13,562 2010 $413,955

$14,790 2011 $454,393

$16,066 2012 $359,796

$16,738 2013 $415,689

$16,738 2014 $430,812

$18,150 2015 $402,435
$19,573 2016 $432,650
Source: Department of U.S. Treasury
 The New Normal 19

Falling CPI

Slower GDP
growth

Historically low
interest rates

Source: Washington Post

 Inside the Debt Supercycle 20

(Consumer Debt)

Mortgage debt

Credit card debt Automobile debt

Source: St. Louis Fed

Inside the Debt Supercycle 21

(The New Credit Bubble - Auto Loans)

Source: Quartz/The Atlas

 Inside the Debt Supercycle
22

(The New Credit Bubble - Student Loans)

Past 10-years student loans up 170% 90% new loans originate dept. of education

Avg. debt loan up 70% to $34,000 42 million Americans owe $1.4 trillion
student loans
 Inside the Debt Supercycle
23

(The New Credit Bubble - Student Loans)

Source: Huffington Post

Inside the Debt Supercycle
24

(Corporate Debt)

Outstanding debt
 Inside the Debt Supercycle 25

Source: Yardeni Research

Main driver stock prices CB & Corporations using debt to buy

corporate buybacks back shares, increase dividends
 Inside the Debt Supercycle 26

Source: St. Louis Fed

Largest increase debt has been U.S.

2000 2017 2027 2037 2047 government

Spending 17.6% 20.7% 23.4% 26.3% 29.4%

President Bush and Obama each
double national debt
Revenue 20.0 17.8 18.4 19.0 19.6
Deficit -2.3 2.9 5.0 7.3 9.8 National debt grew from $1T under
Reagan to $20T under Bush & Obama
Debt 34% 77% 89% 113% 150%
Source: Department of U.S. Treasury/CBO
Debt Supercycle & Financial Repression
27

10-Year Treasury Note

1. Caps or ceilings on interest rates

2. Government ownership or control

Corporate Bond (AAA)
of domestic banks & financial
institutions

3. Creation of captive domestic

markets for government debt
Corporate Bond (BAA)
Broken Relationships 28

Supply and demand

relationship is broken

Bond/stocks out of
alignment

Bond market no
longer functions in
normal fashion
 Deflationary Forces 29

Case of Missing Inflation

Globalization

Decline of
labor unions

Rise of big
multinationals

Technology
 30

The Disruptors
iPod - Changed music industry with iTunes

iPhone - Disrupted digital photography,

communication, entertainment, and computing

iPad - Disrupted computer industry from

laptops to desktops

AppleWatch - Disrupting health industry,

telecom, traditional watch manufacturers
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FRACKING
 Industries Ripe for Disruption
32

Percentage of Affluents Who

Can Identify a Favorite Brand Retail
- Grocery
2007/8 2014/15 - Apparel
80%
67%
Transportation
61%
58%
40%
47% Consumer brands
37%
28% Communication
- Networks
- Newspaper
- Advertising
Fashion Jewelry Luxury
Brand Brand Hotels
Retailer
Education
Source: Findings from the 10th Annual Time Inc./YouGov Survey of Affluence and Wealth, April 2015.
 The Disruptors 33

Apple $805B
Amazon $480B
Facebook $501B
Google $690B Facebook, Google own media 43/60%
Apple own the phone 14.5/79%
Total $2,476T Amazon dominates retail ecosystem
55% of all product searches
 34

The End Game

Extraordinary Era
Interest rates

Debt super cycle

Final phase with government debt

Result
Lower economic growth

Lower inflation

Lower interest rates

Lower asset returns

How Will End Game Play Out
35

Series of QE to stave off

recession, revitalize
GDP

CBs will keep interest

low with financial
repression

Debt will continue to

grow, rates remain low,
series of asset bubbles

Ultimate solution is
Source: Bloomberg devaluation
Two-Minute Warning or Extended Overtime
36

83-84 Penn Square & Continental Illinois

82 Latin banks and Drysdale Securities collapse
American Debt &
Farm Belt Crisis
87 & 89 Stock Market crashes

90 Junk Bond crisis, Real Estate

74 Franklin and Savings & Loans collapse
Natl bankruptcy
97 Asian Currency, Russian Debt
70 Penn Central default, Long-Term Capital Management
bankruptcy 00 Tech Bubble bursts

Subprime Credit Crisis

11 PIG/Debt Ceiling
94 Mexican Peso crisis &
15 China/Global Stall
Orange County bankruptcy
Reflation Phase 37

Output gap
shrinks

Dollar declines

Inflation rises

Commodities
outperform
The Investment Clock 38

Phase Growth Inflation Asset class

I. Reflation Bonds

II. Recovery Stocks

III. Overheat Commodities

IV. Stagflation Cash

 Reflation Phase 39

Copper Dollar: output gap = inflation - import prices, PMI - prices paid

Commodities: copper, oil, and precious metals

CPI: interest rates

Stocks: need to confirm commodity prices

Oil Gold
The Sequence of Market Tops 40

(2000-2002 Bear Market)

Source: StockCharts.com
The Sequence of Market Tops 41

(2007-2009 Bear Market)

Bond yields peak

June 2007

Stocks peaked
October 2007

Commodities peak
July 2008
Source: ?

Source: StockCharts.com
 42

Investment Conclusions

Extraordinary era

End of debt super cycle

Entered 3rd phase business cycle

Two minute warning

Market toping process: bonds,

stocks, and commodities
 Longer-Term Outlook - The Confidence Game 43

Debt levels continue to rise Rates rise as confidence wanes

Series of Fed QE to stave off recessions Eventually, devaluation

Each economic downturn requires more

government stimulus
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Summary and Conclusion

1. End of Debt Super Cycle

2. Two-Minute Warning

3. Market Topping Process