VanEck Vectors J.P. Morgan EM Local Currency Bond ETF
The June Fed meeting essentially let markets know that the US central bank officially was changing to an “easing bias.” This was the “technical decision-maker” for which way the market for the dollar (DXY) would break out of its ascending triangle pattern. Typically, this is a bullish continuation pattern, but in this instance we had a false breakout to the upside on 2 prior occasions, and then ultimately broke out of the bottom.
The EMLC call is one intended to express the bearish view that technically the dollar is breaking down. This is also fundamentally confirmed by the Fed pivot to the “easing bias.”
The “easing bias” is apparent from the dive to 0% in the probability that the Fed Funds Rate will remain at 2.25-2.5% at the July 31 meeting.
To gain perspective on what to expect from EMLC under a bearish condition of the dollar, let us explore how it reacted under a bullish condition.
From July 2014 to March 2015, the DXY moved from ~80 to ~100. This was about a 25% rise. During the same time period, EMLC fell from ~49 to ~39. This was about a 20% fall. The negative correlation is clear.
The idea from the beginning was to exhibit a bearish dollar play via emerging market assets. Government bonds were chosen as a safeguard to potential economic slowdown and as the end route for “yield seekers.”
Essentially, the world economy is slowing. This is shown below in the JPMorgan Global Manufacturing PMI.
This means that emerging market equities may still be at risk due to economic slowdown taking more toll on emerging market company profits.
The second reason for the choice of emerging market bonds over emerging market equities is that this fund (EMLC) currently averages over a 6% interest rate between all of the ETF’s underlying bond holdings. The high interest rate of emerging market bonds is due to the extra risk associated with emerging market assets, but investors will be more willing to take on this risk as alternative options dissipate. This dissipation of alternatives is occurring as we now have over $13 trillion in negative yielding debt in the world. This comprises 24% of the total global investment-grade bond market.
The bullish case is laid out. I will be entering on a pull back within my technical marker or upon a breakout. I have marked fibonacci lines from the all-time high in 2011 to the bottom in September 2018.
With every trade there are risks. For this trade, it is basically all a dollar story. If the dollar turns up, then this trade will not perform well. This risk is muted though, since the world cannot afford a stronger dollar. More importantly, Trump cannot afford a stronger dollar, therefore the dollar’s upside is limited in my opinion. The reason being is that a stronger dollar will result in a lower U.S. stock market. This is due to the entire world essentially being short dollars.
From April 2018 to August 2018, the dollar (DXY) rose about 8%. This caused, on a lagged-basis, the US Stock market to enter into an official bear market (fell greater than 20%), and also caused the Fed to begin the shift to the “easing bias” due to inability for the US Stock market to handle a stronger dollar.
In conclusion, EMLC could be bought on a pullback below $33 or a breakout above $35. In calculating this position’s total return, do not forget about distributions (interest payments) that will occur in holding this bond ETF.
Should the DXY break out above 99, I would look to close the position.
The linearist view of technology fails to appreciate the dangers a new turning can bring. Microsoft founder Bill Gates is now predicting that everyone will soon tune in to a world of unlimited options via high-tech portable devices. What he nowhere mentions is that by merely reversing a few circuits the same technology could empower a central authority to monitor what every individual is doing.
A Crisis arises in response to sudden threats that previously would have been ignored or deferred, but which are now perceived as dire. Great worldly perils boil off the clutter and complexity of life, leaving behind one simple imperative: The society must prevail.
A Prophet generation grows up as increasingly indulged post-Crisis children, comes of age as the narcissistic young crusaders of an Awakening, cultivates principle as moralistic midlifers, and emerges as wise elders guiding the next Crisis.
A Nomad generation grows up as underprotected children during an Awakening, comes of age as the alienated young adults of a post-Awakening world, mellows into pragmatic midlife leaders during a Crisis, and ages into tough post-Crisis elders.
A Hero generation grows up as increasingly protected post-Awakening children, comes of age as the heroic young teamworkers of a Crisis, demonstrates hubris as energetic midlifers, and emerges as powerful elders attacked by the next Awakening.
An Artist generation grows up as overprotected children during a Crisis, comes of age as the sensitive young adults of a post-Crisis world, breaks free as indecisive midlife leaders during an Awakening, and ages into empathic post-Awakening elders.
A key consequence of these cross-cycle shadow relationships is a recurring pattern that lies at the heart of the saeculum: an oscillation between the overprotection and underprotection of children. During a Crisis, Nomad-led families overprotect Artist children; during an Awakening, Artist-led families underprotect Nomad children. Following a Crisis, Hero-led families expand the freedoms of Prophet children; following an Awakening, Prophet-led families curtail the freedoms of Hero children.
If a generation’s shadow is two phases of life older (or younger), then a generation’s matching archetype is four phases of life older (or younger). “It is one of nature’s ways,” Igor Stravinsky once observed, “that we often feel closer to distant generations than to the generation immediately preceding us.” The affinity between grandparent and grandchild is universal folk wisdom.
One thing I can tell you is that it feels a hell of a lot better to sell when you want to, rather than when you feel you have to.
I have been bearish on the US Stock Market since the summer of 2017. This is when my understanding of macroeconomic fundamentals and markets accelerated. I believe that if I had gained enlightenment sooner, then I would have become bearish earlier. I consider myself to have been luckily ignorant. As they say, “Don’t confuse brains and a bull market.”
My immediate family has been luckily ignorant as well. My dad had been fairly aggressive and to our benefit this landed us with more or less of an overall allocation near 80% equities (largely US) and 20% bonds.
The story goes that I became bearish and wanted to essentially sell everything. Conventional family money managers were disciplined and helped us to not blow our selling load too fast. We took some chips off the table and that probably landed us around 65% stocks, 25% bonds, 5% gold, and 5% cash. We have continued to take chips off the table, but I know many have not. At this point in the cycle, one could very easily argue that 65% is still an extreme over allocation to stocks.
I want to convey why 65% stocks does not make sense. If I told you that you could get to the same end portfolio amount at retirement with less big swings, wouldn’t that make you happier? Basically, if you were on a plane would you rather it be turbulent or smooth?
In portfolio management, we have a measure for this tradeoff. It is called the Sharpe Ratio. The idea is to try to create a portfolio that will reach the highest return above the risk free rate for the least portfolio volatility. This is attractive because if you should need your capital sooner than you had priorly anticipated, then it is less likely that your portfolio will be at a disadvantageous level to draw from. Also, from an emotional standpoint, a higher Sharpe Ratio relieves stress of downturns and removes potentially ill-timed panic sales. So what has been an optimal Sharpe Ratio recently? Play around below if you like, but I will give you some examples.
The simple way to use the Sharpe Ratio is to find a portfolio that fits your return goals and risk tolerance and you let it ride from there. This is lazy.
Using the past 5 5-year periods and a 5-asset class universe consisting of US Stocks, US Bonds, Non-US Stocks, Gold, and REITs, the optimal way to achieve a beloved 10% a year has been…
From 2014-2019, the optimal way to achieve a 10% return was 57.80% US Stocks, 4.82% US Bonds, and 37.39% REITs.
From 2009-2014, the optimal way to achieve a 10% return was 39.16% US Stocks and 60.84% US Bonds.
From 2004-2009, the optimal way to achieve a 10% return was 59.97% US Bonds, 1.03% Non-US Stocks, 36.28% Gold, and 2.72% REITs.
From 1999-2004, the optimal way to achieve a 10% return was 61.66% US Bonds, 1.55% Gold, and 36.79% REITs.
From 1994-1999, the optimal way to achieve a 10% return was 24.30% US Stocks and 75.70% US Bonds.
The optimal portfolio allocation is constantly changing. One must understand that setting a portfolio allocation and riding it to end of the Earth is foolish. The probabilities that either US Stocks, US Bonds, Non-US Stocks, Gold, and REITs will be the most optimal portfolio allocation is changing every single day. That does not mean you should change your portfolio every single day, but you are doing yourself an enormous disservice to not question from time to time, “Is my portfolio ready for the next year?”
US Stocks were the most optimal asset allocation in the past 5 years. Interestingly enough, this was the first 5 year period that that was the case in the past 5 of such periods. If they win only 1 in every 5 5-year periods (based on the last 25 years), and starting points are important, do you feel good about being over allocated to US Stocks when they are currently the best?
And I know that for the most part the conventional wisdom money manager will tell you to ride that portfolio, but they have jobs to protect. Going against the herd is difficult for them. Therefore, a paid fiduciary is only working in your best interest to the extent that they will continue to make money from you. If others fiduciaries are about to lose, they will lose with them.
The main surprise from this analysis should be that US Stocks were only the primary asset allocation in 1/5 of the last 5 5-year look back periods. From purely a historical perspective, you should realize that the optimal way to earn 10% a year is usually with your primary allocation being to US bonds. I bet most of you reading this are seeing the statistics in front of you and are still unwilling to see the reality because you have been told for your whole life to invest in stocks. It is never too late to wake up.
I also know that most people have essentially a 0% allocation towards gold because they or their money managers can’t understand an asset that doesn’t pay a yield. Newsflash. Not only is gold pretty, but it is an integral part of much of our technology and thus has demand. That’s the easy part to understand. The important part is that it is the only true money that exists and from time to time it basically re-accounts the whole monetary system and at those times, it is a must own asset. Aside from it being a must own once asset every 40 years or so, make sure you didn’t miss that a small allocation towards gold is usually a necessary piece to creating an optimal portfolio.
In terms of “re-accounting” the system, imagine a world where there are $100 and one ounce of gold. Gold should be valued at $100. Remember, although we are not on an official gold standard, gold has a funny way of maintaining that role, which I will display below. If the government decides to print $100 more dollars, then there will be $200 in the system. The intrinsic value of gold should then be $200. The times to buy gold are when there are more dollars than gold ounces multiplied by the current price.
In Wealth Cycles by Mike Maloney, he shows a graphic that displays a pattern of government money creation, gold lagging in price, and then gold catching up to its intrinsic value. The green line is basically all the dollars that exist, and the gold line is all the ounces of gold that the US Treasury holds multiplied by the gold price. From 1944 to 1971, gold lagged in this relationship under the Bretton Woods system. This system pegged all currencies to the dollar and $35 to one ounce of gold. Well, as all governments eventually do, the US spent recklessly and eventually holders of dollars began to doubt that if everyone redeemed their dollars for gold at the same time that there would be enough gold. This is visible below. Gold was $35 from 1944 to 1971, so in order for the yellow line to go down the US Treasury must have been hemorrhaging gold from doubtful dollar holders.
In 1971, Nixon decided that dollars would no longer be redeemable for gold. This essentially allowed gold to float freely, and the result was that the gold price rose to re-account for all of the past spending.
Gold US Treasury has times Gold Price in dollars vs Value of all Fed Created Base Currency Wealth Cycles by Mike Maloney
This graphic from Santiago Capital is of similar nature. It shows the gold price necessary to re-account for various different countries and their gold holdings.
Brent Johnson @SantiagoAuFund
Over the past year, the fundamentals, geopolitical risks, and liquidity factors have all deteriorated, yet we are still near all time highs. This is the definition of irrational exuberance. If you still have a heavy allocation towards stocks, then this may be your last chance.
Sell high, buy low. Sell stocks, buy gold.
Let me leave you with this. A historically normal mean reversion of the Dow to Gold Ratio would be a move from 20 to 8. With the Dow near 25,000 and Gold near $1,300 and holding the opposite asset constant, either gold would need to rise above $3,000, or the Dow would need to fall under 11,000.
The current chart though is eerily similar to that of the 1966 peak, 1974 trough, and the 1976 retracement, before the eventual 1980 trough where the Dow was roughly the price of an ounce of gold. If that scenario unfolded and holding the opposite asset constant, then the Dow would need to go down about 95% or gold would need to go up about 18 times.
Dow to Gold Ratio – 100 Years https://www.macrotrends.net/1378/dow-to-gold-ratio-100-year-historical-chart
