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    A Painstaking Move for 30-Yr Interest Rates Ahead

     

    A Painstaking Move for 30-Yr Interest Rates Ahead

     

    "Men, it has been well said, think in herds; it will be seen that they go mad in herds, while they only recover their senses slowly, and one by one."
    Extraordinary Popular Delusions and the Madness of Crowds - Charles Mackay

     

    The discipline of security selection is part art and part science.

    The science focuses on the sterile measurement and quantification of the concept of ‘value’.

    The art is the assignment of a probability that a security moves to its assessed value.

    As the CIO of Atlanta Capital Group I recognize that our investment committee members distill information differently and ply their trade based on subjective criteria that matches their own emotional makeup. AND THAT’S FINE.

    So long as research is logically thought out and passes the common sense test my experience is that most disastrous investment decisions are avoided.

    That means our culture focuses on decisions based on three schools of security analysis – Fundamental, Technical (I will call it Visual so as to avoid the emotional response it conjures) and lastly Sentimental.

    For the purposes of this discussion – interest rates where to? - allow me to dwell on the last 2 disciplines and let us agree upfront that US Government bonds are richly valued given the historical low interest rate environment.

    Crowd Sentiment


    The most common refrain we have heard over the last 7-years (since the 2008 crisis) is – “Rates have nowhere to go but higher.”

    We noticed a subtle shift in the mass psychology about a year ago where the common refrain became – “When rates eventually move higher” as exacerbated forecasters recognize that rates have stubbornly refused to move higher.

    Then we noticed with interest this October 18th Bloomberg article - China's Selling Tons of U.S. Debt. Americans Couldn't Care Less.

    China is beginning to disgorge of its $1.4 trillion U.S government bond horde but other buyers – US institutions, US retail and other Foreign entities – are soaking up the supply as well as all the new issuance in a now $12.9 trillion bond market!

    It’s a convincing article with all the hallmarks of justifying bubble behavior:

    Investors in the U.S. “are making a decision based on their outlook and it’s a reflection of the economy as well as their risk aversion,” Nomura’s Goncalves said.
    [GS: is buying bonds at these levels an indication of risk aversion?]

     

    Visual Analysis

     

    The following chart shows an interesting floor exists on 30 Year T-Bond Rates.

    Figure 1 - 30 Year US T-Bonds

    The 2.5% level has acted as a floor 3 times now – in 2008 during the financial crisis, in 2012 during QE3 and early in 2015 during what will be called the Chinese growth implosion (rates moved temporarily below the floor only to bounce back swiftly).

     

    Certainly from a visual perspective 2.5% is statistically meaningful.

    Now we really have no idea whether we are entering a large secular bear market in bonds but we merely lob the question – what would be the effect of a sizeable correction in the bond market [albeit still within a bull market context] ?

    We think we are about to find out over the next 12 months.

    Figure 2 - 25 year price channel US T-Bonds

    Since 1990 30-YR Bond prices have been moving in a well-defined channel (above) with regular oscillations between the top and bottom of the channel lines --- all within the context of a secular bull market in Bonds.

    Having hit the top of the channel in early 2015, it is feasible that prices can make their way to the bottom channel line as they had been doing for the preceding 25 years!

    When could this happen?

    It seems these periods of oscillation takes between 1 and 2 years so we would speculate 2016 / 2017.

    Such a move from the peak to trough would indicate an approximate capital loss of 20% on 30-Yr Treasuries. At a current yield of 3% that is approximately a loss of 7 years’ worth of interest payments!

    How would Pension funds deal with this loss? How would Risk-Parity strategies deal with this loss? Sovereign Wealth Funds, Insurance companies – how would most liability sensitive fixed income investors handle such a loss? Probably not well.

    Why would rates move higher?

    The exact reason is of course beyond our intellect but we could speculate:

    Fed hikes short term rates and the yield curve adjusts higher across all durations;

    Growth oscillation – the market has swung too far towards the deflationary side and adjusts in the opposite direction;

    Chinese selling finally overcomes the mass of buyers;

    The Fed starts to adjust its balance sheet with negative consequences (unlikely to happen);

    An exit for the door of a crowded trade;

     

    Knock-on effects

     

    Interest rate movements have consequences for all other asset classes Real Estate in particular.

    Also, companies with a lot of newly issued investment grade debt may see deterioration in their credit ratings with a knock on effect on their equity prices.

    The following chart shows rolling correlations of Real Estate, BDCs, MLPs, Bank Loans and Investment Grade Credit (respectively) against the 30-Year Bond. Most are positively correlated meaning lower bond prices translate into lower prices.

     

    Figure 3 - Rolling correlation Real Estate, BDCs, MLPs, Bank Loans, Investment Grade Bonds w US T-Bonds


    What to Do

     

    We will stick with our decision to sit on a larger than normal cash allocation – despite the fact that it has no current yield – it may pay us very well when we come to buy assets at discounted prices!

    -- Greg


    p.s. this is a great read for serious market students

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    Thank you for reading my post. I regularly write about private market opportunities and trends. If you would like to read my regular posts feel free to also connect on Linkedin, Twitter or via Atlanta Capital Group.

    Greg Silberman is the Chief Investment Officer of Atlanta Capital Group. Atlanta Capital Group specializes in creating custom private market solutions for RIA/Family Office clients and is an active acquirer of independent wealth management practices.

    Advisory Services offered through Atlanta Capital Group.

    Nothing in this article should be interpreted as a recommendation to buy or sell any security. Please conduct your own due diligence.                  

     

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    A 3rd quarter summary - commercial real estate in Atlanta

    Atlanta multi-family developers have clearly ascribed to the philosophy; “if you build it, they will come.”  I guess this Field of Dreams reference is appropriate for the baseball playoffs of October (pause for painful exhale of Cubs Nation).  If one stands on top of the Federal Reserve Bank of Atlanta, you can count just shy of a dozen cranes…all for multi-family projects.  When you combine this multi-family construction with the construction for the new home of the Braves & Falcons, it all adds up to the suppliers of concrete and steel popping the cork this Holiday season on a good year.  

    What does this mean for the office sector of commercial real estate in Atlanta?  Hot…or in the words of James Brown; “real hot!”  Although rates are rising due to stagnant supply with rising demand, the cost to come out of the ground is high enough that office developers will need to see rates that are still north of the market to justify the ROI in the time frame they desire.  Granted, you are starting to see headlines for projects that hope to break ground but they are still approx. 24 months from delivery and most of the office construction is tenant driven (i.e. State Farm & Mercedez Benz)…or it is self-funded such as Tishman Speyer’s Three Alliance Center in Buckhead.

    To be clear, there is no shortage of devil advocates filling Atlanta’s cocktail parties who claim that Atlanta still has high supply…and on paper, they are correct but when is the last time you have walked into some of this vacant office supply and said; “yep, this is where I want to come work every day.”

    In short, the 3rd quarter of commercial real estate in Atlanta has fulfilled the old saying; “there is nothing new under the sun” while affirming the circular nature of real estate with human behavior being the common denominator.

    Look for office rates to continue to rise in sought after markets through the 4th quarter with landlord brokers slappin the “get while the getting is good” sign on their way out of their office every day.

    Thoughts?  In particular, do you think the Millennials will actually fill all the multi-family developments that are taking place?

    http://cresa.com/webfiles/atlanta/andyroberts/AtlantaMarketSummaryQ32015.pdf

    Andy Roberts

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    Why a Southern Hemisphere Trip Changes Your Investment Perception

    Why a Southern Hemisphere Trip Changes Your Investment Perception

     

    Thursday, October 01, 2015

     

    They rent the babies a friend told me!

     

    I just returned back from a 2 week trip to South Africa with my youngest daughter.

    I spent all my time in Johannesburg, the city I grew up in.

    It was a bittersweet trip for me.

    I have not been back to my native country for over 10 years.

    No, I’m not on the lamb!

    10 years provided me with a rude awakening.

    When I left in the 90s the walls around homes were high – they are even higher now.

    On top of each monstrous wall is electric fencing ... I wondered if all those electric fences were ‘live’ but I didn’t attempt to find out. Given that power outages have become commonplace I’m guessing not all are.

    At most busy traffic lights (called Robots) there is a plethora of activity. Street vendors hock anything you can imagine. And there are begging rings. A friend told me they are predominantly Nigerian and the babies are not necessarily there with their mothers. Nope they are ‘rented’ out for the day to generate revenue!

    Additionally, the city I knew has now been subsumed into its original African roots. That is, the city I grew up in was strictly segregated and planned in meticulous British style – street grids, fancy gardens and parks. For better or worse the chaos that can be Africa exists where the English colonial system once reigned.

    The economy is not in good shape, the Rand has tumbled to close to R14 to $1 which was last seen around 1999 during the Asian financial crisis. However there are positives:

    • Johannesburg is truly the gateway into Africa.
    • Very cosmopolitan and now home to Africans from all countries on the continent.
    • Sandton, the new business district, is humming with energy and activity with the traffic moans and groans to prove it.
    • Uber works without a hitch!
    • While the markets are volatile, well run corporations are making inroads into the continent and recurring earnings are growing.

     

    The Future as I see it:

    I believe Nelson Mandela bestowed an amazing gift on the country, one which will keep on giving long after his passing.

    By refusing to allow the country to descend into civil war and embrace reconciliation – a most bitter pill for him to swallow no doubt – he has left a model for others to follow.

    I have noticed that good things seem to emerge when enemies unite. Here are some examples:

    • Germany after World War II
    • Japan after World War II

    Today Germany and Japan are strong Allies of the USA to the point where nobody sees them as an enemy anymore and trade is flourishing between former foes.

    Contrast this with the Treaty of Versailles where war reparations were forced onto Germany by France, England the USA etc. That short sighted move ultimately bankrupted Germany allowing National Socialism to take root which led to World War II.

    South Africa has embraced the former reconciliatory path and although it is a young democracy which will be tested, I believe it will survive.

    But for that to happen the masses NEED access to faster internet where the industrious will stream FREE EDUCATION and those with willpower WILL raise themselves above their dogmatic station in life.

    As with all things in life this can be seen as an obstacle or an opportunity. I prefer the latter and encourage the backing of investments that seek to achieve this worthy but lofty goal.

    In order for Emerging Markets such as South Africa to begin lifting the malaise, the developed economies need to stem their risk of behavior. Which begs the question whether an intermediate rally is brewing and what danger signs to be aware of longer term?

     

    Tradable Rally approaching?

     

    A curious thing is going on with investor sentiment.

    The American Association of Individual Investors (AAII) Sentiment Survey measures the percentage of individual investors who are bullish, bearish, and neutral on the stock market for the next six months; individuals are polled from the ranks of the AAII membership on a weekly basis. Only one vote per member is accepted in each weekly voting period.

    The AAII Survey is often used as a contrarian indicator that is if investor sentiment is very bullish it indicates that there are not many new buyers left to enter the market and prices could decline and visa-versa for bearish sentiment.

    As recently as last week the AAII Bullish sentiment hit levels indicative of 2003 and 2008/09 bear market lows.

    Figure 1 - AAII Bullish Sentiment (source: stockcharts)

    It seems as if our collective psyche was severely altered by the 2008 market crash. Investors get really nervous, really quickly and given that we’ve ‘only’ had a ~10% correction in the S&P500, the uber low bullish reading is curious – but a good contra-indicator for us to watch out for a rally.

    Now here’s where it gets even curioser (is that even a real word?)

    If investors as a group are NOT bullish you would think they are therefore bearish?

    Not true.

    Figure 2 - AAII Bearish Sentiment (source: stockcharts)

    The AAII Survey indicates only 28% of investors are bearish. That’s a low reading compared to 60% and 70% at the 2003 and 2008/09 lows respectively.

    That implies that a large contingent of investors are neutral or to put it another way, short-term cautious (low bullish percentage) but long-term constructive (low bearish percentage).

    We will humbly take the other side of that view given that the AAII Survey is a good contrarian indicator.

    This ‘correction’ may be over in the next 2-3 weeks and a good year-end rally will ensue to alleviate low bullish sentiment.

    But then we are more concerned over the longer-term mostly because of the preponderance of investment grade bond issuance, some $5.5T* since 2008 and high yield issuance. Again, due to behavioral finance reasons corporate debt has become a crowded trade because investors preferred the safety of debt to equity even though that debt has returned less than the equity for the most part.

    Those bonds have been a windfall for investment grade corporations who have taken advantage of historical low rates to lower their cost of capital and buyback stock.

    The cause for concern longer-term is therefore a widening of spreads and a potential liquidity contagion if investors come to sell their Bonds and find very few dealers making a market on the other side.

    During August/September correction there has been a tightening in credit markets globally

    Figure 3 - Source: @Neckar Value, Bloomberg

    And corporate CDS spreads are sharply wider

    Figure 4 - Source: @MaxDrake007, Bloomberg

    And with pressure in credit markets building, investors are dumping many of the popular spread products. The "reach for yield" has turned into a nightmare

    Figure 5 - Source: Ycharts

     

    Pour Conclure

     

    Stronger Dollar, collapsing commodity prices, severe Emerging market pain and higher rates nowhere to be seen … smells like Deflation to me.

    #GrowthSlowing

    A short term rally may be upon us to relieve the negative sentiment valve … and we will be looking to benefit from this by raising our equity exposure.

    But the downside risk is also building!

    REMAIN VIGILENT and be prepared to move SWIFTLY

     

    Regards
    Greg

    Ps. A lot of readers are asking me for my opinion on the Rugby World …. all I can say for now is it may be a good thing that the Springboks lost to Japan! I ran out of space today but will talk about it next time

    * Source: http://www.sifma.org/research/statistics.aspx

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    Thank you for reading my post. I regularly write about private market opportunities and trends. If you would like to read my regular posts feel free to also connect on Linkedin, Twitter or via Atlanta Capital Group.

    Greg Silberman is the Chief Investment Officer of Atlanta Capital Group. Atlanta Capital Group specializes in creating custom private market solutions for RIA/Family Office clients and is an active acquirer of independent wealth management practices.

    Advisory Services offered through Atlanta Capital Group.

    Nothing in this article should be interpreted as a recommendation to buy or sell any security. Please conduct your own due diligence.                  

    Main picture source: Dexter Morgan

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