Piñera’s pickle

Chile’s president tries to quell unrest

Sebastián Piñera sets a new direction. The country may not follow

THE PROTESTS that have convulsed Chile have taken every conceivable form. They began when students in Santiago, the capital, started dodging metro fares, which had been raised by 30 pesos (four cents) at peak times to 830 pesos. Anger then began to express itself in arson and looting and spread to other cities. The government imposed its first curfew in Santiago since the end of dictatorship in 1990. At least 20 people died in the unrest and more than 1,000 have been injured.

On October 25th 1.2m people, a fifth of the city’s population, converged on central Santiago to express (peacefully) their disgust with inequality and with the way the country is run. “I would like to retire but can’t,” said Carolina, a 62-year-old teacher, who has saved enough for a pension of just $275 a month after 30 years on the job. Placards demanded everything from a lower VAT on books to a new constitution.

Sebastián Piñera, Chile’s centre-right president, at first took a tough line with the malcontents. “We are at war,” he declared during the rioting. The state’s response was heavy-handed. Although most of the deaths occurred because of arson, Chile’s Human Rights Institute is compiling evidence of 120 cases of abuse by security forces, including five killings.

As protests grew, Mr Piñera’s tone changed. On October 19th he rolled back the fare increase. On October 22nd he announced further concessions. These included higher public spending on pensions and health care, a boost to the minimum wage and a reversal of recent rises in electricity prices. These measures will cost the government $1.2bn, 0.4% of GDP. To help pay for this the government is to raise taxes on top earners.

Mr Piñera followed that up on October 28th by replacing eight members of his cabinet. The new cabinet has a younger, friendlier face. The president, who promised “better times” when he took office in 2018, says these changes herald the start of “new times”. But it is unclear how much novelty he is planning, and whether it will satisfy Chile’s restive people.

Violence has lessened, but continues. Some protesters are demanding Mr Piñera’s resignation. On October 30th he announced that two high-profile international meetings, a UN climate conference and a summit of Asian and Pacific countries, will not be held in Santiago. He wants to focus on restoring order and talking to Chileans.

If Mr Piñera is to deal with the roots of discontent, he will have to reform Chile’s way of providing health care, education and pensions, believes Eugenio Tironi, a sociologist. Under a model developed by free-market economists during the dictatorship of Augusto Pinochet, who ruled from 1973 to 1990, citizens are expected to save for their own retirement.

In many other countries, public pensions are financed by taxing current workers and giving the money to current pensioners—a system that comes under strain when the population ages. Chileans, by contrast, invest the money they save in privately managed funds. This system has helped Chile manage its public finances and encouraged the development of long-term capital markets, which in turn has boosted economic growth. But Chileans like Carolina are furious to discover that they have not contributed enough money to pay for adequate pensions. Many are equally angry about long waiting times to see doctors in the public health system and about the lousy education available in public schools.

Post-dictatorship governments have tried to boost public spending on the hard-up. In 2008, for example, the Socialist government of Michelle Bachelet increased the value of payments to schools attended by the children of poor families. But even after such changes the government spends less than 11% of GDP on education, health and pensions, well below the average of the OECD, a club of mainly rich countries, to which Chile belongs.

The conservative Mr Piñera is unlikely to scrap a system which in many ways has served Chile well. It is the second-richest country in Latin America, thanks in part to its healthy public finances and robust private sector. Mr Piñera is likely to resist demands for a constituent assembly to rewrite the constitution. This might push reform in the direction of populism and discourage investment.

One problem for the government is that the protesters’ demands are unclear. Their movement grew largely through social media, without identifiable leaders. Another problem is that Chile’s political class has lost credibility. A survey conducted in May this year by CERC-Mori, a pollster, found that the senate, the chamber of deputies and political parties were among the country’s four least-trusted institutions. (The fourth was the pension-fund managers.)

Mr Piñera’s own approval rating dropped last week from 29% to 14%, an all-time low for a president in the democratic era, according to Cadem, another pollster. A rich businessman, he is seen as an exemplar of what is wrong with Chile. His coalition, Chile Vamos, has a minority of seats in congress, which has made it hard for him to govern. Anger over human-rights abuses may further complicate his efforts to introduce reforms.

Mr Piñera wants to overcome such obstacles by convening town-hall meetings similar to those held by France’s president, Emmanuel Macron, in response to the gilets jaunes (yellow jackets) protests this year. These could help, says Juan Pablo Luna, a political scientist at the Catholic University in Santiago, provided they bring together people from different backgrounds. Mr Piñera is betting that dialogue and a revamped government will break deadlocks over how to reform the country. The result could be a new Chilean model.

Allure of US stocks reflects great expectations

Investors are keen to jump in, anticipating strong outlooks, but caution is warranted

Michael Mackenzie

When stock investors chase after winners, it is striking how often they end up in the US.

All of the top five stocks in the FTSE All World index by market weight are US tech giants, so it is no surprise that over the past decade, Wall Street has eclipsed rivals, driven by big tech and other leading multinationals.

That remains the story for 2019. So far this year, the All World index excluding the US has risen around 9 per cent. Throw in the S&P 500, and the gain moves towards 15 per cent.

Not surprisingly, broad valuation measures of US equities are elevated. Not only that, but they sit well above rivals, such as those for Europe, the UK and emerging markets. The cyclically adjusted price/earnings multiple, known as CAPE, for the S&P 500 currently trades around 29 times, compared to a historical mean of 17.

In contrast, across other equity markets, the CAPE ratio is far lower. That suggests that investors with an eye on valuations and long-term returns should think seriously about areas of Europe, emerging markets and even the UK, which has been harshly downgraded within many portfolios since Brexit erupted.

Daniel Grosvenor, equity strategist at Oxford Economics highlights how the CAPE on the MSCI All Country World Index of 19 times represents “a near record gap” with the S&P 500.

“The US is also where valuations are currently most stretched . . . and it is also the epicentre of our concerns on corporate leverage given the prevalence of share buybacks in recent years,” he warns.

Where does this huge lead for the US come from? It could be that US companies are simply far better at reaping revenues and controlling costs. Aside from the obvious disrupters in the technology sector, Wall Street has gained a great deal from an integrated world economy, which helps multinational companies reduce labour costs, alongside low interest rates and competitive tax codes.

Potentially helping US markets further, the past 18 months of trade friction between the US and China may soon become a touch smoother. A slowing global economy has weighed on corporate profits growth alongside business and consumer confidence, even for the S&P 500.

Keeping the show on the road have been central banks, easing policy rates at their fastest pace since the financial crisis era, while government bond yields are substantially lower since January, providing a valuation crutch for equities and credit.

This has also offset the prospect of an S&P 500 earnings recession for the first time since 2015/2016. Next week, the latest quarterly earnings season starts, led by financials unveiling their results and talking about their business prospects for 2020. This represents an important period for investors as companies at this stage of the year are in a better position to outline how things look beyond January.

Wall Street is relying on upbeat tidings from executives; the fact that the S&P 500 is just shy of its record peak in July reflects expectations of a rebound in activity during 2020. Much of the rise in equity prices since January amounts to a down payment that future earnings growth accelerates. That is why analysts still pencil in S&P 500 earnings growth in the region of 10 per cent for both 2020 and 2021.

The problem is that we have been here before; 12 months ago, for example, analysts expected that S&P 500 earnings would expand by 10 per cent in 2019. Now the market expects a 2 per cent growth pace in earnings for all of the year, with upcoming third-quarter results at this juncture seen contracting when compared to the same period a year ago.

For all the optimism that S&P 500 earnings growth will pick up speed, there is a considerable warning flag fluttering over Wall Street in the form of the recent revision for US whole economy profits, known as the National Income and Product Account, which covers the universe of US companies from small to large.

Anastasios Avgeriou at BCA Research notes that this measure “peaked in advance of SPX earnings in the previous three cycles”. That now appears to be the case again when looking at NIPA profits and profit margins. It is also highlighted by this year’s lagging performance of midsized and smaller US companies.

‘’Economy-wide profits may have already peaked this cycle, warning that the S&P 500 earnings juggernaut is long in the tooth,’’ says Mr Avgeriou.

The heavyweight technology sector, a longstanding winner, has long propped up US large-caps, but history tells us that rotations eventually clip the wings of the largest and expensive areas of the market.

As Rob Arnott at Research Affiliates told a conference in London this week, “the largest stocks in the market are often expensive and have historically underperformed over the next decade.’’

Global equities face earnings fatigue but much lower valuations outside of the S&P 500 provides a degree of insulation and a better long-term starting point that favours Emerging Markets and in particular beaten-down value shares.

No Pullbacks

Jared Dillian

The Federal Reserve has embarked on QE4—sort of.

They are buying Treasury bills.

Here we go again.

There is a genus of financial commentary that revolves solely around the Fed and its relentless pursuit of credit expansion, and how it will result in inflation.

I know, because I used to do this.

This made for a good trade, from 2009-2011. Now it is mostly people being angry. But there is still a pretty huge appetite for this angry, anti-Fed commentary, so I will indulge in it, a little.

The Fed should not be doing QE4.

Something I used to say in The Daily Dirtnap—quantitative easing is not debt monetization.

Debt monetization is a matter of intent.

If the intent is to keep interest rates low to finance the government, then it is debt monetization.

We are getting close.

But ostensibly, there are some reasons to be conducting quantitative easing in T-bills.

It will steepen the yield curve.

Minneapolis Fed President Neel Kashkari went a step further and said that we should be doing yield curve control like Japan, to ensure the yield curve remains steep.

Maybe we should let the market determine interest rates? Unfashionable idea, I know.

To answer your question, yes, we are all going to hell.

It will be because of the Keynesians.

Their sack dance continues, because relentless credit expansion has so far ensured that recessions are in short supply.

My guess is that we’ve lengthened the cycle and increased the amplitude.

If you think inequality (and the political angst that goes with it) is bad now, you ain’t seen nothing yet.

This Is Not a Newsletter about Finance

No fun being a finance junkie these days.

All bad news.

And yes, stocks going up is bad news, if they’re going up for the wrong reasons.

We live in an economy full of distortions caused by interventions of varying magnitudes.

And it is definitely going to get worse.

If you sat around and worried about this stuff all the time, you would make yourself miserable.

But if you sat around passively and didn’t take any action to protect your assets, that wouldn’t be very smart, either.

I suspect many readers of The 10th Man fall into the same camp as me—you have enough wealth to get totally screwed by the authorities, but not enough that you can really protect yourself. You’re not a billionaire.

You do things where you can—buy gold or bitcoin—but I can think of a hundred different ways that won’t work out, either.

My recommendation is simple. Do not spend too much time thinking about this stuff.

Of course, if you were really paranoid, you’d be on the first plane to Singapore with a tube of toothpaste full of diamonds. I really do not want to get to that level of paranoia.

It isn’t healthy.

Then again, there have been times in history where the people with that level of paranoia were the ones who survived.

Things You Should Invest In

This is an investment newsletter, so let’s talk about things you should invest in.

I will preface this with the fair warning that the following applies to people who have already accumulated wealth.

Experiences: Concerts, clubs, hiking trips, winery tours, etc. You should spend money on memorable experiences, then treasure the memories. Fly to Paris for a weekend. Have you ever done that? I have done that. Will never forget it. When your favorite band comes to town, go see them. I know it is past your bedtime. You only get one shot at this.

Luxury: Suits, shirts, casual clothes, watches, shoes, cars. I know the 2005 Corolla helps you save money. We do not know what’s going to happen over the next ten years. You might as well enjoy your money now. I’m not kidding.

Food and Drink: Nice dinners, fine wines. Nothing like the tactile sensation, however fleeting, of eating really good food.

Things you should not invest in:

Stocks And Bonds: They give you no enjoyment. Soon, they will be taxed out the wazoo.
(Please take me seriously, but not literally. Of course, you will have stocks and bonds. The point here is to think about consumption as an asset class, of sorts.)

A lot of people, myself included, spend time trying to think up the optimal asset allocation.

Honestly, most assets look bad, and I’m pessimistic enough about the future that it makes me want to enjoy the present.

Especially if you’re of an age where you should be decumulating assets anyway.

He who dies with the most toys does not win.

So my investment “advice” these days is kind of like anti-investment advice.

Everything is unattractive, and we’re all going to get hosed by wealth taxes and negative interest rates, so you might as well enjoy yourselves.

Start today.

If you’re not in the habit of going out to dinner on a Thursday night, do it.

And stop by the jewelry store on the way home.

I doubt there will be a wealth tax on that.


And finally, some music for the end of the world, courtesy of me.

sábado, noviembre 02, 2019



From London to Space War

By George Friedman

From the beginning, mankind’s presence in space had to do with war.

In World War II, humanity went beyond the Earth’s atmosphere in order to kill. The first rocket that passed out of the Earth’s atmosphere was neither American nor Soviet but rather the German V-2.

It was the first combat missile and had a maximum speed of over 3,000 miles per hour. (The V-1 rocket – basically what is today called a cruise missile – had an air-breathing engine and traveled at a speed of about 350 miles per hour, slower than most World War II fighters. It could, therefore, be shot down if detected by radar.)

The V-2 was powered by liquid fuel – alcohol mixed with liquid oxygen for combustion. It had limited guidance and tended to fly on a trajectory that took it out of the atmosphere and back. The first V-2s hit London, when they hit anything at all, since they had a high failure rate between launch and impact.

It had a warhead weighing 2,200 pounds – about half the payload of a B-17 – but with the explosion being concentrated, it did not distribute the blast efficiently. Nevertheless, it devastated whatever it hit. Adding to the terror, the V-2 hit after it ran out of fuel and therefore fell silently, unlike the V-1, which had a loud engine.

But the V-2 failed strategically. It might have targeted ports the Allies were using, but Hitler thought of it mainly as a weapon of terror in London. Observers thought this irrational but it wasn’t. Missiles are expensive, and the Germans had relatively few.

The V-2 did not have the precision to hit critical port targets and too small a blast radius to engulf any target. Attacking a city meant that it was likely to hit something, and in hitting something, it might compel the British public to force the government to agree to a cease-fire.

That never happened, but instead, it linked the guided missile to terror. It was seen as a weapon so devastating that it could force an enemy to capitulate.

The V-2 was developed by a team headed by Wernher von Braun, a German scientist who was captured, along with much of his team, by the Americans as part of Operation Paperclip, a program that seized samples, plans and above all the scientists who designed the V-2.

Von Braun later became an American citizen and hero. (He wrote a biography titled “I Aim for the Stars.” Humorist Tom Lehrer suggested that the title be changed to “I Aim for the Stars; Sometimes I hit London.”)

The Soviets had a program similar to Operation Paperclip, but it had a number of problems.

The German rocket facilities were located on the North Sea, and scientists elsewhere, aware that Operation Paperclip was underway, preferred to be captured by the Americans, not the Soviets. Still, both the Russian and American missile and space programs were designed in the 1950s and founded on the V-2 rocket by a number of German scientists. The first American space satellite was launched by a Jupiter-C missile, which was an updated and renamed Redstone rocket, which was an updated and renamed V-2 rocket.

Both the Americans and the Soviets grasped the importance of missiles early. At first, the thought was to employ them as the Germans had: as a weapon whose goal was to destroy civilian populations. This thinking shifted with the introduction of the first atomic bomb.

The Cold War quickly settled in on Europe, and the United States had a huge advantage: an advanced long-range bomber force based around the Soviet Union’s periphery. The Soviets’ own long-range bomber force did not encircle the United States, nor could it reach the United States. They, therefore, were in a desperate position. The United States had a nuclear option.

The Soviets did not.

The Soviets could not build an intercontinental bomber force because the technology and the training needed to build a capable strategic air force was stunningly expensive and would take a long time to develop. In the meantime, throughout the 1950s, the United States built up its bomber force, with the B-52 as the superb solution. A conventional war commenced by the Soviets was therefore impossible, as the U.S. had unchallenged nuclear superiority – though, notably, it didn’t use it.

The Soviet solution was to develop a missile force that could counter the American threat. The foundation of their counter was the German V-2 and their German scientists, as well as a strong Soviet engineering team. The problem with V-2 was range. The Soviets needed a weapon with intercontinental range and a better guidance system, and that takes a decade to develop. But they moved forward rapidly.

The U.S., meanwhile, noted the work being done on Soviet missiles and was content to lag behind because of its vast bomber superiority. But the U.S. realized in time that the development of the Soviet intercontinental ballistic missile could pose a threat to its bomber force.

An ICBM launched from the Soviet Union could hit the U.S. in about 30 minutes. Scrambling a B-52 squadron from standby status to airborne and clear of the target would likely take longer. So the U.S. moved to continual alert status, with some B-52s aloft at all times in the north, the North American Air Defense Command (NORAD) operating out of Cheyenne Mountain in Colorado Springs and a line of radar stations positioned throughout northern Canada.

In many ways, this was premature. The Soviets had developed shorter-range missiles, which they used to launch Sputnik and astronauts like Yuri Gagarin into space, but not yet a significant, solid fuel ICBM. It was important that the ICBM use solid fuel because loading a missile with liquid nitrogen takes hours.

Leaving liquid oxygen in a missile is both dangerous and pointless as it bleeds out. Responding to an American attack in Europe, for example, with a liquid fuel ICBM would be difficult. The Soviet dilemma was that, as late as 1960, they could not hit the United States with nuclear weapons, while the U.S. could hit them. The Soviets had based massive fighters in the north, along with surface-to-air missiles to take out attacking B-52s, but they knew there would be massive leakage through the line.

This strategic quandary forced them to develop solid fuel systems that could remain in the missile – something that had been in development since the early 1960s. But the strategic problem was that the Soviets posed no threat to the continental U.S. (aside from some submarines that could hit the United States). This was a driving force behind the Cuban Missile Crisis and Soviet support for Fidel Castro.

Lacking ICBMs and having limited and insufficiently reliable submarine-launched missiles, the Soviets needed bases close to the United States. By having missiles in Cuba, they had the U.S. within range. But the U.S. responded by threatening war; the Soviets knew they could not win a nuclear war and so capitulated.

At this point, the Soviets accelerated their ICBM program, and the Americans accelerated theirs. The speed of the Soviet ICBMs threatened the U.S. bomber force, which was no longer enough of a deterrent. The U.S. was already working on this in the late 1950s, launching satellites and starting the Mercury program, essentially a spin-off of the broader missile program. Both sides surged their nuclear submarine program as well. By the early 1970s, both countries had ICBMs and submarine-launched ballistic missiles, and mutual assured destruction became a meaningful concept.

With the advent of missile development, the key was to know the other side’s capabilities. The Americans used the U-2 spy plane for this purpose. The Soviets used more conventional intelligence capabilities, like hanging around in bars near air force bases. But the U-2 was shot down, and traditional intelligence didn’t work. The satellite programs both countries were working on in the 1960s had less to do with manned flight than with reconnaissance satellites that could see missile facilities from low Earth orbit.

The first U.S. satellite reconnaissance system involved dropping buckets of film from a satellite and having an airplane fly by and catch them. This was not really workable. Another series used TV cameras to beam down really low-quality pictures. By the early sixties, both sides were using high-definition cameras to transmit pictures back to Earth. Their offspring now can be found in your smart phone.

The ICBM required a constant presence in space, circling 60-90 miles above Earth. In geosynchronous orbit (the altitude and speed at which a satellite matches the Earth’s rotation) lurked satellites that had infrared ability and could sense a missile launch. Along with them, there were communication satellites and so on.

The threat of nuclear war required constant surveillance. The only place where that surveillance was possible was in space.

Today, anyone who wants to wage war must destroy those sensors, which are infinitely more sophisticated than they were in the 1960s. Space is very crowded, and the fear of being blinded by the enemy haunts all major countries.

From the moment the first V-2 hit London, the fear of war has driven space exploration.

It’s Time to Rethink the Traditional Retirement Savings Allocation

By Daren Fonda 

Bonds are poised to cause more trouble than they’re worth, and it may be time for investors with a 60/40 mix of stocks and bonds to replace them with other assets, including cyclical dividend stocks, junk bonds, and high-quality munis.

The 60/40 mix, an asset allocation once commonly recommended for retirement savers, “may have thrived in the 2000s and 2010s but will not survive the 2020s,” Michael Hartnett, chief investment strategist at Bank of America Merrill Lynch, and his team assert.

The crux of this idea is that bonds aren’t likely to provide the diversification benefits and risk-adjusted returns that investors have come to expect. As Barron’s points out in this week’s cover story, a huge rally in global fixed-income markets has pushed yields down to near-record lows in the U.S. and below zero across Europe and Japan.

There is now $17 trillion of negatively yielding debt in global markets. The steep decline in yields over the past six months has been one of the fastest collapses since the global financial crisis, according to Hartnett. Long-term Treasuries have rallied 28% in the past six months as yields have plunged.

This heightened volatility in bonds isn’t what you want with a 60/40 portfolio. Bonds are supposed to provide ballast and capital protection against equity volatility, and if bonds are making big price moves, your portfolio could take some hits.

Merrill’s rate strategists team expects 10-year Treasury yields to fall 0.25% in coming quarters to 1.25%. Low economic growth, a Federal Reserve that has been cutting rates, and relatively high U.S. yields compared with the rest of the world could continue sending yields down, Hartnett writes. Purchasing managers for manufacturers recently indicated one of the worst outlooks since 2009, he adds, reinforcing the idea that the Fed will remain in easing mode.

Nonetheless, bonds may not be a great diversifier anymore. Stocks and bonds have had a negative correlation for the past two decades, Hartnett writes. But they had a positive correlation where they moved in the same direction for much of the postwar period.

It wouldn’t take much to push yields back up—a slight pickup in inflation forecasts or signs of a trade deal between the U.S. and China. And this is a twitchy bond market: A 10-year Treasury note bought Sept. 3 fell about 3% over the following 10 days—a big decline for an investment yielding 1.5% over the next 12 months, Hartnett writes.

So what are some other portfolio building blocks? Hartnett says that stocks in high-yielding “bombed out” cyclical sectors with low multiples look attractive. That would be industrials, financials, and materials. Hartnett expects those sectors to outperform technology and classically defensive stocks like utilities and consumer staples, which have been bid up sharply.

He also likes short-term junk bonds and floating-rate loans. Yields are relatively low in junk bonds and bank loans “are reviled,” he writes. But credit risk is better than interest-rate risk and corporate leverage ratios have declined in certain non-growth sectors, indicating that defaults may not be as bad as expected.

As for floating-rate loans, there are worrying signs in the market. But Hartnett views them as a “contrarian buy on plunging supply.” Loan yields would also rise if rates increase in 2020, supporting prices, an outcome that Hartnett says is “underpriced” by the market.

High-quality munis could make a good substitute for Treasuries and investment-grade corporate bonds. Munis would benefit from a flight to quality. Merrill’s fixed-income team expects them to rally at least to May 2020.

Granted, cyclical stocks, junk bonds and floating-rate notes are all “risk assets.” They would sell off sharply in a risk-off climate as investors seek havens like Treasuries. Sure, it might look like 30-year Treasuries can’t go much lower than the 2.2% they’re now yielding. But they’re not at zero yet.