Newsletter – 2019 Predictions
My name is Max Rudolph. I consult with institutional investors, advisors, and other consultants about enterprise risk management, asset-liability management and strategic planning themes. I also do research projects and read quite a bit about financial and historical topics. I try to find examples of history repeating itself through similar cycles. I am a private investor focused on individual stock selection and value investing techniques. My background earning credentials from the Society of Actuaries and CFA Institute, combined with proximity to Warren Buffett and Charlie Munger through Omaha residence, has paid dividends. I believe you can reduce risk and increase return simultaneously using contrarian techniques. Recent interests include complexity theory, behavioral economics, and climate change. These are also the topics I occasionally tweet about @maxrudolph. In addition to client work, I develop and present continuing education programs and am an adjunct professor teaching online graduate level investment and ERM programs at Creighton University. I live in Omaha, Nebraska, USA, am credentialed as an actuary (FSA CERA MAAA) and hold a CFA charter. I have written a monthly newsletter since 2008 and each January post my predictions for the year. Late in the year I review and compare against what actually happened. Some topics are written at a high level, dealing with the general economy. Some are more detailed, covering specific topics like incentives or modeling financial assets. Most cover issues that I am stewing over and need to do a brain dump. In March I update my intrinsic value calculation for Berkshire Hathaway and in the fall I update the scenarios I think should be tested by financial institutions. I am a lifelong learner, and that impacts how my current thinking evolves. My newsletters are educational in nature and do not constitute investment advice. They are released publicly at www.rudolph-financial.com with a delay of several months after they are released to subscribers.
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Predictions for 2019
These are not really predictions in the classic sense. Treat them more like scenarios that you should build resilience against to survive over the long term.
Disclosure - please remember that these predictions are for fun and to encourage deeper thinking across topics and a longer time horizon. If I really knew what was going to happen I would not share that information with you! You must make your own personal investment and risk decisions, consider your unique financial circumstances, and not hold others (especially me) responsible for your own financial planning or lack thereof. If you don’t accept these conditions you should stop reading now. Keep in mind that this is NOT investment advice. For those still with me, Enjoy!
The financial markets continue to confuse me. I see lots of warning signs; geopolitical risk, monetary policy tightening, reduced covenants, higher leverage (especially margin debt), warnings from pundits. In addition, we are now a year post tax reduction – the period when stimulus traditionally ceases to be effective. It feels like all we are waiting for is a trigger for a crash. What could cause emotions to turn against assets? A Presidential tweet, war in the Middle East, an implosion in Venezuela or North Korea could be all it takes. Trump has now completed two years, and it has been very stressful even for those of us who are not involved (I am proud to be an American and very concerned about the path we are on, both politically and environmentally). This makes it even harder to understand how the economy continues to grow so quickly. The lack of business investment, with companies preferring to pay out dividends or buy back shares, is a worrying development. It is a good time to pay down debt. Are we better off on auto-pilot with a nonfunctional political situation? Do human interactions reduce growth, so taking us away from decision making means better decisions are made?
The US tax plan has added to the imbalances in the system that needs so desperately to clear. Reducing regulations makes sense in some instances, but unwinding Dodd-Frank without discussion and shutting down EPA and DOE functions with no discussion is scary. Monetary policy should have tightened more last year (or in 2011), and continued dovish stance will make any recession deeper.
European and Japanese Central Banks have gone beyond buying government assets and now are major players in the equity markets. They will be challenged while unwinding those positions or getting in the middle of a proxy fight. I wrote an essay in 2018 titled Driverless Investing about my concerns.
I tend to think farther out on the time horizon than most, and I can see a scenario that scares me very much. One where bullies with guns take what they want with immunity, destroying the economy and civilization as we know it. The Fourth Turning shows additional signs of its appearance each year. Can moving away from gerrymandered districts create moderate candidates? We have populists at both ends of the spectrum, left and right, who back scary and poorly thought out policies. Some states should test a top-two election methodology. Those who do, and create moderates, may end up with outsized power as the brokers for change and lead other states to follow. Everything is cyclical.
Climate change will continue to be a major topic for as long as I can see. Humans have created change at such a rapid pace that plants and animals can’t keep up. Species are being eliminated so quickly that we will have to carefully choose which ones to retain since we can’t save them all. I will be talking publicly about climate change in a webinar for Actex Learning on March 5 where I will share some of my thoughts about what each of us can do to help.
I continue to believe that the underlying world economy never cleared the imbalances built up over the past 20 years (starting with the Fed’s reaction to Y2K, and arguably earlier than that based on After the Fall that goes back to Continental Illinois). Even worse, we have entered a new Gilded Age where everything is pay to play and inequality gets worse.
Central banks need to push back on politicians who act as if they can spend all they want because they want you to think that the Fed drives the economy. Monetary policy only works when fiscal policy is reasonable and debt/GDP is below 90% (per Reinhart/Rogoff This Time is Different). We need infrastructure spending but political posturing is just that.
I see similarities to 1938 moving into 1939, when the Great Depression was reenergized by the Fed and fascism had gained momentum. War soon followed. 1973 and the nifty fifty have many similarities with the current environment, with guns and butter making a comeback in economic analysis. Deficits cannot continue without ramifications. There are also similarities to other 4th turning cycles such as right before the Civil War.
Trump’s appointments include many who are unqualified, and others who care more about their own earnings than whether the next generation gets a fair shake. New judges are particularly scary as they are lifetime posts.
In 2019 the Fed will back off its tightening schedule as it reviews the post-tax reduction cycle. It will be interesting to see if tax refunds appear as expected. I know I’m very uncomfortable with the withholding put in place early last year. I would not be surprised to see a European financial crisis kick up soon, perhaps triggered by Brexit. Southern Europe would be better off out of the EU. Germany would not.
In the US velocity of money may have bottomed, but it doesn’t feel that way.
Fracking will eventually find itself more noted for the water it wastes and the loans it defaults on than being able to make the US energy dependent.
This late in the cycle individuals should be looking closely at the debt in companies they buy. Reduced covenants in bonds will also be a problem, along with anything collateralized. Keep it simple at this point in the cycle. Don’t be the sucker at the table. The US continues to live off their reserve currency status, and this gives politicians an excuse to spend and blame the fallout on others. They make fun of modern monetary theory (MMT), as they should, but how is what they are currently doing any different? Active investment strategies will do better over the next few years than passive ones do as a recession hits, but only when value strategies are followed. Those running after last year’s best performers will not do well. Subsidies from both fiscal and monetary policy remain in the system. Investors should become versed in MMT and the impact it could have (bad) if implemented.
Will passive strategies create their own form of bubble? Yes, but it is not clear what it will look like. Many ETFs carry basis risk by not investing in the entire group they represent. This is a concern since a selloff won’t be evenly distributed across all assets, but will be driven by those with the most leverage trying to sell their most liquid positions.
Risk appetite is not constant; it varies with volatility and the length of time since the last correction. If someone is honest they will admit that they were scared to death in March 2009 and willing to accept the extra risk for return proposition in 2006. How did those decisions work out? Or someone who took all their money off the table in 2006 but has not yet reentered the market? Their risk is one of omission.
When everyone is on board with culture, and everyone agrees, is anyone really on board? If contrarian views are missing, then a period where risk is growing ensues.
Russia, China and India continue to accumulate gold as if a new Bretton Woods is on the horizon. Tariffs and a haphazard trade policy make it hard to tell if the dollar will rise or fall, making it very hard for exporters. The investments to look for are companies with US monopolies once imports are turned off. This should result in pure profit for them as prices can rise with no increase in quality or volume. Warren Buffett’s Berkshire Hathaway should do well, using volatility to buy back shares while it waits to deploy capital (over $100 billion).
North Korea seems to accept its role as a distraction, but the real risk is in China and the Middle East. The South America issues will cause some problems in the US, mainly in Florida and any groups with exposure to Citgo. Housing bubbles are growing everywhere, especially where airports have direct flights to China (US, Canada, Australia especially). Venezuela has imploded, but other South American countries are stabilizing.
The world is susceptible to novel viruses, especially now due to warming temperatures. Anthrax has already appeared in decaying animals that had been frozen (recall that Alaskan permafrost was visited to capture H1N1 from 1918). The Middle East remains unstable, and growing populations in Africa either need something to do or somewhere to go. Climate change and other sustainability issues are making water and other resources the driving force behind regional conflicts. This will only get worse, and an isolationist US is not going to help. The 2020 election will be interesting, and the Democrats have, in my opinion, made a mistake by moving further to the left. A moderate candidate would more easily take votes from the Republican base. I still expect Nancy Pelosi to have a succession plan in place, and perhaps implemented, by the end of the 2020 primaries.
Climate change is real and scary. I learn more about it every year. It is fascinating how little we really know about how it will play out, and how often when something new is learned that it makes things worse. The shrinking Arctic ice sheet’s impact on jet stream and ocean currents, the sinking of the ocean floor due to the heavier weight on top of it as glaciers melt and water expands, and the important role of methane in global warming. There are NOT two sides to the science. It is real, and those who say otherwise should produce their tax returns to show who is paying them.
It is too late for a carbon tax to work by itself, and I wish we were spending money and resources to develop cost effective methods to scrub carbon from the air and oceans. The problem is that the rate of change is destroying biodiversity (plants and animals can’t evolve quickly enough to survive). Where should you buy if you are a billionaire? Do I want the fresh water of the Great Lakes, or the desert of Montana? The climate is evolving, but not always as expected. Tornados were expected to move north as temperatures increased, but instead they have moved east and north as the plains became more dry.
Extreme events happen every year. They are rarely identified in advance. Scientists are better able to show what has happened in the past, and many have turned these findings into documentaries. Earthquakes, volcanos, tsunamis, fires, floods, and tornados have all been subject to the small screen, and the big screen can be expected to see more climate related fiction in the future.
Tariffs and heated rhetoric, tied with the government shutdown, make it hard to interpret data in 2019. Fiscal policy remains stimulative, even as the economy is strong. This is a concern as fiscal policy is the signal, with monetary policy only noise. The high current debt levels mean that minimal growth is added by stimulus. We will see individuals and companies avoid locales where public pensions are underfunded. This will play out over many years. Don’t move to such an area today if you can avoid it.
Outlier (Qualitative) Scenarios
Here are some outlier scenarios I think are more likely to happen than consensus in the next several years (some may not happen for a decade or more). Due to the long-term nature of these scenarios, in some years they might not change or only slightly be tweaked. Examples focus on the US but these are worldwide risks.
While I tweaked some of these, there were no major additions.
These predictions were made in January 2019.
Emerging Risks - Concerns
Top Actuarial Issues
Predictions from January 2013
I posted my first annual financial predictions in 2007. Each year I will look back and share interesting comments I made that seem accurate in hindsight. I have deleted sections but not changed the wording in what remains.
These (mainly) economic predictions were made in January 2013. Recall that this year featured the first year of President Obama’s second term.
Top Actuarial Issues
Hopefully these annual letters look at things from a slightly different perspective than you see from others and make you think. That is my goal.
Happy New Year!
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Omaha, Nebraska, USA