The China Syndrome

for what's to come. And of course we'll close out the episode with our tradition the craziest thing I saw in markets this week, And if you're listening at home and you notice something crazy, by all means, call our hotline at six four six three to four three four nine oh and leave us a voicemail about the craziest thing you saw in Mark's or if you have a question for the hosts or the guests, put that on a voicemail too, and maybe we'll play it on air.

But as you said, we have two portfolio managers here from Washington Crossing Advisors, which is a subsidiary of Steeple Financial Corp. And Sarah as you mentioned to Jersey guys. That makes three Jersey guys and you on the show. So you know, warning things could get a little weird if we start arguing about where to get the best pork role. That's when yeah, we'll just edit that out, lad here, or what the best rest stop is? Maybe

I don't know. There's a lot we can get into, but here there, let's stas him now first from Washing Washington Crossing Advisors. He started out what twenty eight years ago at grunt Hole and Company. His name is Chad Morgan Lander. Chad, welcome to the show. Well, thanks for having me on. And I believe you started with our other guests Kevin Karen around that same time at grunt All. Uh. Now you're both at Washington Crossing Advisors. Uh. Kevin, welcome

to the show. Thank you for having me. Okay, so twenty eight years you guys have known each other. There must be some good stories to hear there is. We're like an old married company. But tell us about the firm. Uh, you guys are helping us run. Now. Basically from my understanding, it's about three and a half billion in assets in separate accounts and you have about with three or four

different strategies. Is that that sound about right? Sure, we come in investing from a couple of different points of view, and we look at the top down macro environment, and we're also looking at individual stocks and bonds from bottom up fundamental perspective, and we think that bringing all of this together is a very good way to have a holistic and comprehensive view of how to structure and put

together a portfolio. So we've hammered this these disciplines out over the last thirty years more or less, and we've think we've found some ways that we can really help investors in a unique way to do things maybe a little bit differently with their portfolio. So tell us about this research you guys have been doing into China. I mean, clearly the whole financial world is dead focused on China, uh these days. What approach did you guys take and sort of what are the main takeaways of the research

you've been doing. Yeah, So, the it's a big investment topic, obviously, and it has is one that has become very much politicized.

There's a lot of um, there's a lot about this topic because the economies are so big, so diverse, and they've been the history of these of these imbalances, which is really we're talking about the large sustained trade and capital account balances between our two countries have been so big for so long, we thought it would be really good to take a step back, really try to just look at the history of this without a political bias to it, and try to just to unwind where we

came from and try to draw some investment in locations about where we go forward and to the bottom line of it for us is that debt levels have soared as a result of this, and we want to be very careful with owning companies that have lots of debt on their balance sheets. And then secondly, we think that this has had a significant influence on global interest rates, and we want to be prepared in having a portfolio that can respond to what we see as a eventual

period of rising interest rates around the world. You guys wrote a three part series of research notes, and I was fascinated by the first one and the title being the U. S. China Trade mess How did we get here? I mean, how did we get here? Actually? Tell us what you guys found? Well forty years ago we had we we had a China that was vastly different than it was today. It was a very very backwards country

in a lot of ways. It was under invested um in a lot of ways, and policies were put place at that point which really removed a lot of restrictions and allowed China throughout the nineteen eighties and early nineteen nineties to begin to develop more towards its potential. That was a very good period of growth for China, and it really did help China and to really begin to

get some momentum. And then as we came into the nineteen nineties, um that continued, but we started to see China not making the transition to the kind of developed country that most other developed countries are. Specifically, when you look at the population, the average person in China earns about ten thousand dollars a year, and the degree to which those consumers are willing to spend is still very

very depressed, making China a bit of a contradiction. On the one hand, China I would like to be considered one of the largest countries on the planet, and by some measures they are, but when you look at the standards of living in the income for the average Chinese person there nowhere is near where the United States is or the many developed countries where incomes are anywhere from fifty to sixty to seventy thousand dollars a year per capita. So that was really kind of uh, that was a

big part of this. It was it had to do with China not fully making the transition to an open economy and having an economy that's very much based upon domestically driven investment, but it has not been fully shared by China's household sector, which is subsidizing a lot of the investments that are generating the growth and ultimately not sustainable. It's something that we're concerned about, right and it seems like something that can't be fixed overnight, that it would

take decades years, if not decades, to to work. It's its way through. I mean, um I Meanwhile, President Trump is kind of operating on an election cycle timeline. Where do you see it all? I mean, it will progress be made? Do you think is are we putting the right pressure? Is the US putting the right pressure on China to sort of fix the issues? You're ing that the consumer in China is not really at the at the level it should be as far as UH income

and wealth. Well, the pressures are coming from not just

the United States and not just this administration. If you think about where we've where we've come, you've had very large capital flows coming from a developing nation into a very developed nation the United States and the United States got to a point where we had a tremendous buildup of debt leading up to the Financial crisis, a doubling of our national debt following the financial crisis that led to a downgrade of our debt in two thousand eleven

by Standard and Pores. So we had a very significant ramp up of debt, which has been a significant burden on the US economy. And at the same time, our growth rate, particularly in manufacturing, has been much less than

it otherwise could have been. So what started out as a good thing for the U S consumer lowering of inflation rates the availability of cheap Chinese Chinese goods really did help solve some of our inflation problems in the seventies, and but it has now gotten to the point where the pendulum has fully swung and what was originally a good thing for both China and the United States has now become a bit of a burden with a lot of deadweight, loss and drag which is weighing on the

global economy in various ways. So some of this is just a natural pushback against the process that's been many years in the making. And some of the issues that you have now is that China needs to readjust. Unfortunately, the fragility of the economy there is as they readjust. You can see it within their growth rates as well as within the financial markets. Unfortunately, though, this also flies in the face of communism UH and the political party.

They are unwilling to allow the free flow of capital and by doing that has created this massive distortion that Kevin's talking about. One thing I think pops out at me, UH and correct me if I'm misinterpreting your guys work. But you really believe that this UH global regime of ultra low interest rates is not here to stay, that it will reverse eventually, UH, sort of paraphrase from from the trying to report um U ultra low interest rates

are unlikely to persist and the savings glut is unsustainable. UM. I mean that's a big deal. I think. Obviously, we have this aging population around the world contributing to this massive savings glut, big reason why yields are so low around the world. Um, what do you see that makes you think that that will reverse and and sort of what's the time timeline of that, well, the the globe. We first of all, we're following very much in the tradition of what Ben Bernanki laid out in the framework

of the global savings glut. But the reality is it's not so much a global savings glut because at the level of Planet Earth, the savings and investment do balance. What you're seeing is a glut of savings in one region of the world, particularly the emerging markets led by China, in a that savings has to go somewhere, and it has to go to uh the other to the developed nations around the world, including the United States. So this this is something that this is something that ultimately it

doesn't go on forever. And what ultimately we would expect to have happened is we would have all of these things that are happening, the financial crisis, the build up of debt in the in the Western World, the build up of debt within China, if those if those investments, particularly in China that are being put to that are being put in place, are not funded internally by jet cash flows that they can generate. Then ultimately that's going to lead to problems. Um credit growth that is not

that is not productive. There's no experience in history that I know of that has has staining that kind of growth indefinitely. So ultimately that tends to lead to problems. If it was Latin America in the seventies and eighties or Japan, Ultimately that reverses. And there's two ways for that to happen. It can either be a period of a slow process of very low growth in China where

they rebalance, growth comes down, consumer growth picks up. You begin you have a rise of a consumer class in China perhaps ten years from now, very different than where it is today. Or at some point if this continues, then those imbalances and the amount of non productive credit becomes a problem, and then you eventually have some kind of debt problem that we have to contend with. So can either happen slowly or can happen all at once. So the point is is that interest rates aren't going

higher overnight. Over the course of next three to six months, you still have to go through this glide path, and if they decide not to at least acclimate themselves to normalcy, then you're going to see potentially that China dislocation that China bey think about. We're hoping that that won't occur, that over a longer period of time of five, ten,

fifteen years, they're going to start rebalancing their economy. Overall interest rates right now are going to stay lower for this period of time, So if you're a long only portfolio manager, you still want to continue to be in bond. So to me, it seems like when people talk about risks right now, when people think about the situation in China, they think about it as something separate from the idea of extremely low interest rates, low bond yiells. You have

an inverted yield curve. We saw it once again this week. People think of them as separate situations. Would you say that's kind of wrong in a way, you can intertwine the two and say one is related to the other. Certainly um that that you cannot look at things today as they were in the past. And we're very aware of the inverted yield curve and the historical record of the inverted yield curve. But you've got some very different

things that you have, different different market structures. You have. You haven't the existence of negative yield elsewhere in the world, which we've never had before. You've had very repressive interest rate regimes around the world, and you still have the savings glut that exists. So it's too it's it's too

easy just to say history will repeat. But the in the inverted deal curve is something that we as portfolio managers have to be sensitive to because it does change to a certain extent the incentives to borrow and lend, and there is this this historic tendency for it to be a precursor of recessions. In many cases, we just need to see other things begin to get worse in

the data that we're looking at. We haven't seen that yet. Yes, the foreign data in many cases doesn't look so good, but here in the United States data looks pretty good. And therefore we're remaining overweight in our allocation to US equities versus overseas. But no big changes yet. So you guys have uh what you call the w C a fundamental conditions barometer. And for a good chunk of the year, let's see from November to April, UH, it was at a level blow fifty, which you say is a heightened

risk of recession. UM. Now in August it's back up to sixty two, so above that sort of you know, fifty dividing line. UM. What are sort of the inputs of this indicator and and why is it doing so well right now compared to earlier in the year. So

we have a thirty inputs that go into it. Ten are credit indicators UH, US domestic, ten are international as well are as ten are US economic and right now actually UH, the barometers have been around fifty, so we're equally weighted between stocks and bonds at this point from our last reading. Over All, UH, we're looking at things like credit spreads, indicators of that nature UM, US economic

auto sales, economic activity here. And what we're seeing is that the US economy is doing okay, I should decelerating, and we're looking at a two percent handle on GDP to two and a quarter of the pressure is coming from international economic data points from international as well as credit UH, that are the ones that are showing some softness at this at this point. But overall, our global GDP expectation is that it's going to continue to decelerate.

Uh US economic activity we believe going into two thousand and twenty will continue to decelerate, but we're seeing a modest increase, probably modest probability of a recession a little higher, but overall we're not calling for recession at this point. That's interesting. So this report was like in mid July, I think it was like sixty two. Then it's it's it's come down pretty quick to about fifty, say so

I would say so about fifty. It's been pretty clear that we've seen a slowdown in the manufacturing sector and people have been looking at the services numbers saying is this going to potentially bleed over? Well, this past Thursday, we did get some market p m I data. You saw the manufacturing numbers coming at forty nine point nine, so slightly in contractionary territory, and you saw services slip

as well to really just of fifty. Yeah. I mean you could say it's one number, you can't look at it in a vacuum, but does something like this put you on edge at all? Well? As Chad just mentioned in the in the last month or so, our barometer has come down just a little bit towards the first downtick in several months as a matter of fact, and it is manufacturing tied to the global economy that is driving that. On the other side of that, when you

look at the U s consumer remains very strong. So we look at retail sales, we look at income, we look at spending. That data all looks very solid, and uh, that's why where we are where we are, we do still continue to think that the United States is relatively good and the dollars should hold up relatively well. We want to focus here in the United States where we see a more stable situation versus the rest of the world where things seem to be getting um difficult, particularly

in manufacturing. As you point out, want to be very cautious about that. One note. We created the barometer as a non biased way of investing and and tactically overweighting our underweighting risk within our portfolios. And what what we do here is we're just watching and observing the data points when they're coming in. And obviously you can tell that the Europeans as well as as China. More importantly China, which has been the engine of growth global growth, that

is is starting to decelerate. That's having a washback effect on on Europe as in particular Germany. UM, and that is really what's driving and pulling down the diffusion index at this point. So U since you guys focus a lot on acid allocation, and this was a candidate from one of my craziest things, but i'll spit it out early.

Is I think it was last week we had a story looking at money market mutual funds, which I think when I I edited the story, the yield on like the big federated one was something like two point ten, you know, percent um. At that point, a money market yield was above the thirty year treasury yield, which I don't know if you guys have ever seen that happen, but I imagine as an asset allocator, that's the type

of thing you have a nightmare about. After how do you how do you look at that sort of opportunity set where cash is yielding more than thirty year bonds? It's okay, it's a couple of a couple of things on the on the short end, and this is one this is one of the important drivers where the forward path of interest rates are. We would expect to have lower short term rates over the next number of months. It just seems to us that policy is heading in

that direction all over the world. So that short number, that two number, we would expect that to come down over the next several months funds rate, I guess to some degree, right. And then the other part of it, the longer end of the curve, which is uh, you know, between the ten and thirty. That's a little bit unusual too, um, but also reflecting a lot of the pressures around the world emanating from weak weaker growth in all of these rate cuts around the world to see rates all along

the curve come down. Um. So ultimately we would our our guests at this point is that the long end sort of stabilizes short rates come down somewhat and so that the global so the US YELD curve remains flat to relatively you know, some little slope in it by the time we get to let's say, the end of the year. If however, things get worse, which will show up in our barometer in the data that flow that's comes in, we're going to have to cut from that point of view. So our base case is that we

restore some upward slope to the curve. But we're also cognizant of there's weaker things coming in from overseas which might cause to change our tune on that. We just haven't pulled that trigger yet. So also on the outset allocation side, I saw you also recently raised gold to overweight. I mean, is that where that comes in keeping track of the global economy and the buffers that we could see, Yeah, that that's exactly what what we did was we wanted to take a little bit of risk off off the

table within the portfolio. We upped our gold allocation. We did have gold in the portfolio for the last several years, so now we're overweight gold, and as well we took high yield down to an underweight as well as reets we took down to an underweight, which I know has been a popular trade. Our belief is that you don't want to be income Benie right now that have a lot of debt on their balance sheet based off of what Kevin and has been talking about, and how often

do you sort of rebounced the portfolios. Is it a monthly thing or or every every every month. We go through and we look at our long term capital market assumptions, we look at what's happening in terms of what the data flow is telling us through the lens of our barometer. If we see that things are going in a way that's pointing towards recession or more cautious and more cautious

postures is justified, will make those changes monthly um. If it's going the other way, obviously we're willing to put on risk and that's been something that barometer has been very helpful in helping us guide the portfolio tactically through good times and bad going all the way back to two thousand five when we began working with the E t f S and tactical acid allocation. So barometer must make it a little bit more difficult, that's right. That's right that in the case stay balanced. You're at a

low rate rate in a low return environment. And what makes us fairly unique is that we do our own long term forecast and returns and volatility on each asset class. So that's where we should be right now. So Chad printed out for me the numbers on the the dividend rising dividend portfolio. So so this is your biggest strategy, I guess right is uh? It was about one point eight billion. You said in the strategy, it's about one point seven one point eight billion that Kevin and I

manage alongside Matt Adapaglia. Uh, it's had a fairly a fairly stable type of kind of companies that we're looking for, the companies that are consistently growing, consistently profitable. The general thematic here, which makes us fairly unique, is that we don't like companies that have a lot of debt on their balance sheet. So you're not going to see overweight within financials and for a value manager or or divid rising dividend manager. Uh, most dividend managers are value managers,

are overweight Uh, financials, m LPs or whatnot. Speaking of debt, I will say. Goldman Sachs put out a research note earlier this week pointing out that net leverage for the SMP five D is now at a record high, So all the more reason to really be thinking about that. Yeah, well, well, we we think we agree with with their assessment. Everywhere we look, debt has increased, and debt has increased in

the financial system globally. When I began in the business in the early ninety nineties, debt was less than global GDP. Now it's significantly more than global GDP, and that creates some of fixed costs all around the world, which can create some volatility. And in the SMP, you're gonna be looking. We're gonna be looking for businesses that are very consistent, going to be able to get through whatever the world

throws at us in the years ahead. And also we want to know that those businesses are conservatively financed so that they survive difficult times to be able to get through to the other side. Or I think we're about to get through to the other side of the pod cast to the craziest thing we all saw in markets this week? Was that a good That was a good second, it was a really good Sarah kick it off. What's the craziest thing you saw in uh this week? Alright,

I will kick it off. This is just kind of strange. Um, there's a headline of an article and it says this ham just sold for one million dollars at the Kentucky State Fair. Oh wait, all right, I'm gonna I'm gonna go out this week. But it gets even better because when you read through the article, there's actually a regional bank out in Kentucky called Central Bank. But the way the article reads is saying that a chief at the central bank bought a ham for a million dollars. So

I had to double check. Mature. There was actually a regional bank out in Kentucky called central Bank. No, it was not anyone on the federal reserve. Um, but quite interesting. But still, I mean, the most expensive ham, it must be. I think I want a sandwich show of that's a good good hands all right, I think next, let's play. We did get a good call from our own Dave Wilson of Bloomberg Radio, and so the what goes up hotline,

So let's give that a listen. Here's something crazy. You go back to last September and take a look at Tilbray, the Canadian cannabis grower. The shares reached three hundred dollars in US trading. Well, now you can lop a zero off of that and you're pretty much where the shares are now. Just this past week they dropped below thirty dollars. Simple math tells you that's to climb. As it happens.

Whitney Tilson, who is a one time fund manager now in the investment newsletter Business, talked about last September how he expected the stock to drop, and sure enough it did. It's a little late for him to be able to make money off the decline, but nonetheless it's definitely one for the books, Uhain. And you could say it was a stock that was high and then came down in a big way. No one wants to hear that. No

one wants that. When you guys started at Grunnel in the early nineties, would it ever would you ever have dreamed that we'd be talking about pot stocks one day and we were talking about a O L and internet stocks at that point, right, But I will I will add speaking of a Canadian pot stock, I will give you back our hot line number. And we did get some heat on Twitter from one of our podcast followers and listeners that we never say that the U. S

actually has an international code, which is one. So I will say this time as one six or six three two four three for zero. Right. He gave us a hard time for American exceptionalisms there not. So alright, guys, you're in the hot seat. Now, what's the craziest thing that Shington crossing advisors that scene this week? So for me, it's the merger and acquisition of other countries into the United States. I've got someone and the M and a deals of small little countries. Right, Well, you figured it

could be a creative to GDP. We can avoid that recession, just tack on a few other countries. You know, no one said it had to be organic growth, right, just as long as you don't buy it with that, it is pretty unbelievable. It seems like there's something new every single week, and this week it just happened to be Greenland. All right, that's a good one, chat Viny. My craziest thing would be the fact that the Danes didn't actually

even consider the offers. There's there's half the population, there's half the size of Edison, New Jerseys, and they could they could have done pretty well with this, actually at least looked at the deal. I mean, it's not the craziest idea in the world, actually, you know, is it? No? Well, well, I think through history, I think there was other offers that the United States has made to actually get green Inland.

I think right back in the day. Oh boy, all right, well, I'm gonna I'm gonna steal mine from a Twitter guy too. I couldn't. I couldn't come up with one that top this Twitter user who goes by the initials j MT. His profile says he's a bond trader. So, uh, if you believe Twitter profiles, then he's a bond trader. I'll take him out of sere. And he says anything related to Trump is assumed to be crazy and occurs every day,

let alone every week. Alright, fine, but he goes, But I'd go with the Porsche Type sixty four Nazi car clown show auction at Southeby's. I read that and I had no idea what he was talking about. I had to look this up. It's insane. I saw the headline earlier this week, but I didn't look at the details until recently. And my understanding of it was it was a botched auction basically, and this the car was supposed to go for an awful lot in the auction, and

it was yeah, it was. So it said nineteen thirty nine Type sixty four worsh uh believe to be actually the first Porsche written by Ferdinand Porsche himself, and they had a Dutch auction near and no one could understand his accent. So He's meant to say bidding starting at seventeen million, and instead he said seventy million, and the whole crowd got up and everyone went crazy. They're clapping and taking pictures like, oh my gosh, this car is

gonna sell for at least seventy million. And then he said, wait, no, I got that wrong. In seventeen million in the place there's it sounds like there was almost a riot. They all got up and started booing him and left, so they had to cancel the auction. So that's pretty good. Absolutely so thanks to our our Twitter guy j MT for that one. But with that said, bad auction, but

hopefully good podcasts. Hope you enjoyed it anyways. Kevin Garrett Chad Morgan Lander thinks so much for joining us A bad German bund auction two this week too, so they I don't know the tour related, but it's a bad week for German aug same guy. Maybe what goes up. We'll be back next week. Until then, you can find us on the Bloomberg Terminal website and app or wherever

you get your podcasts. We'd love it if you took the time to rate and review the show on Apple podcasts so more listeners can find us, and you can find us on Twitter, follow me at at Sarah Ponzack, Mike is at reag Anonymous, and Washington Crossing Advisors is at steeple w c A. You can also follow Bloomberg Podcasts at podcasts. What Goes Up is produced by Tobrah Foreheads. The head of Bloomberg podcast is Francesco Levie. Thanks for listening, See you next time.