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 Recent Event Highlights

Reports of Value’s Death Have Been Greatly Exaggerated – February 28, 2020

That was the message heard by nearly 150 members and guests at the Hilton Frontenac Ballroom when Research Affiliates’ Founder & Chairman, Rob Arnott spoke February 28.

“Value makes sense” according to Arnott, but he pointed out value investing has lagged growth for the last twelve years. For the last 56 years (including these last twelve), value has beaten growth better than six-fold, albeit with drops during the hey-day of the Nifty Fifty, the Iranian Oil Crisis, the Biotech and (just-plain) Tech Bubbles, and most recently, the Global Financial Crisis. Arnott dismissed a couple of narratives purporting to explain the recent and sustained lag (e.g. crowded trade, low interest rates, less mean reversion) as having weak or no support before settling on two more promising explanations.


Value is currently in its largest drawdown relative to growth. Bootstrapping data from 1963-2007 to create a distribution of drawdowns, Arnott’s team calculated the probability of the current underperformance of value at about 25% - not enough to assume we are in a different regime. Individually, they looked at whether profitability differences between value and growth pre- and post-2007 have changed (no), whether migration of companies – that is, the movement of stocks out of value that have had a run-up in price and poor performing stocks dropping out of growth – has changed (also no).

Decomposing the alpha of a long value (high B/P) – short growth (low B/P) or High minus Low (HML) portfolio, into alpha from relative pricing between value & growth and structural alpha (growth in the HML portfolio with flat relative pricing), Arnott estimates that variability in drawdown is 70% due (roughly) to relative valuation, 10% other factors, and 20% noise.


Because the definition of a value stock used in academic research is based on B/P ratios, the measure of book value is critical. The argument can be made that much of a firm’s value lies not in its physical assets, but in its workforce, customer relationships, brands, and patents. These intangible assets are not always accounted for in the book value of a firm.

To (literally) account for intangibles, Arnott looked at an alternative measure of book value that capitalizes R&D and 20% of SG&A and amortizes them over 10 years. Firms recharacterized as value under this intangibles method outperformed recharacterized growth stocks (intangible HML or iHML) to an even greater extent than the traditional measure beginning in the 1990s. Under this measure, value has only under-performed growth for 5 years, rather than 12.


Value stocks are at the extreme tail (97th percentile) according to Arnott’s research. The research indicates an HML return of 5.1% due to structural alpha if there is no change in relative valuation, but a nearly 45% HML return if relative valuations were to mean revert in one year. This is unlikely to happen that quickly, but the research points to a mean-reversion half-life of just 2.2 years. Value may make more sense than ever today.


On Emerging Markets (EM) Value: “Every time you have a bargain, you have a narrative of why it’s not a bargain. EM Value is the best buy today.” Arnott stated that half of his personal portfolio is in EM Value while none is in U.S. stocks.

EBITDA measures versus P/E ratios: Arnott is not a fan of the manipulation opportunities in EBITDA. He pointed out WeWork referenced something they called ‘community-sourced EBITDA’.

Buybacks: “A response to valuation, not a cause of valuation.” Suggested there’s a tendency to use them to fund management compensation.

Valuations at real interest rate and inflation levels: There is a ‘sweet spot’ for both these levels.

Impact of Buy & Hold vs rebalancing in the HML portfolio: Rebalancing is the source of structural alpha.

Other questions touched on: Central bank intervention (views as extremely dangerous), ESG trends (favors growth stocks and has migrated from expecting lower returns under Socially Responsible Investing of years past to expecting higher returns with ESG), the availability of an iHML strategy coupled with Research Affiliates’ Fundamental Indexing (RAFI) product (RAFI™ is long-only though when there is a large spread between value and growth, there is a larger value tilt to the index), the concentration of growth’s outperformance in a handful of stocks, and research into fixed income.


To see the paper by Arnott and his colleagues Campbell Harvey, Vitali Kalesnik, and Juhani Linnainmaa behind the presentation, click here.


Can the FOMC Achieve a Soft Landing in 2020? – February 11, 2020 - Federal Reserve Bank of St. Louis President James Bullard 

Watch the recorded video of the event Click HERE

Over 200 members and guests lunched at the Missouri Athletic Club to hear Dr. James Bullard’s answer to this question. (SPOILER: It’s ‘let’s wait and see.’)

Speaking at the biennial Fed Forecast presentation to the CFA Society St. Louis, Bullard, President and Chief Executive Officer of the Federal Reserve Bank of St. Louis, recapped the recent trends in real GDP growth at the FOMC’s policy moves before addressing the prospects of a ‘soft landing’ – i.e., real GDP growth not falling below the ‘potential’ growth rate.


According to Bullard, the United States economy grew at a year-over-year rate exceeding 3% during the second and third quarters of 2018, an upside surprise in the wake of a political agenda of deregulation and tax reform. Since then, growth has slowed – an expected reversion to the economy’s potential growth rate. The key risk in 2019 was that the slowing would be sharper than anticipated and cause a ‘hard landing’.

Recall that the FOMC had raised interest rates nine times, beginning in late 2015. The FOMC was aware of the slowing economy in 2019 and started off the year projecting fewer rate increases, eventually indicating lower rates beginning in June. Rates were eventually lowered 25 basis points at each of the July, September, and October meetings. A nominal 75 basis point drop, Dr. Bullard argued the effective reduction was 144 basis points from November 2018 to January 2020 as measured by the two-year Treasury yield, whose levels embody the market’s prediction of anticipated FOMC moves. Bottom line: in the face of a slowing economy and increasing trade uncertainty, the FOMC moved quickly to reverse policy and adopt an accommodative stance. Bullard noted that the 10-year minus 2-year Treasury rates measure of yield curve shape came close but did not go negative (invert).


With that accommodative policy as a starting point, what factors could affect a soft landing?

Has the uncertainty in global trade policy been dampened enough to encourage global manufacturing? Listing recent trade developments (USMCA, Phase 1 of a U.S./China deal, and a U.K. plan for Brexit), Dr. Bullard pointed out that the global trade policy uncertainty that had had a chilling effect on global manufacturers is certainly reduced (as measured by the trade policy uncertainty index). Additionally, manufacturers have not been sitting idly by waiting for trade accords to materialize but have been cautiously adapting to global trade pressures and may be more robust for the efforts.

Expecting interest-sensitive sectors to react to monetary policy moves (albeit with a lag), Bullard highlighted rebounding home sales in reaction to lower rates as at least one indication that the FOMC moves are helping the economy avoid a hard landing.

Finally, Dr. Bullard addressed the latest risk, the outbreak of the coronavirus in China. In addition to the human tragedy involved, moves taken by the Chinese government to combat the deadly virus are expected to slow China’s growth in the first quarter. Past experience with outbreaks indicates there may be an impact on U.S. interest rates as well, with a temporary dip of 20 – 55 basis points in the 10-year Treasury rate within the first month of the outbreak before rates get back to normal.

Opening the floor, Dr. Bullard fielded questions concerning the markets’ reactions to the (10-year minus 3-month) yield curve inversion (it was not substantial or long-lasting and Bullard prefers the 10- minus 2-year indicator which did not invert), student and auto loan debt levels (outsized balances are a concern and there needs to be a reasonable expectation of repayment before the loan is made), and the (historically) low level of the long-term real GDP growth trend (‘As a policymaker, it’s safe to not assume a burst in productivity growth’ beyond a historic 1.25% and unless there are policy and social changes, the labor force growth will be 0.75%).

He also addressed changes in reserve demand brought about by Dodd-Frank and last year’s repo market stress, the death of the Phillips Curve, loosening of bank holding company rules, and negative real interest rates in Japan and the European Union.

Though advocating the aforementioned wait-and-see approach, Bullard feels the accommodative moves made by the FOMC last year helped to create a ‘reasonable prospect’ of a soft landing in 2020.

Slides from the presentation can be found at the St. Louis Fed website or by clicking here.

​Building Advocacy in St. Louis - February 3, 2020 Click here for the full article

CFA Society St. Louis recently hosed a member event with Blaine Luetkemeyer, the U.S. Representative for Missouri's 3rd congressional district.  The artical appeared in Connexions. 

Top 5 Government Policy Catalysts for 2020 – September 26, 2019 (Click Here for the video and audio of the presentation)

Politics does not equal policy, but policy can be a powerful leading indicator for investment returns according to Ben Phillips, CFA, Chief Investment Officer at EventShares, host of the podcast 10 Minutes/10 Answers, and Managing Director & Chief Investment Strategist at the brand new market insights provider, MarketDesk Research.

Phillips lead off the presentation by stressing that his firm is not in the business of making predictions about the future, but rather focuses on what is happening and its impact on markets. United States policy impacts 100% of U.S. companies – no company is immune to policy changes and policy changes abound. On average, Congress passes 758 bills, the Supreme Court rules on 130 cases, and federal agencies issue 3,853 rules each year according to Phillips. The alpha generated by policy disruption is, he offers, uncorrelated with other sources of alpha. He identifies four major sources of policy disruption:

  • Judicial: District & Federal rulings
  • Congressional: House & Senate committees
  • States: Governors, legislatures, and state agencies – and –
  • Federal Agencies: e.g., CFPB, EPA, CMS

Looking at return data since 1935, Phillips pointed out post-midterm years, especially a president's 3rd year in office, has produced the strongest stock market returns, although he cautions this is based on a small sample size. Contrary to market folk wisdom, post-midterm years with one-party control of both the White House and Congress, regardless of party, have outperformed gridlock.


  1. Defense Spending – Cyclical, but U.S. defense sales growth is not precisely correlated with sales growth in the S&P 500.
  2. Infrastructure Spending – Driven by the states; 29 states have raised fuel taxes since 2013. Says EventShares, 'We put the odds at 100%'
  3. Cannabis Legalization – Legalization has proceeded a wholesale drop in price. While the SAFE Act may pass soon, other questions remain.
  4. Sales Tax Compliance – The Wayfair decision has introduced compliance difficulties for online retailers. Software firms are offering solutions.


  1. Sports Betting – Regional Casinos and Sports Betting Software
  2. IMO 2020 – A requirement to use fuel with lower sulfur content impacts Crude Tankers and Outsourced Fuel Logistics
  3. Renewable Fuels (and Uranium) – EPA has authorized year-round sales of E15 (Ethanol). 50 new nuclear reactors are currently under construction globally (Uranium)
  4. Media Deregulation – Local TV Station. FCC review of local market ownership rules in light of advertising growth of social media
  5. 5G Telecom – Western Equipment Providers and Servicers. The United States views reliance on Chinese 5G as a national security issue.

EventShares make their policy tracker available to the public as well as managing an active ETF to invest in their highest conviction themes.

Before moving on to Q&A, Phillips debuted the newest offering from EventShares, their MarketDesk Research suite. Hoping to become the 'Vanguard of Research', they are offering this paid subscription resource as a one-stop source of research.

Questions varied from impeachment (a low probability of removal by the Senate), short opportunities in cannabis (growers are essentially agriculture firms with a 50-100x revenue valuation), China trade (challenging for EventShares – not investable), and portfolio timing and turnover (they wait for certainty – not polling – and expect a 30%-50% rotation immediately after an election if there is a change in President).

Washington creates investment opportunities and investors need to be aware of them.

The Value Proposition of Hedge Funds Today – September 20

Sentiment toward hedge funds remains notably negative, with mediocre to poor returns the primary focus.

Dave McMillan, Mercer's Chief investment Officer for Hedge Funds spoke to what he considers the value proposition for hedge funds today – not coincidentally the same value proposition offered fifteen years ago when he created Hammond Associates' hedge fund consulting efforts (since acquired by Mercer). Namely:

  • Generate Equity-Like Returns
  • Generate Bond-Like Volatility
  • Provide Downside Protection
  • Diversify Interest Rate Risk – and –
  • Diversify Equity Risk

Of course, any student of the Capital Asset Pricing Model (CAPM) will recognize that the first two bullet points taken together imply a risk/return trade-off above and to the left of the Efficient Frontier – an enviable position if realized. The target return selected by Mercer at inception was cash (T-Bills) + 4%; a reasonable proxy for equity-like returns given the historical equity risk premium. Cumulative returns since 2005 show mixed results: On one hand, Mercer's realized experience hugging their target (cash + 3.8%) while falling short of replicating equity returns (here represented by the MSCI All-Country World Index) in an environment where realized risk premia have exceed the target; while on the other hand, the broader Hedge Fund Research Fund of Funds Composite Index (HFR FOF) has fallen far short of both equities and the cash + 4% target. On the risk side, both Mercer's experience and the Composite Index fulfilled the promise of bond-like volatility, measuring slightly above that of  the BBg Barclays Aggregate Index.

As the name implies, hedging the downside risk is where Hedge Funds shined during the Global Financial Crisis. With a drawdown of value less than ¼ that of global equities, Mercer's funds were in a position to get back to their high-water marks a full four years ahead of the equity markets – not by out-earning equities in the recovery, but by preserving capital in the drawdown. This trend has continued for both Mercer and the HFR FOF Index in the 2015-16 and late 2018 market declines.

In examining beta to equities in the form of the MSCI ACWI and fixed income as represented by the BBg Barclays Aggregate Index, McMillan illustrated that hedge funds provide an almost unique source of diversification with low betas to both asset classes.

McMillan highlighted the returns available on a consistent basis to long/short investors that have not been historically available to long-only investors. The spread between the 66th and 33rd percentile global equity issues in any given year has averaged 23.5%, has been remarkably consistent, and, of course by construction, has been positive each year. McMillian was quick to point out having the opportunity and being able to harvest that spread are two different things.

Opportunities on the credit side arise for hedge funds as well that not all investors can participate in. Hedge funds can provide liquidity when institutional investors are forced to divest issues after downgrades or missed coupons. Furthermore, according to McMillan, they have the expertise and are in a position to drive favorable outcomes through their influence as members of credit committees and through restructuring.

McMillian cautioned that hedge funds are not homogeneous and should not be treated as an asset class – rather each should be viewed as an individual small business. On top of this, he warned against placing a portfolio's entire hedge fund allocation with a small number of managers. Finally, care should be taken not to substitute hedge funds for other classes simply because the fund invests in the space – a hedge fund with equity exposure is not a substitute for equities.

Most of the Q&A that followed focused on expenses. Though the original '2 and 20' structure has fallen in price, McMillan offered that he is still paying a fairly expensive 1.45% (of assets) and 17.5% carry. He pointed out that these are negotiated rates and newer manager are usually less expensive. Justifying the fees, he noted, "we pay for things I can't buy at Vanguard" and "More capital is destroyed by bad managers than fees." He was also questioned on the current opportunity set for hedge fund managers (long/short and distressed debt) and his turnover (roughly 8%).

McMillan left us with the thought that hedge funds are meant to perform over a complete business cycle. Recent underperformance has come late in one of the longest expansions in history. Hedge funds may well show their true value when the expansion ends.


Positioned for Success – August 21

10% of Charterholders serve in the role of financial advisor and 40% serve or manage individual assets.

This prompted the CFA Institute to conduct research in 2018 to investigate how the CFAI can differentiate its Charterholders in the High Net Worth (HNW) advisory market, articulate this message to HNW clients, and deliver value to its practitioner/members. Bob Dannhauser, CFA, Head, Global Private Wealth Management at the CFA Institute delivered these results to the membership over lunch at the St. Louis Club. Beginning with industry research, CFAI assembled focus groups of HNW investors and practitioners, both CFA Charterholders and non-CFA advisors. Survey were sent to those groups as well as CFA candidates. Results were collated by age and wealth levels.


  • High Net Worth Individuals
    • The search for a Private Wealth Manager (PWM) is often triggered by a referral or simply accumulating enough assets that it makes sense to seek professional advice.
    • Relationships are sticky, but the main reasons for switching are clients' unhappiness with the PWM's performance or the retirement of the PWM.
    • The biggest challenge HNW have in finding a Wealth Manager they like and trust is knowing the right questions to ask.
    • More attention is being paid to credentials than in the past, but the CFP® designation is still better recognized than the CFA® (66% vs 43%). CFA Chaterholders are more recognized for their technical competence.
    • The biggest surprise may have been the relatively high number of 25 to 39 year-olds with PWMs, though among those who don't have one, half feel they are comfortable managing their own investments, while 1/5th are concerned about receiving value for the cost.
    • The top skillsets valued by HNW individuals by age were:
      • 25-39 – knowledge of a variety of products
      • 40-49 – Good listening skills
      • 50+ (and overall) – Experience and savvy in investments
    • Overall, about a quarter of HNW individuals report considering Fintech solutions over PWMs. As might be expected, the rate is twice as high in the 25-39 cohort than the 50+.
  • Practitioners
    • CFA Members want to be seen as trusted advisors.
    • Non-CFA advisors want to be regarded as reliable financial practitioners.
    • CFAs are more pessimistic than non-chartered practitioners about being able differentiate themselves based on credentials.
    • From the CFA Institute, Charterholders want:
      • Intellectual capital vs. soft skills; programs to provide soft skills are not gaining traction at the CFAI level or from members.
      • HNW awareness of the value of the CFA charter.

The CFA Institute estimates there may be as many as 126,000 HNW individuals over the age of 50 receptive to selecting a new PWM and 111,000 under 50 out of roughly 3 million (of all ages). To raise awareness, they've launched the media campaign: Does Your Wealth Manager Measure Up? centered around investing. In addition, they've launched he website Dannhauser closed with news that the campaign will be back on the market in October and showed an ad run on CNBC.

(For the pre-roll video presented at the meeting, click here)


Freight Futures – August 14

The trucking industry is 30% larger than the oil, natural gas, and coal industries combined. It is subject to large swings in supply and demand, and thus, prices. It is facing a current shortage of drivers. And it has had no way to hedge this variability in prices.

Until recently.

Craig Fuller, CEO and Founder of FreightWaves spoke to a small, but curious, audience at the St. Louis Club about the freight futures market his firm, with Nodal Exchange, launched in late March of this year. Currently trading eleven contracts on just seven of the most popular 'lanes', as the thousands of freight routes in the United States are called, the contracts are standardized 1,000 mile lots in specific lanes (e.g. LA-Dallas) that settle on a cash basis. As Fuller put it, "there's no danger of a trailer showing up at your loading dock."

There was immediate demand for trading as profitability of many firms turns on transportation costs. Almost every food company faces narrow margins that can turn on shipping costs. On the other hand, freight companies were looking for a way to manage demand in the face of limited, but sunk cost physical capacity and, more importantly, fluctuation in a driver supply running a chronic shortage. Many companies missing earnings expectations last year cited transportation costs as a major element.

The contracts are regulated futures with FreightWaves/Nodal Exchange acting as the clearing house. FreightWaves earns commissions on the contracts.

Questions from the audience touched on the specifics of the contracts noted above as well as taking advantage of FreightWaves' position as the leading source of information in the industry (they employ 30 journalists and seven PhDs). Fuller predicts driverless trucks are years out –the resistance is more political than technological. He also pointed out the utility of freight as a leading economic indicator with 30% of the GDP exposed to freight costs in one way or another.

Despite a late start and technical problems, the members enjoyed an insightful presentation and an inquisitive exchange.


Changing the Framework of Asset Manager Research – March 20

With the continual wearing-away of competitive returns, Tom Brakke, CFA contends that it is in the interest of both asset allocators and asset managers to improve the asset manager research process.

The compression of out-performance by asset managers is an old and oft-repeated story: from active mutual funds in the 1980s, to hedge funds a decade later, to private equity, success fosters competition among analysts and erosion of alpha. This makes selection of active managers more difficult over time. Brakke presented a framework to the attending members and guests with which to analyze that selection.

Brakke suggests looking for points of differentiation when evaluating asset managers and enumerates seven facets to examine. He points out that research suggests that to be successful in delivering alpha, a firm needs to be effective along all seven of these dimensions:

  • Organizational Design
  • Human Capital
  • Culture
  • Narratives
  • Process
  • Performance
  • Flows, Scale, Capacity

For each of these facets, he rooted out the essential questions that allocators should be asking and how managers can best answer them.


Presenting a couple of complementary organizational models, Brakke offered a simple three factor model from Focus Consulting consisting of the interaction of Performance, Operations, and Distribution. Whereas typical manager research focuses on Performance (and just a subset of Performance at that), effective evaluation should take a holistic view of the firm under scrutiny and concentrate on the intersections. For example: where operations and distribution meet, probe the accuracy of the information used to market the investment strategy – are there capacity issues?

Brakke offered a list of sample questions to ask about the firm's organizational design. Allocators should ask which organizational characteristics add and which detract from the firm's value proposition. Managers should be prepared to explain why they are organized the way they are.


According to Brakke, allocators should not be focused on superficial people traits: years in the business, eloquence, familiarity, or even intelligence when it's not correlated with wisdom – but rather they should ask themselves what traits they want in a manager, what traits they wish to avoid, and how to test for those traits. In a broad sense, focus on the theory of the firm, hiring practices and processes, training and development, and organization of teams and units – especially in terms of diversity and breadth of capabilities. Managers must be able to articulate their plan for the effective development and use of their human capital. Underlying any assessment of human capital is the realization that investment roles are, and will continue to be, changing.


Citing Charlie Ellis's What It Takes, Brakke pointed out culture is one of the keys to success for a professional firm and presented Stanley Herman's "Cultural Iceberg" model – the formal, overt aspects of the firm, they way they say they get things done, being the smaller, visible tip of the iceberg. The larger, hidden piece of the firm's culture – its beliefs, attitudes, norms and other informal, covert aspects – are how things 'really' get done. Brakke presented two more models for understanding: a two-dimensional representation with stability/flexibility representing one axis and independence/interdependence representing the other (from the research of Groysberg et al.) and a model from the intelligence alliance Five Eyes illustrating the tensions that push teams together or pull them apart.

In encounters with managers, Brakke urged allocators to act like anthropologists or investigative journalists – spending more time discovering information that is not common knowledge. Documentation should be done outside time spent with the manager and 'investment chatter' kept to a minimum. Allocators should develop strategies to designed to get at deeper cultural issues within the subject organization. Managers should understand the distinguishing aspects of their culture and how the reveal them.


The respective goals, according to Brakke, are for the asset manager to create the narrative and the asset allocator to crack it. Unfortunately, in practice, 95% of what an asset allocator reports to their principal is the manager's original narrative. Allocators must form insights independent of the manager's narrative and managers, ideally, should craft a narrative that generates a deep understanding of what they do.


Brakke presented a simplified investment funnel ranging from the universe of securities through screens, research, and candidate issues to portfolio inclusion. Focus, he argues, should be on the break-points between the stages of the process: Where is value added? Where do errors occur? What behavioral guardrails are in place? Stress changes the process and in a complex adaptive system, he notes, consistent and repeatable processes lose while continuous improvement wins.

A process is often marketed, but the marketed version is not the true process. Process is inferred from performance and allocators must ask themselves if they are spending enough time digging into the details of the advertised investment process. Asset managers need to probe how deep they can go into describing their investment process.


Often, performance dominates all other considerations in asset manager evaluation, but short-term, luck often dominates skill says Brakke. Long-term we assume skill plays the largest role in performance, but it may take 25 to 30 years before that is a settled question. There are genuine business and career risks for an allocator who persists in placing capital with a manager who is under-performing in the short term, but according to the model Brakke presented from Scott Stewart's Manager Selection, chasing performance on a cycle dominated by luck may exacerbate under-performance. Presenting a list of performance evaluation problems, including the performance compression effects presented at the beginning of the talk, Brakke suggests the allocator should not look to performance for answers, but to generate questions. For the allocator: Are they willing to design out performance chasing? For asset managers: Does their performance presentation tend to exacerbate that tendency?


Brakke presented several findings regarding performance and fund flows (performance affects fund flows and vice versa) and scale (bad for future performance) and introduced the concept of 'auto-flow', the stage at which the money into an investment product decreases in terms of quality while its volume increases. As he put it, "This is a business of herding." Allocators should ask themselves if they reassess alpha for flows, scale, and capacity, while asset managers should determine how robust their own models are.

Answering questions from the audience, Brakke offered that to avoid 'short-term-itis' (regarding performance), you "need to do the ground work up front" to manage expectations. When asked about Artificial Intelligence (AI), he reiterated this opening observation that alpha has been, and continues to be, eroded and will be in the future as more analysts are drawn to the profession and AI improves.

For more from Tom Brakke, see his recent article for the CFA Institute, "Disruption and Differentiation".


An Investment Odyssey – early 2019 Global Market Perspective – February 20

The Hilton Frontenac St. Louis hosted the CFA Society St. Louis and guest speaker Chris Dillon, CFA, Investment Specialist, Capital Markets at T. Rowe Price. Bringing a unique analysis from his studies as a history major (in addition to finance), Dillon unloaded a Gatling gun's-worth of informational slugs and views at the audience regarding T. Rowe Price's global market perspective - early-2019 version.

Noting that T. Rowe Price was 'taking something off' after the recent run-up, Dillon allowed that there were still worries over the current US-China trade war posturing and the flat yield curve. What's different at the moment, Dillion says, is the FOMC which has backed off its more aggressive rate hike posture. Also troubling Dillon is an 'earnings recession' now that the tax rate reductions introduced by the Tax Cuts & Jobs Act has washed through companies' financials.

Globally, he pointed to a chart showing the close correlation between the MSCI All-World ex-US equity index and weakness in the U.S. dollar. That weakness began to reverse early in 2018 as the Fed started to unwind its balance sheet. Peaking near $4.5 trillion, Dillion does not expect assets and liabilities to fall to the pre-Great Recession levels of $800 billion ('maybe $3 trillion'). Like Odysseus, Dillion noted, it may take ten years for the Fed to return 'home'. Meanwhile, he observed, 'Fed Funds died with QE' as an effective lever in the machinery of central banking in the U.S. as excess reserve balances have eliminated the need for Fed Funds.

And with the strengthening of the dollar, how will various overseas markets fare? Not so well in the case of Europe which, Dillon points out, has little of its economy invested in information technology and faces the financial drag of zombie banks. Emerging markets will fare better, especially China where nearly 60% of their economy is driven by the financial and IT sectors and, with 1.6 billion people with little expectation of privacy, data or otherwise, have a goldmine of data for AI technology to exploit. Dillon expects China to prevail regarding trade policy as well, seeing superficial concessions on soybeans and steel while conceding little ground on intellectual property. He sees China expanding its trade capabilities outside the U.S. with its One Belt, One Road initiative.

Before opening the floor for questions, Dillion highlighted his takeaways:

  • As quantitative tightening continues to replace quantitative tightening, we expect market behavior patterns to change
  • And in an environment of rapid change, value investing trends may be prospectively unique
  • The U.S. dollar is a key factor for determining what to expect from international and emerging market equity classes
  • As material clouds have formed around the investment environment, we expect active management to matter increasingly more

In the Q&A, he revealed his concern over the U.S. budget deficit, advised that creditworthiness of high-yield and corporate issues be reviewed – suggesting there may be value in munis, and reiterated the importance of currency movements as a driver of market in 2019.

Investing in Tomorrow – A Presentation on Thematic Investing – February 6

Electric Vehicles. Lithium. IoT. FinTech.

Just a few of the thematic ideas presented by Jay Jacobs, CFA – Head of Research & Strategy at Global X ETFs. Contrasting Thematic Investing to Factor Investing, Jacobs expressed Thematic Investing as forward-looking and paradigm-changing as opposed to harvesting alpha from factors that are, backward-looking, cyclical and mean-reverting. In constructing ETFs (and indices to support them), Global X takes a top-down/bottom-up approach, looking for disruptive macro trends (e.g., robotics and AI), then identifies companies well-positioned to exploit those trends.

What makes a theme attractive? According to Jacobs, there needs to be a high level of conviction around the theme. As an example, he offered 'lithium' as a viable theme thanks to a well-defined use case, while something as ephemeral as 'space' is, at present, more of an exploratory concept than a defined theme. Investability is key as well with a minimum of 20 and preferably 25-30 companies in the space. Viable themes should also avoid cyclicality, opting instead to focus on one-off paradigm shifts that follow an S-Curve of growth, often over 5 years or more, on the way to permanent adoption.

To illustrate his point, Jacobs presented four specific themes:


Robots have been around for decades on manufacturing – why would they be a growth theme now? According to Jacobs, the answer lies in the aging populations of industrialized countries, especially Japan and China, where the trend is accompanied by rising labor costs – and performance improvements in manufacturing, military applications, medicine, transportation, and agriculture. China and the U.S. are far behind high robot-density markets like South Korea and Japan.


Currently, 60% of lithium use is industrial with 40% of demand coming from battery production. Jacobs thinks those numbers will reverse soon. What is the source of the demand? Electric vehicles (EVs) according to Jacobs. Costs of EVs are falling as manufacturers have been able to scale up production. Demand has also benefitted from government intervention in the form of subsidies and emissions regulation. All major auto manufacturers are investing in EVs. Why is this pushing lithium up the S-curve? Consumer demand so far has been driven by smart phones and other small devices. A single EV uses over 10,000x the lithium as a smart phone and it seems unlikely auto manufacturing would revert to carbon fuels.


IoT, a web of connected devices that connect, interact, and exchange data, is riding simultaneous waves of rapidly falling costs, improved internet speeds and connectivity (with 5G on the horizon), strong consumer demand, and growing commercial adoption according to Jacobs. It is being expressed as driverless cars, smart cities (for example, trash cans connected to the internet to make servicing them more efficient), smart homes (Nest, smart toasters), and robotics (see above). Who benefits? Connected device manufacturers (e.g., fitbit), communication providers (the IoT 'pipeline'), and chip manufacturers.


Jacobs points out Fintech provides advantages to the customer and provider alike. The customer gets anytime, anywhere service, personalized experience, and real-time data. On the operations side, there is reduced operations risk, enhanced financial risk management, scalability, and a source of data to fuel predictive analytics. Fintech is really taking off in large, emerging markets. India & China's middle classes are growing at 6% per annum and further growth is being pushed by the ease of digital remittance and demonetization, particularly in India. Finally, because Fintech scales so well, incremental costs are zero so the market is expanding to include small accounts that were previously too expensive to be bankable.

Jacobs noted that these trends are interconnected.

Expanding on questions from the audience, Jacobs expressed his view that in assessing the relative value between AI platforms, algorithms, and data, data was the hardest to replicate and the most valuable, noting that based on their size and lack of expectation of privacy, China had a large advantage. Regarding geopolitical risk, he answered there is always tension between diffusion and protection of technology.

Other questions asked about the creation and lag time of tracking indices for the ETFs (Global X works with index providers to create custom indexes six-twelve months prior to the ETF launch) and the impact the recent cold snap might have had on EV adoption (though cold weather negatively impacts range and recharge times, adding to 'range anxiety', advances in battery chemistry are working to adapt to differentiated environments).

Finally, recalling Buffett's observation about another permanent, disruptive technology, ("investors have poured their money into airlines and airline manufacturers for 100 years with terrible results,") a questioner asked if identifying the themes necessarily led to good investments. Jacobs replied that the technologies presented today were scalable and, unlike a commoditized product like air flight, were protected by economic moats making them sustainable, investable, themes.



The Growth of Passive Investing and Its Impact on the Market – January 30

 Around 70 members, candidates, and guests braved the frigid weather to meet and hear Christopher Escobar and Ivan Cajic of ITG deliver insights on the state of the Indexing industry.

And industry it is, with the major index providers, S&P Dow Jones, MSCI, and FTSE Russell, providing the bulk of the indices (though new entrants are challenging) and global growth in passive investing doubling in less than seven years to reach $13.5 trillion. As a portion of investment in U.S. equities alone, passive investment makes up $6.5 trillion or roughly 45% of the public float. For many firms, passive investment makes up over 20% of total ownership.

According to Cajic, Head of Global Index & ETF Research at ITG, demand is being driven by low cost, ESG (Environmental, Social, & Governance) criteria, factor/smart beta investing, and foreign market access. Low cost indexing has arisen as cost transparency has increased and as a result of consumer demand via innovation like robo-advisors. Passive index fund expenses have fallen into the single basis point range for U.S. equity and fixed income as well as developed markets, with emerging markets only slightly costlier according to ITG at 11-14 bp. ESG (e.g., firms with a low carbon footprint, strong corporate governance) has become more popular with a growth in consistent criteria for index inclusion. Factor and smart beta strategies are a hybrid of passive and active – often with liquidity, volatility, or momentum overlays. Demand for access to foreign markets, especially China and other emerging markets, has further driven demand for passive indices and funds targeted at those markets.


U.S.-China Trade Relationship – January 23

In the last of three programs in January centered around the economic outlook, Dr. Yi Wen, Assistant Vice President – Federal Reserve Bank of St. Louis1, spoke to the CFA St. Louis membership at the

St. Louis Club on the US-China Trade Relationship: A Macroeconomic Perspective.


Dr. Wen observed that the U.S. trade balance ran a surplus until the 1970s. The trade deficit began with the collapse of the Bretton Woods agreement and the abandonment of the fixed dollar-to-gold exchange rate. Since then, the U.S. trade deficit had been growing in absolute terms and relative to GDP. There has been a concurrent rise in foreign holdings of U.S. Treasury debt (35% of debt outstanding) and the holding of dollars as foreign reserves.

Wen gave evidence the decline of manufacturing employment in the U.S. was primarily due to structural changes brought on by productivity growth, much like the decline in agricultural employment in the first half of the twentieth century, rather than the result of the trade deficit and the outsourcing of manufacturing jobs. What then is the rationale for a trade war with China?

Dr. Wen points to a recent Bloomberg article by Stephen Roach, "Is China Really Cheating?", that asserts there is no evidence supporting the main allegations:

In fact, data showed foreign intellectual property payments to the U.S. grew 20-fold in the 1999-2017 period, and China's share grew 11x – faster than their GDP.


Wen predicted the effects of tariffs will:

  • Make imports to the U.S. costlier
  • Make exports from the U.S. more expensive
  • Shift the trade deficit to other countries
  • Not increase exports to China

He went on to suggest a trade war becomes a 'strategic gift' to China, internationalizing the renminbi, encouraging more government investment in science & technology, and spurring them into a leadership role in globalization.

So why China? Wen contends the trade deficit has followed labor-intensive industry's off-shoring from Japan to the Asian Tigers to China. To compete, Dr. Wen thinks the U.S. needs to reform its education system, invest more in infrastructure, science, & technology, and redistribute trading profits.

In taking questions, Dr. Wen was asked to predict the 'winner' of the current trade war ('who knows?'), and to comment on the life-cycle of nations, what portion of the trade imbalance is due to unfair practices, and whether imbalances due to changes in relative advantages could be deemed 'unfair'.

Wen likened China's position to that of the U.S. in the 19th century. He argued that the size of the United States allowed it take over from Great Britain as a global powerhouse – the same factor that will let China succeed where Japan failed.  He thinks it will be at least 50 years before the renminbi will take over from the dollar as the world's reserve currency as first China will need to force trade in the currency, stabilize the RMB, and have a robust futures market.

1Dr. Wen reminded the audience that his opinions were his and not those of the Federal Reserve Bank of St. Louis


2019 Macroeconomic Outlook – January 17, 2019

Anne Vandenabeele, Economist at Capital Group, delivered her firm's 2019 outlook before a large crowd at the St. Louis Club.

Recapping developments of the last quarter, she observed that the S&P 500 was down 19.8% on the close and 23% intraday from 2018 highs, if not technically a bear market certainly close enough to be wary. Though there are conflicting signals as to whether a recession is looming, we are 'starting to see contours of the next recession'. She feels those causal factors will be:

GLOBAL TIGHTENING: Despite Chairman Powell signaling a pause in rate hikes for the next FOMC meeting, planned hikes and quantitative tightening will proceed apace.

A SLOWING CHINA ECONOMY: Not just due to U.S. tariffs, but 55% of Chinese firms have been impacted by the tariffs and 25% of those affected are cutting CapX and other spending.

FISCAL POLICY: Countries have increased their deficits despite being in the boom stage of their economic cycles. This has been built on low interest rates, but now they are rising. The U.S. tax cut has washed through the economy and the partial government shutdown is costing an estimated 10-15 bp in GDP each week.

Right now though, the U.S. economy is fundamentally sound with low unemployment and inflation hovering around the Fed's target of 2%. So what tripwires should we look for? According to Vandenabeele:

EMPLOYMENT: The unemployment rate stops declining before recessions.

INFLATION: The New York Fed's Underlying Inflation Gauge (UIG) forecasts inflation rising to 2.5 – 3.0%

BUILDING DEBT IMBALANCES: Corporate debt levels have risen as borrowing is being used to pay dividends and buy back shares in excess of free cash flows.

Ms. Vandenabeele wrapped up quickly and left plenty of time for Q&A where she dealt with: China's recent fiscal stimulus moves (limited effect from rate cuts – not likely to curb their slow-down), feedback loops between 10-year rates and the stock market, why the U.S. is doing better than the rest of the world (a slow-down in oil demand hurting exporters and the consumer-driven nature of the U.S. economy), and the outlook for the U.S. Dollar (the U.S. is close to its maximum inflation & interest rate differential – there may be a weakening in the dollar though a global recession and a flight to quality would be good for the dollar). Responding to a question about leverage, Vandenabeele pointed out that there has not been an increase in interest coverage for some firms because they took advantage of lower rates to lever up. The worst offenders may be looking at a dividend cut when rates rise. Sovereign debt levels have also continued to grow, but households have, by and large, managed to de-lever. The exceptions are low income households and new workforce entrants (thanks to student debt).

Addressing a question about the yield curve's power in predicting a recession, Ms. Vandenabeele offered that Capital Group's adjustments signal a much lower chance of recession than that predicted by the raw yield curve data. After fielding questions about the conflicting data signals being seen by the FOMC and PG&E's bankruptcy, she turned to global issues, opining that political instability was 'important, but not critical' and driven in part by the rising share of GDP flowing to profits at the expense of labor. Expectations are low enough in Europe that surprises are more likely on the upside than the downside.

This was the second of three broad economic presentations to kick off the new year, following on the heels of January 10th's Annual Forecast Dinner where public policy issues were addressed. The series concludes January 23rd when Dr. Yi Wen, Assistant Vice President of the Federal Reserve Bank of St. Louis, speaks on the US-China Trade Relationship: Past, Present, & Future.


Forecast Dinner – January 10, 2019

 2019 kicked off in grand style as the CFA Society St. Louis hosted its Annual Forecast Dinner at the Ritz-Carlton in downtown Clayton.

Members and guests noted an addition to the program this year on their arrival. Member Zheng Liu, CFA greeted the attendees with solo piano to accompany the pre-dinner conversation and drinks. She was followed by vocalist/guitarist John Dutemple, CFA before the remaining members of The Charters – all members of the CFA Society St. Louis – took the stage: Winnie Cai, CFA-vocals/drums and Steve Jones, CFA-vocals/bass/guitar/keys.

The crowd filtered into the ballroom to hear the speakers for the evening. President Paul Simmons, CFA kicked off the program, noting that 2019 is a special year for the CFA Society St. Louis – our 70th Anniversary! He thanked those that make the Society work and asked for recognition from the audience: the volunteers and especially Joan Hecker, our Executive Director. Added to the list of thanks were those that made the event special, the band and the evening's sponsors: Kennedy Capital Management, PIMCO, and Voya Financial.

Always a highlight of the Forecast Dinner, Vice-President Nong Lin, CFA joined President Simmons to give out the Bullseye Awards for 2018's market predictions and the Volunteer of the Year Award. Winners were:

  • S&P 500: Josh Snyder, CFA, GQG Partners
  • 10-Year Treasury Yield: Kevin Schultz, CFA, NISA Investment Advisors, LLC
  • Crude Oil: Greg Ferguson, CFA, Wells Fargo
  • Stock Selection: Tom Eidelman, CFA, Eidelman Virant Capital with his pick of Renewable Energy Group, Inc. (REGI)
  • Volunteer of the Year: John Dutemple, CFA, Compton Advisors, LLC

After reminding the membership of upcoming events, President Simmons turned the night over to the featured speaker of the evening, Libby Cantrill, CFA and Moderator Christine Sinicrope.

Ms. Cantrill, a regular contributor the Bloomberg and CNBC, is a Managing Director and head of Public Policy for PIMCO. She is a member of PIMCO's Americas Committee and Co-Head of their New York office. She is a founding member of PIMCO Parents and PIMCO Women. Prior to PIMCO, she served as a legislative aide to a member of Congress. In her role at PIMCO, she helps coordinate the firm's response to public policy issues and analyzes policy & political risk for the firm's Investment Committee. She brought those insights to her discussion with Ms. Sinicrope.

Cantrill's thoughts on the Federal government shutdown:

  • The highest visibility is at the TSA though there are about 800,000 Federal employees that have now gone without a paycheck
  • No quick compromise as both sides are politically entrenched
  • Any declaration of a National Emergency to reallocate funding to a border wall would be immediately contested in court and, if upheld, set a bad precedence.
  • She shared the estimate that the shutdown could cost 10 bp in GDP for every week it continues.

Her thoughts on trade:

  • Markets underestimated President Trump's resolve on trade
  • The appointment of Robert Lighthizer as U.S. Trade Representative (USTR) signaled the President's seriousness. Lighthizer curbed Japanese steel exports to the U.S. with threats of tariffs when he was Deputy USTR under Ronald Reagan.
  • The U.S. trade position with China is anathema to their 'Made in China 2025' plan

Her thoughts on the economy in 2019:

  • Recession is unlikely (30%) in 2019
  • Real GDP growth in the 2.1% - 2.2% range
  • Auto tariffs are coming

Political Issues:

  • Any investigations of the President's administration under Speaker Pelosi will be deliberate and focused
  • There is an appetite for a bipartisan agreement on regulating internet companies where privacy is concerned, but Congress needs to give the SEC more authority before that can happen
  • Many positions remain unfilled at Treasury under the current administration

Ms. Cantrill also addressed the importance of diversity of race, gender, and opinion to the industry and the steps that PIMCO has taken towards that ongoing standard.

Questions from the floor touched on the impact of the deficit on the currency trade and international equities relative to the U.S., foreign policy, Michael Bloomberg's 'green' platform, and the true extent of the shutdown.


Navigating Tax Reform, Key Provisions Impacting Investors - December 6, 2018

Dan Thieret and Luke Pope of CliftonLarsonAllen LLP met with membership at the St. Louis Club to present an overview of the 2017 Tax Cuts and Jobs Act (Tax Act) and Opportunity Zone Funds December 6.

Mr. Thieret kicked off the discussion by briefly reviewing the highlights of the Tax Act's changes for Individuals, Businesses, and Estates, specifically:

For individuals and families:

  • Lowering of the marginal tax rates (generally)
  • Raising of the Standard Deduction
  • Capping the deduction of State and Local taxes
  • Repeal of the Personal Exemption
  • . . . and more

Thieret shared his observation that in over 99% of the cases he's examined, his clients pay less tax under the new rules.

Businesses find their corporate tax rate falling to 21% and are benefitting from bonus depreciation along with an increase in Section 179 limits. Certain pass-through businesses will benefit from a 20% net income deduction while the domestic manufacturing deduction is being repealed. Some changes favor businesses, especially small businesses, while others like changes in net operating loss treatment, removal of entertainment expense deductions, and interest deductibility limits negatively impact businesses.

On the estate tax side, the estate tax exemption was raised to nearly $11.2 million per person.

Mr. Thieret fielded questions from the floor including the impact of the changes on farmers, Roth conversion strategies, and charitable giving strategies under the new rules.

Luke Pope then shared information on an aspect of Tax Act that was not as well-known: Opportunity Zones.

Created by the Tax Act to spur economic development and job creation in economically distressed areas (as designated by states' Governors), investments in Opportunity Zones provide investors with the ability to shelter from taxes some existing capital gains as well as 100% of capital gains on reinvested funds placed into a Qualified Opportunity Fund (QOF) and held for 10 years.

According to Pope, capital gains reinvested into a QOF within 180 days can be deferred until the end of 2026 of the QOF investment is sold (if sooner). Furthermore, 10% of the deferred gains are excluded if the QOF investment is held for 5 years – 15% if held for 7 years. Gains in the QOF itself will be untaxed if held for ten years.

Questions focused on the structure and mechanics of QOFs and the tax treatment of depreciation and losses.