Tiho's Analysis And Immediate Outlook For Stocks, Bonds And U.S. Dollar

Jordan Roy-Byrne: Hello everyone and welcome back to the Atlas Investor podcast. This is episode number 17 with Tiho Brkan. Thank you so much for tuning in today. And Tiho, before we get into episode 17, let's discuss what you've been working on recently, because we have not been able to record a podcast for quite a while, and that's not just because we're ignoring or avoiding our listeners, that's because you've actually been doing some real work.

Tiho Brkan: Yeah, as opposed to doing no work and traveling, right? So, first of all, hello from Prague and thank you for having me back on the podcast. Excited to be doing this again. I've been working very hard and getting a lot of things done away from the financial markets. I've been very busy with some property work, some property deals here in Prague, and after purchasing some real estate last year, co-investing with my clients, we are now in a process of renovation, and that is very time-consuming for anyone that's done that on their own house, their own apartment. They've seen how difficult it is getting it from a planning stage to the renovation building stage, and all the way to the completion stage.

So yeah. We have a decent project here. There's three of us involved, and I'm the one on the ground doing all the leg work, including running all the errands, if you want to say. So yeah, it's been quite exciting at the same time too, but not a lot of time to sit down and do the podcast until today. But I'm happy to be back, Jordan. And one thing I would like to say is that we'll definitely cover some of the things that I've been doing here in Prague with real estate and how some of the listeners and readers could also go about doing their own investments. Or, if they might need help, they could contact theatlasinvestor.com and get in touch with me because I'm always looking to partner up with investors in private deals away from financial markets, and we'll be discussing more of what I'm doing and how I'm doing it in coming episodes. So, I think that'll be interesting too for those that wanted to diversify away from financial markets.

Jordan Roy-Byrne: Okay, great. Now Tiho, before we start this episode, can you please tell us what you're going to be covering today.

Tiho Brkan: So, I'll be giving a basic market summary because I've been away for a while. We're going to be looking deeply into stock regions of the world. There is a bit of volatility that's returned over the last few months, since February, and that's ongoing. It's kind of spread into various other areas away from just the stock market. So, we'll cover that and we'll cover some of the reasons as to why and pinpoint some of the regions as to where it's happening. And that's always interesting to cover, even though the price action is always a lot more important than the fundamental analysis, which is kind of lagging, as the market likes to discount it.

And finally, we are going to be introducing a new section of summary, where I'll be introducing my benchmark index. Basically, an index that I track and benchmark myself against and try to outperform. This is your classic stocks, bonds, credit, commodities, precious metals, and a mixture of everything in a classic way, diversified asset class-wise and also regionally around the world. And so, it will enable us to summarize things very well by looking at how the whole world asset classes are performing, generally speaking, and giving us a feel as to generally how the funds who might be using similar indexes or similar strategies are performing, as well as how global investors and high net worth individuals are doing.

So generally speaking, that'll be a good summary, and we will do that from podcast to podcast, Jordan. So, shall we get into it?

Jordan Roy-Byrne: Okay Tiho. So, you're going to be updating us on global equity markets. Let's start off with the US and the S&P 500 (SPY). Now Tiho, what do you make of the recent action in the S&P 500? It has been consolidating, but it looks like recently it's regained its moving averages. What do you make of this action, and what we might see going forward?

Tiho Brkan: Yes. So, we haven't discussed this since episode number 15. Last episode, number 16, we discussed interest rates, and treasuries, and credit, and so forth. But in episode number 15, I discussed the fact that most likely the correction in the equity markets is over for now, and we are going to be having some kind of a relief rally. Now, this turned out to be half correct, Jordan, as we will see as we do this podcast. In particular, if you have exposure to the US equities, then you can just give me a tick and tick the box, and I got that right.

So, it was my feeling that equities around the world could have a relief rally. But clearly, some regions have done better than others. And the region that's performed best is the United States stock market, in particular technology stocks, like FANGs, which still continue to perform very well, and small caps, they have been leading on the upside.

But there are also sections of the US stock market, and in particular, certain sectors that are not doing so well. An example of this is staples, which has been under pressure quite a lot as of late. But nonetheless, the US stock market is around 2.5% from its all-time record high, is still holding above the three-month moving average, the 200-day moving average, the 12-month moving average and the uptrend line that's been in place since February 2016. So, the bulls are still in control, but there are no new highs yet. Obviously, that could take time. And we currently hit this resistance level during this below-average seasonal period, the summer lull, as we call it, selling may go away. So here, this tends not to work as well as it normally would, but we're now in this resistance zone, and we're kind of pausing here as the Federal Reserve once again hikes interest rate and turns a bit more hawkish.

However, looking back throughout his whole bull market, one of the things that I would like to summarize in this episode is that on an annualized basis, US stocks have been the better performers relative to the rest of the global regions. We've rarely seen a negative dip. I mean, I think United States stocks were down about 7% year over year in 2015-2016 period. That's the worst that we've seen it when adjusted, including dividends. If you've held US stocks since March 2009 or even since January 2009, Jordan, you've been up every single year for the last nine years.

There's been times when the US stock market was going to finish maybe down for the year, but the dividends kind of pulled performance through. I think one of those years was 2011 and the other one was 2015. Both of those were not good years, especially since we've had eurozone crisis in 2011 and emerging market crisis in 2015, in particular, China devaluation.

But most of those periods did not affect the United States stock market, which has had a terrific time. And I think over the last decade or so, we're looking at a 14% annualized period, especially as we start to look from October or November 2008 towards October or November 2018. That decade-long period, the annualized performance there, is going to look fabulous. So, if you bought like Warren Buffett did 10 years ago, you are in a very good position with your portfolio right now, and I congratulate you.

Jordan Roy-Byrne: Okay Tiho. Now, you mentioned some areas are performing better than others, and you mentioned that this recent strength has been led by the tech stocks. I want to get your thoughts on what's going on with the FANG stocks because, at the end of last year, I don't remember which podcast number it was, but you warned about the FANG stocks which were really overheating. Now, you were right, and they corrected along with the market. But now they're recovering again, and even leading. Now, does their performance tell you anything about the overall market and where we could be in the cycle? What are your thoughts on that, and if there are any other insights you have that the listeners should take away from the strength in the FANG stocks?

Tiho Brkan: Sure. Well, there was a great chart published by DoubleLine by Jeffrey Gundlach recently in his own webcast, not a podcast, and he discussed the fact that Dow Jones e-commerce index, which is basically the FANG stocks, is up by more than six times, and it's the third-largest bubble in the past several decades. And comparing it to Europe, or India, or China, or relatively speaking, comparing it to any other sector of the world, a handful of these companies have a higher market cap than anywhere else.

One thing that's interesting about this chart that we're looking at is that every generation and every decade has its own bubble. And of course, over the last decade or so, it's really been e-commerce. I mean, you can even throw biotech until the healthcare reforms and some bureaucratic laws were passed through, putting a lot more pressure on healthcare and biotech in 2015 and 2016. But the e-commerce space still continues to run very, very hard. So clearly, we are having a bubble here. And that doesn't mean when I say it's a bubble that you go out and short it immediately or you tell everybody it's a bubble. What that means is that these things can run, and they can run very hard and very fast. And eventually, all bubbles, including Bitcoin and Litecoin, Jordan, they do come to an end and they do have some kind of a crash.

The US stock market is very much dependent on these leaders. So, whenever they stop rising, whenever their earnings stop performing, or whenever some kind of restrictions or bureaucratic regulations come on against these companies, or something happens in the tax world to change the way they report their taxes or just the general economy slows down, these stocks tend to move down just as much as they moved up.

We saw after the late '90s bubble, some of these stocks, including Amazon (NASDAQ:AMZN), they were down by 90%, 80% from their all-time highs. So, the crashes can be extremely severe. So yes, this space is extremely expensive and overextended, but that doesn't mean that in future podcasts we won't be talking about it again as it gets up even higher. This could be the bubble that tops all previous ones, and we'll keep a track on this one. It's very, very interesting.

Jordan Roy-Byrne: Absolutely. Now, moving on from that, let's talk about foreign stocks and first, foreign developed markets. Can you discuss the recent action in this group as compared to the US?

Tiho Brkan: So, they are also in an uptrend, as we discussed previously with the United States. However, having said that, since the February 9th low, there is very much a sideways trend, barely above some of the shorter-term moving averages, still kind of holding up to the uptrend line and hanging in there. But one of the things that's interesting about this index, in particular - the major part of this index comes from Europe - is the fact that eurozone index does not have a lot of tech stocks, Jordan.

So, from that aspect, if e-commerce is really the bubble of the current trend and it's really pushing the indices higher, one of the things that we can notice with European stocks is they lack those components, and therefore, maybe international developed markets would be performing just as well or maybe quite similar to the United States if they had their own version of FANGs. But they really don't.

The strong dollar is also putting pressure on foreign markets, as we'll discuss later, but the lack of tech stocks here is showing in the index, and the rest of the financials, and the real estate, and the staples. They're not performing as well, as I've said. So, we have leadership from small caps in the United States and globally from tech stocks, and it's not helping this area and this region of the world.

Jordan Roy-Byrne: Okay, a lack of tech stocks and a strong dollar. Thank you for that. Now, sticking with the strong dollar, let's talk about emerging markets, your favorite equity group. Tiho, if we look at the EEM ETF, emerging markets have been underperforming, they're still below their three-month moving average, while US stocks, as we already know, they've regained all the key moving averages. So, is there any other reason why emerging markets are performing other than this rebound in the dollar, and do you expect their current underperformance to continue or change?

Tiho Brkan: Well, we'll get into the reasons later and we'll discuss that for sure. But what I would like to say is that, yes, it is my favorite part of the portfolio to allocate towards, but clearly not so good (despite my favoritism) as of late. The one thing that we should keep in mind is that from January 2016, emerging markets did bottom one month earlier than S&P 500. From January 2016, this stock market region led the world, and I think at one point in time it was up almost 90% from that low. So, it's only normal to see what we're seeing here. And the dollar was so weak in 2017, and it's been weakening since December 2016. So it's only normal to see the dollar rebound and for it to go through a short squeeze after so many people piled in on the short side, and in particular, jumped on the long side with the euro.

So, what's happening right now is normal and what we're seeing in emerging markets is a mean reversion back to the trend, or the trend line in some way, or the 12-month moving average, or the 200-day moving average. At the moment, emerging markets are not acting as if there's going to be some kind of a major crisis, but anything's possible.

One thing to keep in mind is that over the long term, emerging markets have broken above their 2007, 2011, and 2014 highs. So, we had this last decade and we've seen a proper meaningful strong attempt at the break, and we just went straight through it. We sliced it and diced it, as you would say, and we're holding above the trend line and we are retracing back to it. It's only normal. Having said that, the US continues to outperform emerging markets in the equity space on a relative basis. So, emerging markets are not doing all that well at the moment, and the dollar is not helping. There's a variety of other reasons why emerging market contagion is happening, and we'll discuss those in the next section.

Jordan Roy-Byrne: Tiho, now you are going to cover the things that have been happening around the world. These are the things that aren't always front and center in the headlines in the west. Some of these things are happening under the surface, but we should definitely keep a look on. And first, you want to talk about bond yields in Italy. So, bond yields in Italy have surged in recent weeks. What does this imply, in your opinion, for conventional markets. And if bond yields in Italy continue to rise, then what markets would be most affected in the future?

Tiho Brkan: Well, first and foremost, this is something that has been in the headlines and kind of shook the market a couple of weeks ago. So, it's a great place to start the conversation. Since we peaked in January 2018, there's been a variety of things that have brought back volatility from the lulls of 2017, which was the second least volatile year and the second least drawdown on an annual basis since 1995. Those two years stand out as just the most peaceful, record-breaking, super-gain, great performance years, just making the US stock market great again basically, that's what 2017 was. 2018, not so much.

So, clearly now, the issue at hand is Italy, and in recent times, it's always been southern Europe. It's been Greece. Maybe we're kind of tired of Greece for a while and we just know all the bad news and it just doesn't worry investors all that much anymore. But we have Italy and the Deutsche Bank (NYSE:DB) saga, and there's also Portugal and Spain, even though they're not kind of on the front headlines of the newspapers right now.

Basically, we've artificially suppressed some of these countries' bond yields, and in particular, southern states of the eurozone. And this is the ECB's Mario Draghi bond-buying program that's artificially suppressing these interest rates, and they're trying to revert back to more normal levels, Jordan, in my opinion. And every time there's a catalyst for it, the market moves the needle towards some kind of a main reversion, and then these kinds of stories in the press are used as a catalyst.

But clearly, Italian 10-year government bonds had no business trading at 1.5% yield while the United States was approaching 3%. I mean, you cannot tell me that the United States with a world's reserve currency is riskier and should be yielding more than the Italian government bonds. There should be a premium for some of these relative to the reserve currency.

Sure, there could be a case made in some ways that the US has better growth and therefore requires high interest rates and so forth, but in my opinion, it's all to do with artificial stimulus from ECB. If you let these interest rate find their own normal levels, I'm pretty sure Italian debt will be trading at a lot higher levels than it is right now. But that's one of the things that shook up the markets recently.

Moving along, things have been pretty bad in Turkey and this is affecting emerging markets. So, we've got Turkey, we've got Indonesia, we've got Mexico, we've got Argentina, we've got the Philippines, you name it. There is Brazil as well. So, a handful of these emerging markets, some of them have borrowed a lot in US-denominated or euro-denominated currency, so therefore, they have issues with paying off their debt. As their local currencies weaken, the debt servicing factor comes in. And obviously, this has been happening with the Turkish lira for a while now. We've seen it sink to 2.5, then 3 over the years, then 3.5, then 4... we're going for over 4.5 recently, almost touching 5.

So, the lira has been kind of in a waterfall crash here, and this is putting pressure on all kinds of Turkish assets, including real estate in Istanbul, as well as, let's say Turkish equities denominated in US dollars. That is trading at a single-digit CAPE ratio and price-to-book ratio that's very, very attractive right now. But what can you do despite the fact that its expected return in the future will be great, I think, eventually when it bottoms, the current weakness in the lira and the continued weakness in the lira will continue to put pressure on some of these assets. And part of the contagion also we have down in Latin America with a Brazilian stock market nosediving in recent weeks, and the whole Latin American index is down quite a bit in a short period of time.

Argentina is in the headlines again. They borrowed a lot in US dollars, and they've issued these century bonds, which was a mistake, in my opinion. Definitely, for the investors who bought these bonds it was a mistake, and the IMF is now providing them another credit line by the looks of it, and they're asking for the peso to devalue further.

I mean, I have a very interesting person that I tend to have some dinners with here in Prague from time to time, and he has investments in Argentina, and I remember us sitting a month ago at the dinner table having a nice meal in the center of Prague and he was saying to me, "So, where is the peso at now?" Because he hasn't visited Argentina recently, and he said, "22, 23?" I said, "No, it's a 26." And he said, "26!" and yeah, so it looks like it's going to be going towards 30 or higher.

So, a strong devaluation of the currency there as the currency tries to find its natural normal flow without the peg, and I think in the long term that's healthy, what's happening in Argentina. But it's a period of adjustment, and through this adjustment there's pain. And naturally, that's happening in Indonesia and in a lot of other places as well. Mexico too and Brazil, and therefore, the stock markets priced in US dollars are being affected.

Generally speaking, Jordan, this all links to the US dollar rally.

Jordan Roy-Byrne: Yes, and that was my next question, because what's going to happen in the dollar over the coming months and over the next year? And so, it seems very crucial and critical to various markets. And I guess the question is, is this just a bear market rally or is this the start of a bigger move higher? I know you don't like to give your opinion, you just liked to watch the market and anticipate what's going to happen, but give us some insight on that and what you see for the dollar here and now.

Tiho Brkan: Well, one of the reasons that I don't really muck around with Mr. Market is because Mr. Market has taught me some lessons. There is a handful of investors out there that write newsletters and kind of pretend that they're investing, but it's not real money. So they, from time to time, define this whole fun factor about trying to predict what's around the corner and trying to guess how the macro puzzle falls into place as if they were George Sorrows and Stanley Druckenmiller at a table in the 1980s with the trousers and the suspenders, trying to figure out how the global markets will move. There's some kind of romanticism to all that, but I have to admit when real money is involved, the only romanticism I have is with my girlfriend. I'd rather keep the risk management very tight in this regard.

So, from that aspect, I don't like to muck around with the markets and try to make predictions which people would quote you on and then come back six months later and say, "Well, that didn't work out the way that is." And I usually say, "Well, I had a stop loss," and because I had a stop loss, I didn't really lose what you lost. And that's the difficult part about it.

But coming back to the currencies, I would say it's not all about the US dollar. First of all, the US dollar is currently rallying very strongly, and yes, we are in a short squeeze, especially against the euro, where we had this huge buildup in positions. So, the dollar I think still has a bit of a rebound left because we haven't even squeezed all the shorts. There's still some shorts left. I'm thinking it still might take some weeks or some months. So, this is a natural rally for the dollar, considering it had a horrific 2017 and its last 18 months have not been good.

But I have to say that the dollar is not all that fabulous of a currency despite having a bull market against the euro or the pound over the last 10 years. If you have a look at the dollar against the Swiss franc, Jordan, it is not actually performing all that well despite the fact that the dollar is doing really well against the yen, and the pound, and the euro, and the Aussie dollar, and so forth. But the Swiss franc has held its own. Another currency that I would like to mention is the Singapore dollar and the Korean yuan. Both of those countries have pretty good fundamentals, and if the US dollar bottomed in 2008, it's lower against all three of those currencies.

There's a handful of other currencies too, including the Chinese yuan that has been very, very strong. The Thai baht has not been weak at all since the 2008 bottom for the US dollar. As a matter of fact, the Thai baht is holding its own in a nice, peaceful and moderate range. Of course, there are other currencies, like the Indian rupee and the Filipino peso, Indonesian rupiah, that have been quite weak since 2008, including the Vietnamese dong, where I spent a lot of time looking at investments, and the Latin American area is always bad. The Brazilian real and Mexican peso are always getting devalued.

But there's a handful of currencies, including ones in Europe, where I'm making some investments now, and you can see fundamentals coming through in places like the Czech Republic with the Czech krona. It's quite strong on a relative basis to the US dollar. And also, I think the Israeli currency has barely budged since the US dollar started a bull market in 2008. So, very, very strong.

So, I would have to say that it comes down to fundamentals, and not every currency is falling apart as the media would make it sound to be. And therefore, this is why the emerging market index is not correcting all that much. I would like to say that if you look at the Taiwanese dollar, the Chinese yuan, and also the South Korean yuan, as well as their stock markets, these three countries in Asia make up about 50% of the emerging market ETF, and they are actually outperforming the rest of Latin America and Africa and the Middle East, and all kinds of problems that we are having everywhere with these currencies falling apart.

So, generally speaking, half of EEM is kind of holding up pretty well. So, from that aspect, it's not all about the dollar. But nevertheless, if the dollar rally intensifies against all of those currencies that I managed to discuss here, then, of course, you will have more pressure. And I guarantee you, you won't only have pressure in emerging market equities, you'll have pressure around the world, because as the dollar rallies, it tends to put pressure on forward earnings per share and revenue per share - so don't mistake that. At least 50% of revenue for United States companies comes from abroad these days. So, the dollar is a key indicator to watch, Jordan.

Jordan Roy-Byrne: Okay. I just have a quick follow-up on that. I know you're not a big fan of targets, but what sort of level do you think the dollar index would have to go to where it starts creating issues around the world and not just in emerging markets? I believe it topped out just a tick or two below 95. Would the dollar have to go up to that old high around 103 for that to happen? What's your sense of how much higher the dollar would have to go before the issues that it causes start to be magnified?

Tiho Brkan: Sure. Well, one of the ways that I would answer that without a target, and clearly, I'm pulling myself away from making a prediction here, is that when the dollar starts to gain a lot of momentum based on year-over-year percentage return. So, if the dollar is up a lot a year from now, that will start to affect things in a dramatic way. You will see South Korean exports down, you'll see semiconductors struggling, you'll see energy stocks, material stocks struggling, you'll see commodities, precious metals miners not doing all that well. And you will see various international stocks away from the United States, and in particular, tech and staples probably face some pressure. And other asset classes will also be affected too.

So, if the dollar is up year over year, it tends to put pressure on company profit and loss statements too. So, earnings reports might be a little bit different than what they are currently expected to be. Everyone thinks that earnings will continue to grow very strongly, Jordan. So, that's the way that I would answer.

Jordan Roy-Byrne: Okay, very good. So, follow the annual rate of change. Okay, Tiho. Now, moving on. Just a couple of other things we should discuss. Let's talking about interest rates and, specifically, 10-year and 30-year yields which have corrected and consolidated after testing major resistance. And as you recall, this is something we covered, as you noted, I believe, in the last episode, episode number 16. So, are we closer to a breakout now in these long-term bond yields, or do we need to see more bearish positions unwound?

Tiho Brkan: Yeah, well, that's a very good question. We have a lot of bearish positions betting on higher bond yields. So, the Fed is now at 2%, and generally speaking, the yield curve is really, really narrowing and flattening. Therefore, we're getting close to inversion, which tends to be a warning signal for economic growth to start to stall. As interest rates have risen, same fashion as the US dollar has risen, this is obviously putting pressure on emerging markets, in particular, the Argentinas and the Mexicos and the Turkeys, that have borrowed in other currencies rather than their own local currency. So, interest rates are also very important to watch.

The 30-year yield failed to move above 3.25, which is something that we discussed in the last podcast, episode 16, and it kind of held there. We were about to break, and as it was looking like the yields were ready to move up, and I think the 10-year actually crossed over 3%, which was kind of like the magic number the media has been watching. There's been a refusal to move above that on the first go, and in particular that whole issue occurred around the Italian catalyst, and as soon as Italian bonds collapsed and their yields spiked, everybody moved very quickly into treasuries, and the spread between the Italian yields and the US yields started to converge in favor of the US, and clearly it should, as I was discussing above.

We have a very low sentiment on bonds and we have some kind of technical divergences now, and there doesn't seem to be a follow-through. So, I am also wondering whether we're going to have a short-squeeze rally, and we're definitely set up for one, Jordan, so I'm watching the space very closely and I basically have my finger on the trigger.

So, in case we get some interesting developments happening with the price in a technical way, I'm looking at positioning and I'm looking at the potential for a short-covering rally in bonds. And generally speaking, everybody's kind of hawkish now. Everyone's expecting four rate hikes this year. Two are already done, and quite possibly four next year. So, a lot of this is getting priced into the market, and we will see if the bonds want to go lower.

After the Fed meeting, we're seeing a rebound in the bonds right now. So, it's very interesting. And a 3.25% level, resistance level, on the 30-year US Treasury bond is holding for now, and the 3% is, give or take, it's holding for the 10-year too. But the five-year yield is now catching up, and the two-year yield catching up. So, as I said, the yield curve is really, really flattening. So, if the long-term rates don't want to move up and the Fed continues to press the short-term rates pedal to the metal, we will get an inversion very soon, and that could signal a recession and, possibly, a stock bear market. So, something really to keep an eye on, Jordan. Very interesting setup as we are moving into the second quarter of 2018 and the beginning of 2019. Really, really watching this.

Jordan Roy-Byrne: Yes, absolutely. And that's actually why I want to ask you a follow-up question, if you don't mind. So, let's just assume that the yield curve becomes inverted. Which assets or markets do you think would perform best, not so much in the long term after an inversion, but as soon as the yield curve inverts. Historically, which assets or sectors or markets tend to perform best upon that inversion and then over the next couple of quarters after that?

Tiho Brkan: So, I think stocks might be the surprising answer to everyone, but I think credit will start to underperform. We tend to have a divergence between credit spreads and the equity prices, a delayed cycle prior to a recession. So, as you have a yield curve inversion, stocks tend to, sometimes - not always, but often - they tend to enter a bubble mania stage. Sometimes they don't, of course. Like in various periods throughout the last, let's say 70 years or so of historical data, where we can trust a yield curve a bit more. But stocks tend to do very, very well. And it's about the time when the yield curve goes from inversion back towards steepening that a recession starts. That's when it becomes obvious to the stock market, the Fed, and all the investors that they've overcooked it. They cooked the goose that lays the golden eggs, and it's time to start loosening monetary policy.

And usually on Wall Street, the initial cuts in interest rate as we saw them in 2007 are perceived to be bullish, but that can't be further from the truth. It's too late to save the bubble, and in this case, it could be the e-commerce bubble that we just discussed. And in previous episodes, we discussed the valuation extremes with the price-to-book ratio, CAPE ratio, price-to-sales ratio. Some of these valuations have exceeded 1929 and some have exceeded the peak in 2000.

So, my answer is credit tends to underperform at the beginning as the yield curve gets inverted, and I think treasuries will start to outperform other fixed income. And they also try to find some kind of a flaw, because at that point in time, the Fed stops hiking and some initial sections of the economy start to slow, and then it becomes more and more apparent that the Fed was hiking too fast for the economy to handle it and it broke something within the system. It usually leads to a recession.

Stocks can still ignore this. Investors tend to lose their minds at the end of the cycle, and one thing that I would like to mention is that I believe the Nasdaq went up something like three times from the mid-'90s into 1998, and then it quadrupled from 1998 to March 2000. So, I'm not saying that that's going to happen again, but definitely there's a possibility to have a blow-off top in the bull market, no doubt about that.

And then finally, as the Fed starts to loosen and the yield curve goes from inversion towards deepening, you'd probably want to own treasury bonds at that point in time, and also you might consider owning gold. But it very much depends on what happens in this recession, or whether the US dollar will also rally hard and put precious metals and commodities under pressure, or whether the US dollar will start to lose its yield advantage over other economies like Japan and the eurozone and emerging markets, and at that point in time, the dollar could start falling and gold could start rallying.

So, we will be discussing these developments as they happen, but I'd say there's a potential for stocks to still do well, and not that I'm telling you to go out and buy a truckload of them right now. But something to keep in mind, don't get bearish just because the yield curve is flattening and we're coming towards a recession, because the last blowoff top, even if it lasts three to six months, it can be magnificent.

Jordan Roy-Byrne: Yes, and thank you for that great detailed answer. I and I'm sure the listeners really appreciate it. Now, Tiho, one more thing, you mentioned credit. So, let's talk about credit and what's happening around the globe. One question I had, why are investment grade in emerging market credit spreads widening a bit, yet junk bond spreads are not widening?

Tiho Brkan: Because junk bonds are the new safe haven, Jordan. And we saw something similar in 2007. I mean, we saw emerging market credit spreads kind of trend sideways at the beginning of 2007, and we saw investment grade start to spike up a little bit in February of 2007. So, during the end of the last cycle, prior to the recession, we saw junk bond investors be totally oblivious to what was going on in subprime and ignoring it. But then they paid the price, because the mean reversion in the opposite direction was swift and fast, and it ended up killing a lot of funds and a lot of investors.

So, right now, basically, junk bonds - and I mentioned this in our previous podcast - are not only outperforming equities, they are outperforming the whole fixed-income space. And I think maybe only commodities are doing a little bit better than them. But even commodities have now started to react to the downside, with gold and oil having a recent correction. So, junk bonds are the new safe haven.

One thing that we just discussed in a previous question, which was great, I think, is what to hold and what not to hold as the yield curve moves towards inversion and the spread between the twos and the 10s, let's say, or the fives and the 30s go negative. And that's definitely not credit, in my opinion, as it usually tends to weaken first. And we're already seeing a little bit of an uptick in the spreads. It's hard to say whether this is the start of something more important to watch.

I would like to mention that credit investors, or bond investors as they will like to call themselves, they're not smarter than equity investors. They always try to say bond investors sniff out troubles a lot earlier than equity investors. Actually, they're too early in the investment game, if you ask me. Yes, they figure out the problem earlier, but the equity trend is still moving upwards, and as long as the trend is your friend, you got to stay with the trade and you can make a lot of money, especially in the final parts of the bull market.

So, if we look at the history prior to 2007 cycle, the previous one was 1997. That's where credit spreads troughed and we had the start of the Asian financial crisis, followed by the Russian default and Asian flu crisis, and then we had the period of tech crash and the global recession, as well as Argentina defaulting in 2001, and all kinds of, I think, US corporate bankruptcies and accounting scandals in 2002. So, credit spreads kept widening the whole way through that. But obviously, credit investors were way too early, because the US stock market peaked in 2000, not in 1997. So, just keep that in mind.

Sometimes credit spreads are a good warning indicator, but sometimes they're too early. It's good to keep an eye on them, because if they start to diverge relative to the equity market, there's definitely something wrong, and then there is basically a ticking time bomb in the equity market. It's just a matter of time before it rolls over also.

Jordan Roy-Byrne: Okay Tiho. You've done a great job today giving us an update on what's going on in the various global capital markets. But before we sign off here, one thing I'd like you to talk about is the Atlas Investor benchmark index and why we're going to continue to discuss that at the end of every podcast and what exactly it's comprised of. I don't want you to give away all your details, but just give us information on how you constructed this and why you follow it.

Tiho Brkan: So basically, this is a good way to analyze what's happening in the global asset markets, especially if it's constructed in a way that it's not US-centric, but globally diversified, properly exposed to all regions, and to all asset classes too, all industries and all sectors. So, this is a benchmark that I use to track my performance against on a relative basis, and I try to outperform this benchmark.

It's a simple mix of stocks, REITs, government bonds all around the world, credit all around the world, commodities, precious metals and other kinds of alternative assets, like infrastructure and so forth. And what you have here is a basic representation or what's happening for the majority of the funds. It kind of follows the 60/40 to a degree as well, but it has periods of outperformance and underperformance against it because it's not all that similar, and it's a diversified portfolio that a lot of the investors, as Ray Dalio says always, should be using, because it's too difficult to just try to play the game of poker against these funds and traders who are so skillful and so good at what they do that they will probably every time you put your money on the table, you'll leave empty-handed. So, it's good to have a basic strategy.

If we have a look at the asset class performance of this portfolio, basically the Atlas Investor Benchmark Index, since the February 9th bottom when we had the big spike, we've just gone sideways. So, various asset classes have done okay, and others have not done all that well. So, generally speaking, the performance has been flat and there hasn't been a lot of money to be made, and we've kind of been chopping around in a very strange format. Like US equities are kind of lifting the index towards the upside and various other asset classes are pushing it towards the downside.

The one final thing I would like to say is that despite the fact that this benchmark of diversified portfolio benchmark that we're looking at here is sitting on a 12-month moving average as well as the trend line support, one thing that's interesting is that it hasn't had a 9% correction in more than two years. We're approaching 130 weeks now. Why did I choose 9%? Because 9% is about the drawdown that you would get, on average. It's about between one to two standard deviations of the historical drawdown when I backtested this portfolio going back about 50, 60 years. And that's about a normal run of the mill crisis correction that you would get, whether recently it was the eurozone debt crisis or the taper tantrum, or the emerging markets slowdown and China crash, which kind of went towards 17%. Some of them tend to be a little bit less like 6%, or 7% in recent trade war correction and the US elections during Donald Trump.

So, we haven't had this correction of 9% in a long time now. And I think we eventually will have a mean reversion and it's just a matter of time. So, the question is, what will push this index lower? Will it be the treasury bonds that go lower? Will it be credit? Will it be commodities and gold? Will it be some other alternative assets? Or will it be equities and real estate and REITs? Or will it be all of them together? It remains to be seen.

But this is something that I don't want to drone on too much about in this podcast, but definitely something that we'll be discussing more. And we'll have some fabulous indicators around this globally diversified portfolio so everyone can follow it.

Jordan Roy-Byrne: Absolutely, Tiho. Thank you so much for that. And finally, before I let you go, please tell us what you'd like to cover in episode number 18.

Tiho Brkan: Well, we are overdue to cover Vietnam, and I think we'll be focusing on that country. In 2017 and 2016, I spent at least, I believe, 12 months or more over those two years in the country looking for investments, looking at real estate, and the stock market, and various companies, and doing on-the-ground research, getting connected with lawyers and builders and developers and so forth.

So, it was a very interesting period for me, and real estate agents, whom I want to give a shout too. They know who they are.

So yes, I'll be discussing Vietnam and we'll talk about all the great prospects this country has for the future, Jordan, and also all the risks that it carries, as other frontier markets do, pertaining to the boom and bust cycles. They are very, very common and often occur when you least expect it.

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