Staying Above Water - May 7, 2015

Click Here for this Week's Full Letter

     

Greetings,

          The US government won’t have a debt problem unless growth drops below the cost of financing said debt. Since 2007, the country’s debt burden has grown from 64% of GDP in 2007 to 104% currently. Reinhart and Rogoff’s seminal economic paper from 2010, “Growth in a Time of Debt,” hypothesized that countries with ratios of public debt to GDP above 90% tend to see their economies contract by about 0.1% annually. While graduate students have since challenged that paper, it’s worrisome that growth expectations in the US are being cut once again in 2015.

          On Wednesday, HSBC’s US economist cut 2015 growth estimates from 2.9% to 2.5%, citing the accelerated decline in oil drilling activity. This marks the third consecutive year economists have cut expectations in the second quarter and it comes on the heels of Jeremy Grantham’s latest letter, which highlighted the downward pressures on long-term US growth prospects. Grantham believes the country’s secular growth rate is around 1.5% Y/Y; below the 2.4% Y/Y growth from 2014. Assuming his 1.5% estimate is correct, 10-year yields at 2.2% (-0.7% on the chart below) spells debt trouble ahead for the US.

          How does the government reverse this trend? Either growth needs to pick up or debt needs to decline, although they’re not necessarily mutually exclusive. The Federal government has already cut back significantly on debt issuance. The country’s budget deficit is down to -2.8% of GDP, compared to -6.5% in 2013. In theory, interest rates at 0.25% should take care of the growth equation, but that’s clearly not working.

           Hypothetically, if Congress was serious about jumpstarting growth, it could do worse than bolstering the country’s lousy infrastructure. The World Economic Forum calculates a long-term gain of five to twenty-five cents on annual GDP for every dollar spent on public infrastructure. If Congress doesn’t want to pony-up for better roads and airports, the private sector should get involved.

          The demand is there. Goldman Sachs recently announced plans for a new $3 billion infrastructure fund, and Norway’s sovereign wealth fund, the world’s largest, is increasingly interested in the sector. These types of investments have a good track record. For private investors in Australia, it's estimated that infrastructure investments in the mid-1990s yielded 7-8% annually, with favorable risk exposure. Congress isn’t known for prudent decision-making, but if they want to avoid a debt problem, infrastructure would be a good place to start. Investors looking to capitalize on this theme should keep an eye on ETFs like IGF and GHII.

     

The Cup & Handle Fund is still roughly flat on the year, and +15% since August (inception). I’m still increasing risk after a slow start to this year after some sloppy positioning. I added one new theme this week, shorting a high-flying sector that I believe will come back to earth in short order. I’ve decided on a pick for my May letter, and just have to write it. Hopefully it will be available within the next week or so. If you’d like to start receiving these letters click here.

Today’s letter will cover several topics, including:

  • The Tesla Trap
  • Don’t Call It a Bounce-back
  • The Buffett Barometer
  • Chart of the Week

      

With that, I give you this week's letter:

May 7, 2015

      

          As always, if you have any questions or comments or just want to vent, please send me an email at mike@cup-handle.com.

Until next time, tread lightly out there,

Michael Lingenheld

Managing Editor – Cup & Handle Macro

Posted to Cup & Handle Macro Research on May 06, 2015 — 11:05 AM
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