Camp Kotok Asks: Does The Fed Matter?

August 06, 2017

Sen. Susan Collins

R – Maine

 

 

 

Camp Kotok, Maine – Each year, David Kotok of Cumberland Advisors gathers 50 or so people in the deep woods of Northeast Maine to discuss the state of the global economy and catch the occasional fish.

The gathering has often been called a shadow-Fed meeting, or perhaps a micro-“Davos,” and the description is appropriate. The attendees are incredibly sharp and diverse, including economists both public and private, wealth managers, pundits, CIOs, a handful of journalists and, and for some inexplicable reason, me.

The discussions are held under Chatham House Rules, a depression-era conceit that says attendees can report out about the “sense of the room” but that the identities of attendees and their specific statements can only be cited with their express permission.

Last year, the discussion was predictably about the upcoming election, with a side order of China. Even at that contentious moment in history, the discussion was erudite and respectful, despite wildly different and strongly held opinions.

This year was equally respectful, but the topics were different. Here are my takeaways.

Is This Market Long In The Tooth?

If there was a single question that kept coming up, it was whether global asset markets were overvalued. “This bull market is tired,” was a common refrain.

The counterarguments were many and vigorous. Barry Ritholtz of Ritholtz Wealth Management was quick to point out that measuring bull markets from the lowest-lows—March 2009—is essentially a mental error—by that measure, the 1980s bull market started in the 1970s.

Instead, measuring from the “higher highs,” the current bull market is essentially a toddler:

 

ETFExplainerXLB

For a larger view, please click on the image above.

 

Further on the bull side, there was broad dismissal of the current chaos in Washington, and a strong focus on fundamentals that still look strong: Corporate earnings are at all-time highs, and that should remain the driver of at least the U.S. equity markets.

 

ETFExplainerXLB

For a larger view, please click on the image above.

 

This was far from a consensus view; there were plenty of bears worrying about valuations and the impact of passive investing.

Will ETFs Eat The World?

In any group of folks as diverse as this one, there are always a few topics of conversation that end up being so contentious as to be nearly off limits. The meteoric rise of indexing and passive investing veered close to that “no go” territory.

Several dinner-table and fishing-boat conversations I had went deep into the core talking points: What if everyone indexed? Does indexing destroy price discovery? What happens when everyone wants out of the iShares iBoxx $ High Yield Corporate Bond ETF (HYG) in a hurry?

The good news is that for the most part, even the skeptics were willing to engage in the conversation and learn how the real underpinnings of the ETF structure work.

On the other hand, the straw-man argument of 100% indexing is difficult to refute. I remain convinced, however, that this straw man blows away in the wind pretty quickly. What if everyone decided to never to spend money on movies? What if everyone decided they would only live in the suburbs? These arguments make for interesting dinner discussions, but ultimately don’t lead to any logical conclusions.

The pro-indexing crew (of which there were quite a few) was well-versed in the defense, but I’m not sure any minds were changed. As participants in the ETF ecosystem—advisors, issuers or investors—it’s worth recognizing that with record flows and high visibility comes a constant need to explain. As the Boy Scouts say: Be prepared.

Does The Fed—Or Even Washington—Matter?

Perhaps the liveliest discussion of the weekend came during the annual fed policy debate, where several chief economists, former Federal Reserve Ph.D.s and Fed watchers discussed the impacts of global quantitative easing and zero/negative interest rate policies, the coming normalization of global central bank balance sheets.

It’s a heady topic that brought out some of the most heated discussions of the weekend. Broadly speaking, there were two camps: Fed defenders who believed the Fed had been and would continue to act rationally based on available information, and those who believed the Fed had been acting in an academic vacuum without real research underpinning either QE or the coming tightening.

These were entrenched, representative philosophical positions, I think, of two common camps among Fed-watchers right now.

 

Even so, there was at least some consensus that the challenge facing central banks is significant. Megan Greene, chief economist at Manulife, put it succinctly: If the only direct correlation between easing and inflation was asset price inflation, it’s logical to think that the coming tightening should have the reverse effect.

While most of the room nodded, the question remains: With the Fed being enormously transparent about the coming sales of bonds (and implied rising interest rates and potential for lower equity prices), is the effect of tightening already priced in?

However, there was a small but vocal group that voiced the fairly dramatic opinion that the Fed’s actions are at this point irrelevant, and that the past decade had shown that central bank policy has far less ability to impact the real economy than many predicted, making policy changes nothing but so much expensive noise.

A Surprise Guest

Health care was an unexpected topic of conversation when Maine’s Republican Senator Susan Collins unexpectedly dropped in for dinner. Sen. Collins, one of the three deciding Republican votes to kill the recent Senate efforts to repeal or amend the Affordable Care Act, relayed her personal account of the dramatic vote by fellow Republican Senator John McCain in the middle of the night.

More interesting, however, was a Q&A that followed in which several of the attendees expressed their dismay over the current state of the underlying U.S. health care system, and support for a single-payer system.

This sparked a dramatic response from Collins—and many others in the room—over the cost of any such proposal. While there was broad consensus that there are deeply embedded problems with this particular 20% of the economy, much like Washington, there was little consensus in Maine on how to solve the problem.

The good news was that I walked away from our discussions with Senator Collins at least believing there are some folks on both sides of the aisle in Congress who are actively and intellectually engaged in rational good-faith discussions, all trying to find solutions that work for the betterment of the country.

Honestly, I’m not sure I would have believed that a week ago, so I’ll take that as a win.

At the time of writing, the author held no positions in HYG. Dave Nadig can be reached at [email protected]

 

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