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about General Stanley McChrystal? Flying from the opposite side of the planet to be fired by the president certainly cannot be easy on the ego. McChrystal’s visit to the White House lasted around thirty five minutes or so. A life in the armed forces comes to a close in a brief firing from the Commander in Chief. Nothing like going out with a bang is there? What is most interesting in the story is not so much that a man was fired for insubordination. Of most interest is a quote from Politico suggesting the writer of the Rolling Stone article, Michael Hastings, was able to write the piece because, as a freelance journalist and not a beat reporter, “burning bridges by publishing many of McChrystal’s remarks” was not a worry to him. Frank Rich, in the New York Times on June 27, 2010 said, “Politico had the big picture right. It’s the Hastings-esque outsiders with no fear of burning bridges who have often uncovered the epochal stories missed by those with high-level access.” Wow! How does one feel? Again, SummitVIEW is reminded that what one often reads or hears in the news just may not be the full picture. Why would anyone want to report the ugly truth when spin is so easily digested by the American populace? What else is not being reported for fear of burning bridges? Where is Clark Kent when you need him? SummitVIEW is beginning to understand the motivations for the creation of Superman in 1939. See Rosenberg’s quote on page 5 titled, Daring to Compare Today to the 30’s. Another news item of interest is the announcement see disclaimer on last page

As readers of prior SummitVIEWs know, a primary concern is the current level of risk in the system or, rather, the financial markets. Relying on your local newspaper or news program to provide the proper insight likely will engender confusion and a belief in false realities. If one were to follow the national media attention on the imminent threat of inflation, the result would be a belief that the US is doomed to experience inflation very soon. Reality is likely to be quite different. Recent housing data points to the continued decline in real estate prices. Although there does exist pricing power in some industries, with a pillar of economy, real estate, still experiencing declining values, the likelihood of inflation rearing its ugly head in the next few years is low. Wage increases? Not happening. Unemployment rate declining? Nope. The data point most telling to SummitVIEW is that which is cited by David Rosenberg

July 2010

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Groucho Marx

of a trade agreement between Taiwan and China. For two entities embroiled in a dispute over sovereignty for the last 60 plus years, the signing of the agreement represents a form of detente. Bloomberg reports, “in the trade agreement between the sovereignties China will also open markets in 11 service sectors such as banking, securities, insurance, hospitals and accounting, while Taiwan agreed to offer wider access in seven areas, including banking and movies, the two sides said. They also signed an agreement on intellectual property rights protection.” The agreement appears to reflect the thoughts of Mohamed El-Erian, Chief Executive Officer of PIMCO. El-Erian stated in an article titled Driving Without a Spare, that the new normal is a world of “changing risks and opportunities.” For this global economic transition period, investment with the safest carry will be “in sovereigns that, due to their economic and financial fundamentals, are truly core countries in the midst of the global paradigm shift.”


“Politics is the art of looking for trouble, finding it everywhere, diagnosing it incorrectly and applying the wrong remedies.”

summit creek summitVIEW 2

on page 4, in the quote titled The Bottom Line. Rosenberg says “[t]he world is awash with $222.5 trillion of total liabilities across public and private sector claims, or the equivalent of 362% of global GDP. Extinguishing this debt will be deflationary even as central banks will be forced to print money as an antidote and we are really in the early stages of this deleveraging cycle.” Rosenberg goes on to say in Dinner with Dave from June 30, 2010 the following:

July 2010

Resolving the pension crisis in the U.S. though [sic] a longer worklife and higher contribution rates is surely going to mean that deflation, not inflation, as it pertains to many discretionary segments of the consumer spending pie, is going to be the primary trend for some period of time; likely five years or more. In other words, the time to be worried about inflation is really beyond our forecasting horizon. Think about the ratio cited above for a moment. On a global scale there exists over 4 times (and rapidly approaching 5 times) the level of debt as the level of annual global production. As we all know most of that debt is held in the developed world. Without extend and pretend accounting standards in the banking and mortgage industries, where would equity values be today? As leading economic indicators roll over in the United States, few choices are available that have not already been deployed. How do equity values hold up when the economic engine is slowing and leverage is excessive. As an investor one should seek high earnings yield companies (that is low price to earnings) with little to no leverage, if you have to be in stocks that is. Otherwise, holding cash, high quality debt, and sovereigns of those countries that are recipients of the new economic paradigm likely will prove prudent. Protecting one’s wealth in this epochal transition is of primary importance. Long term asset performance averages are irrelevant when risk is defined as the probability of the permanent

loss of capital. In an environment where most underfunded pension funds are holding out for the return of an equity bull market, the underfunded state of pensions is likely to get worse than better in the near term. 2010 is likely to go down in history as a seminal year. The confluence of events shaping geopolitics and global economics are starting to make their mark. Although the events will be the focus of headlines, the response to the events is how our time will be defined. SummitVIEW holds to the belief that, although the transition to a new period of growth will be rife with strife and stress, a new period of prosperity will emerge on a scale few can forecast. Getting through a stormy sea of debt and tractionless economic growth requires proactive risk assessment and management. As James Montier of GMO LLC says, as quoted below, “[h]aving defined the [return] target, managers should be given as much discretion as possible to deliver

that real return. This avoids the benchmarkhugging behavior that is typically induced by policy portfolios.”

Recent market volatility is a reminder to all investors to fasten seat belts. The wild ride is just leaving the station.

1. Brock, H. Wood, Profile May 2010, Is the “Age of Rage” at Hand? - Sovereign Debt, the European Crisis, and the Euro, Strategic Economic Decisions, Inc.

July 2010

To sum up, what we are experiencing is not an event-driven turning point as in 1990, but rather a conceptual revolution in which much received wisdom about the role of the state and economic prospects for the future is being stood on its head. On both sides of the Atlantic, there is a sense that the Social Contract has been broken, and that government is the true culprit. What a change from a year ago when bankers were deemed the sole villains! The historian Simon Schama detects the beginnings of the Age of Rage, and he is probably right. The stakes are very high, and the political and economic consequences will be severe.1


In closing I turn to the words of Woody Brock:


Francois Trahan, Vice Chairman and Chief Investment Strategist at Wolfe Trahan & Co., expects the forthcoming period of deflation to be reflected in the equity markets with lower price to earnings multiples. In research titled Time to Throw Out Your Textbooks, Trahan states, “the fact is that the majority of empirical data show that lower interest rates are consistent with lower P/E multiples for the market.” Echoing SummitVIEW’s sentiment that our time will be defined by the responses to current economic circumstances, Trahan goes on to say, “[w]e hope policy makers will be somewhat proactive and the market won’t have to once again force the “invisible hand”.


Quotes: Driving Without a Spare


Over the next few years, Australia and Canada will constitute the analytical battle-ground as elements of the new normal come head-to-head with those of the old normal. Our sense is that the two countries’ exposure to the dynamic components of global growth - through direct trade links with Asia and the commodity angel will likely outweigh the drag from the legacy of household leverage (Australia) and the economic links to the U.S. ( Canada).

July 2010

For investors, this translates into a secular period of changing risks and opportunities: • The distribution of global outcomes is

going through a transformation, both in terms of overall shape (flatter) and tails (fatter);

• It is a world where several of the old

simplifying adages that once brought comfort to investors - such as industrial country governments constitute interest rate risk while emerging economies involve credit risk - require considerable refinement;

• It is a world that calls for a broader

investment universe and guidelines and , for those who use them, revamped benchmarks that better capture the world of today and tomorrow rather than that of yesterday;

• It is a world of significant country, regional

and instrument differentiation when it comes to harvesting equity and credit premiums in high-quality corporates, financials and emerging markets;

• It is a world where the currencies of the

emerging (as opposed to submerging) economies will continue to warrant a greater allocation over time; and

• It is a world where the safest of carry

will come from duration and curve in sovereigns that, due to their economic and financial fundamentals, are truly core countries in the midst of the global paradigm shift.

Mohamed El-Erian, PIMCO, “Driving Without a Spare,” Secular Outlook, , May 2010

I Want to Break Free, or, Strategic Asset Allocation ≠ Static Asset Allocation Clients should liaise with their managers to set a “realistic” real return target (recognizing that available returns are a function of the opportunity set, not a function of the needs of the fund). After all, the aim of investing must surely be “maximum real returns after tax” as Sir John Templeton observed long ago. None but a few very lucky fund managers get to retire on relative performance. Having defined the target, managers should be given as much discretion as possible to deliver that real return. This avoids the benchmarkhugging behavior that is typically induced by policy portfolios. Of course, it creates problems for measurement. Indeed, as I mentioned at the beginning of this paper, the most common response when I present these arguments is, “So, how should we measure you?” This obsession with performance measurement at the expense of investment sense is disturbing to me. There is no easy mark to judge fund managers against. This may actually be a good thing. It may force investors to allocate capital on the basis of process: i.e., you will only let managers that you trust and understand run your money. [emphasis added]

James Montier, GMO LLC May 2010, “I Want to Break Free, or, Strategic Asset Allocation ≠ Static Asset Allocation”

The Bottom Line The bottom line is that all levels of society, and across most countries in the industrialized world, have far too much debt and far too much debt-servicing costs in relation to income. The world is awash with $222.5 trillion of total liabilities across public and private sector claims, or the equivalent of 362% of global GDP. Extinguishing this debt will be deflationary even as central banks will be forced to print money as an antidote and we are really in the early stages of this deleveraging cycle.

David A. Rosenberg, “Breakfast with Dave,” Gluskin Sheff & Co., June 22, 2010

Daring to Compare Today to the 30’s

How The Middle Class, Or The New Rentiers, Is Stuck Between Deflation And Hyperinflation The world is currently overwhelmed with debt, but underwhelmed with growth. Everyone is trying to export, but no country has embraced the concept of expanding domestic consumption. Although I personally like consumption, I am an American and therefore over-borrowed and unable to service the debt loads of my city, my state, and my country, not to mention my own personal debt load. With the Americans no longer available as consumer of the last resort, and no one else stepping up, global final sales will stagnate in the years ahead. As a result, global debt loads will become relatively larger. If the world economic pie can not grow strongly, thereby lessening the relative size of global debts, the magic of compound interest will certainly bankrupt many governments and commercial entities. Currently there is a growing solvency crisis impacting many Eurozone sovereigns and another one that is occurring within many states and jurisdictions in the United States. It seems quite obvious that many of these problems will lead to default and the loss of principal on a grand scale. In the next few years, a greatly increased percentage of all outstanding investment grade global debt will default.

John R. Taylor, Jr., Chief Investment Officer, “FX Concepts,” June 24, 2010

For a glimpse of changed societal mores, this headline speaks volumes.....

How Many Graduates Does It Take to Be No. 1? Principals say that recognizing multiple valedictorians reduces pressure and competition among students, and is a more equitable way to honor achievement, particularly when No. 1 and No. 5 may be separated by only the smallest fraction of a grade from sophomore science. But some scholars and parents have criticized the swelling valedictorian ranks as yet another symptom of rampant grade inflation, with teachers reluctant to jeopardize the best and brightest’s chances of admission to top-tier colleges.

Winnie Hu, New York Times, June 26, 2010

Disclaimer: All material presented herein is believed to be reliable but we cannot attest to its accuracy. Neither the information nor any opinion expressed constitutes a solicitation by us for the purchase or sale of any securities.

July 2010

David A. Rosenberg, “Breakfast with Dave,” Gluskin Sheff & Co., June 24, 2010



Coming off a crash (‘29) and rebound (‘30); aftermath of an asset deflation and credit collapse banks fail (Bank of New York back then, Lehman this time around); natural disaster (dust bowl then, oil spill now); global policy discord (with the U.K. then, with Germany now); geopolitical threats; interventionist governments; ultra low interest rates (long bond yield finished the 1930s below 2%); chronic unemployment (25% then, 17% now); deflation pressures; competitive devaluations; gold bull market (doubled in Sterling terms in the 30s); debt defaults; sputtering recoveries and rallies; onset of consumer frugality.

In 2010, the authorities seem to have only two choices: allow defaults, which lead to deflation and tremendous stress to the political system and public order; or inflate so that debts lose their significance, which eventually leads to hyperinflation and tremendous stress to the political system and public order. Growth is a theoretical way out of this dilemma, but with shrinking populations and increased regulation, Europe cannot manage this option. The US might, but the way will be difficult. Cascading defaults will strip away many entitlements upsetting the rentiers [the debt owners, or, rather, the beneficiaries of the coupon payments] and those who had planned to become rentiers in the future. Countries that choose to allow defaults will see their currencies rally as there will be a shrinkage of currency outstanding increasing the value of the rest, but collapsing equity markets will test their resolve at every turn. We rentiers will be lucky if we can enjoy our dotage.


The data point most telling to SummitVIEW is that which is cited by David Rosenberg s u m m it V I E W ow about General Stanley McChrystal?...