Q4 2017 Market Review & Outlook
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Q4 2017 Market Review & Outlook Morgan Creek Capital Management MORGAN CREEK CAPITAL MANAGEMENT Q4 2017 Market Review & Outlook Table of Contents Letter to Fellow Investors 3 Fourth Quarter Market Review and Outlook 25 Update on Morgan Creek 89 Q4 2017 Market Review & Outlook 2 Letter to Fellow Investors The Year of the Frog: #HackedMarkets Source(s): whitelotusfs.com, savethefrogs.com, usatoday.com, dailyhaha.com, flickr.com, content.time.com (12/31/65) Over the past year we have presented the Quarterly Letter almost like an old-time Serial, where each successive letter is connected to the last through a character or plot twist. Our story began last February with the first installment titled Babson’s Brilliance: #WelcomeToHooverville, which introduced our protagonist, Sir Isaac Newton (brilliant scientist who discovered Gravity), through the eyes of Roger Babson (brilliant entrepreneur and market observer who called the 1929 Crash), who was obsessed with gravity throughout his lifetime (founded a research foundation to find a “cure”). The letter described how we believed that with the election of Donald Trump, a President with no experience just like Herbert Hoover, there was a risk of a Bubble Melt-up in the equity markets that would follow the 1929 pattern (peaking at 2,800). The second installment in May, titled Not So Intelligent Investors: #GravityRules, connected Newton to the father of Value Investing, Benjamin Graham, who (like Sir Isaac) had learned about the power of Value Investing by using the exact opposite approach (leveraged speculation) during the Bubble leading up to the 1929 Crash. Graham quickly discovered that gravity does indeed rule and lost everything, causing him to rethink the error of his ways, embrace the discipline of Value Investing, pen the two most important books on the topic (Security Analysis and The Intelligent Investor) and become a professor who inspired some of the most widely recognized investors of our generation (like Warren Buffett). The third installment in August, titled What Goes Up Must Come Down: #DarknessFalls, linked the total solar eclipse to Newton’s pioneering work on gravity and the movements of the sun, moon and stars and introduced W.D. Gann, a self-taught trader and market forecaster, who right after the turn of the twentieth century wrote about market cycles that would later predict the 1929 Crash (to the month) and nearly every major crash, crisis or market turning point during the last hundred years. The fourth installment from November, titledIt’s Déjà Vu All Over Again: #Pure Imagination, used the wisdom of Yogi Berra to discuss how perhaps the repeal of gravity (stocks moving to ever higher levels of overvaluation) might persist because, as Yogi liked to say “It’s not over until it’s over.” We also sought the wisdom of Willy Wonka to help us understand a world of pure imagination (while every valuation metric was signaling a Bubble and imminent return of gravity there was a possible explanation insofar as the nominal value of equities was high, but when deflated by gold (real money) the valuations were lower than previous Bubble peaks – an old Banana Republic trick of inflating asset prices that benefit wealthy by slowly devaluing the currency, like boiling a frog). With our latest installment, we introduce a few new characters to our story, but weave our way back to our hero, Sir Isaac Newton, and his battle against the evil central bankers and their seemingly never-ending production of the anti-gravity element, “Upsidasium.” The Chinese animal zodiac (Shēng Xiào) is a repeating cycle of twelve years beginning on the Lunar New Year, where each year is represented by an animal and persons born in that year are said to share that animal’s associated Q4 2017 Market Review & Outlook 3 Fourth Quarter 2017 characteristics. The twelve-year cycle was derived from an approximation of the 11.86-year orbital period of Jupiter, the largest planet of the solar system. In order (by legend, the order in which the animals arrived at the Emperor’s banquet), the twelve animals are the Rat, Ox, Tiger, Rabbit, Dragon, Snake, Horse, Goat, Monkey, Rooster, Dog and Pig. February 16th ushered in 2018 as the year of the Dog. The zodiac also has five elements (Wu Xíng) which, when combined with the twelve animals, are associated with a 60-year cycle (interesting correlation to the Gann 60-year cycle). The elements are Jin (Metal), Mu (Wood), Shui (Water), Huo (Fire), and Tu (Earth) and the theory is that these core elements follow a predictable cycle of control that dominate all human relationships over time. The elements interact with the intrinsic characteristics of each animal and create character traits which are reflected as follows Metal (Determined, Persistent, Manager, Tiger), Wood (Talented, Idealist, Planner, Owl), Water (Sympathetic, Perfectionist, Coordinator, Chameleon), Fire (Courageous, Passionate, King, Koala) and Earth (Tolerant, Honest, Leader, Peacock). Further, odd numbered years are labeled Yin and even numbered years are labeled Yang (another cycle of energy), so that 2018 is the Year of the Yang Earth Dog. The logic is that investment markets are made up of individuals and those individuals are impacted by these cycles, thus there would be a logical cyclicality to market events over time. This is what W.D. Gann wrote about in the early 1900s when he created his Financial Time Table, and what we have observed over the last century within the cyclicality predicted by the Gann charts has been quite evident in economic activity and equity markets. Most of us would agree with the characterization of dogs as our best animal friends and would further agree with their description as loyal, friendly, dependable and kind (other than those who, like one of the characters in The Italian Job says, “The dude’s got dogs. I don’t do dogs… I had. A bad. Experience). People born under the sign of the Dog are said to share similar traits. Within the Chinese zodiac, the Dog is associated with loyalty, honesty, intelligence and known to be easygoing and helpful to others (contrasting to the Rooster from last year, which is seen as demanding and fickle). Dogs are known to be swift and passionate believers in their own personal philosophy, while on the other hand, they may sometimes be critical, stubborn, and cold and have difficulty communicating. The year of the Earth Dog focuses on dependability, loyalty, building relationships, and interestingly, building material wealth. The earth element will make this particular Dog year gentler than others, increasing the likelihood that we observe people fighting for causes they believe in deeply, which could emerge as large political movements or simple local activism (perhaps more of the latter than the former, due to the Earth element). The earth element encourages a ooler-headedc approach to problem solving, rather than emotional responses that lack judgment and reasoning. Curiously, two notable Earth Dogs are entertainers Madonna and Michael Jackson while Elvis Presley was a Wood Dog and three of the last four Presidents, Bill Clinton, George W. Bush, and Donald Trump are all Fire Dogs (born in 1946). Unfortunately, 2018 is likely to be an unlucky year for people born under the sign of the Dog as in Chinese astrology the years that share your birth sign are thought to bring bad luck. For the rest of the signs, 2018 will be a year where new industrial projects and developments in energy should be successful (interesting given movement to try Fiscal spending) as well as entrepreneurial activity as Dog years are good times to make lifestyle changes and start businesses. Family relationships are critically important, while individual focused activities based on personal greed or ambition are likely to fail. From a global perspective, the Year of the Earth Dog could be a year of hope where meaningful dialogue helps countries and cultures move toward solidarity and away from indifference and conflict (did we see some of that at the Winter Olympics?). Many years ago, we came across an annual forecast by Paul Ng (a well-known Feng Shui Advisor and Geomancer) that we found quite useful in thinking about the year ahead in politics, the economy and markets (and have read his annual forecast every year since). Feng Shui is the Chinese metaphysical and quasi-philosophical system that Q4 2017 Market Review & Outlook 4 Fourth Quarter 2017 seeks to harmonize individuals with their surrounding environment. Feng Shui literally means wind and water and is based on the views of poet Po Kwok nearly 1,700 years ago that expound the theory that when positive energy is correctly managed in a home, good luck follows as a matter of course. Master Ng has worked with individuals, corporations and governments all over the world to create more positive living and working environments and has also developed a comprehensive approach to forecasting events in geopolitics, economics and markets by focusing on the natural cycles of the Chinese Lunar Cycle. Looking at the 2018 forecast at the highest level, Master Ng summarizes his perspective saying “The 9-Violet star is the controlling force for this year. This is the 14th year of the 8-Cycle of the world. This arst represents joy and its element is fire. It represents mobility and changes, but also hints at heat and fire problems around the world.” Globally, this means that regions in favor include China and South-East Asia, while regions not in favor include the U.S., the U.K., Russia, Japan and Korea. China’s politics should remain very stable and economic growth is likely to surprise to the upside (as high as 8%), so living standards should rise and the government would put more emphasis on education.