Monday, January 22, 2018

The 2018 Treasury Bond Bear Market?

Brian Romanchuk, publisher of the Bond Economics blog, wrote a comment over the weekend, The Highly Predictable Treasury Bond Bear Market (added emphasis is mine):
The benchmark U.S. 10-year Treasury has entered a predictable mild bond bear market, and the financial press has rolled out their "What happens when the Treasury Market Dies?" think pieces. (As an immediate disclaimer, I do not do forecasts, and thus I did not "predict" this bear market. At most, I probably noted that previous pricing was consistent with a decent probability of recession happening over the next few years.) As is usual, we are seeing a lot of technical analysis. The technical analysis battle is between two forces: the drawing straight lines is destiny belief, versus the belief in the power of round numbers.

The "straight lines are destiny belief" is fairly well known; it is easy to draw a descending straight line on a long-term bond yield chart (like the one above). The latest move probably broke above a lot of the lines that you could draw. The next logical step is the following: if bond yields are no longer going down, they have to go up.

This is going to collide with the "big round numbers" theory. The theory is that a lot of asset allocators/bond managers have said: "I will cover my short/underweight when the yield hits a round number (3% in this case)." I no longer pay attention to market chatter, but anecdotes about liability managers having hedging programmes kick in at those round number levels was a constant across all developed markets.

As a recovering secular bond bull, I have a natural affinity for the "round numbers" theory. Anyone selling stories about a bond market apocalypse has to explain why institutional investors that are massively short duration versus their liabilities are going to let yields shoot higher. (By contrast, most institutional investors did not even know how to calculate the duration of their liabilities before the early 1990s.) That said, a 3% nominal yield is pathetically low in an environment where nominal GDP averaged 4% a year even during the worst of "secular stagnation." So if I were to rely on the "round number" theory, I would put a lot more faith in 4%, as that is an even rounder number.

Once again, the fundamentals will win, with the fundamentals being forward Fed pricing.

Bond "Bubbles" -- Augh

The phrase "bond bubble" is back. That usage is an insult to any self-respecting bubble. In financial theory, people have tried to use a technical description -- a hyper-exponential price trajectory, based on the expectation that the asset can be sold to someone else also discounting a hyper-exponential price trajectory. Other commentators use a qualitative measure: is there mass participation by retail investors, and does the asset gain lots of popular coverage?

Unless a lot of people think that interest rates can get really negative, an asset that guarantees sub-3% nominal annual returns over 10 years (less than 30% cumulative) is never going to display hyper-exponential pricing. And face it, bonds are a hated asset class. The reason why editors run scary stories by bond bears is that they know that most of their readers hate bonds. Frankly, I am ex-secular bond bull and run a website whose domain name value is derived entirely upon an interest in bonds, and I can hardly get excited by them. (My idea of an exciting bullish headline is "Bonds: You Might Not Lose a Lot of Money in Real Terms!")

Bonds were arguably mispriced -- on the basis that you can now buy them cheaper. However, any losses on long-term bonds are still paper losses. If there is a recession within the next few years, 10-year bonds purchased earlier might still outperform cash if held to maturity.

Irrational, Or What?

The chart above shows the origin of the mispricing: the front end of the curve disrespected the Fed's intentions to hike rates over a relatively short time span. The fact that the Fed was taking baby steps in tightening probably helped the complacency. (In some years, it was one hike per year, whereas the historical pace was one hike per meeting, with eight meetings a year.) The 2-year is finally starting to work in a bit of a cushion.

That said, even if the front end continues to get hammered, bond bulls could come up for reasons for the curve to flatten (meaning that bond yields will rise less than one-to-one than the policy rate). It is not enough to expect forward rates to match the median Fed forecast (plus a term premium), an expectation has to incorporate the skew around the median forecast. Based on the post-1992 historical experience, the probability distribution is skewed towards a much lower policy rate in a recession, whereas accelerating inflation that justifies rapid rate hikes (as seen in the 1970s) has not happened. Even oil price spikes were not enough to trigger a second round of inflationary pressures.

In other words, it appears entirely rational for the bond market to rise slowly in response to Fed rate hikes, as the hard-to-judge probability of recession counters the rise in the baseline forecast for the path of the policy rate. When the Fed was hiking at a pace at 200 points a year, the tightening was front-loaded, and the skew due to recession probability is relatively less important. In that environment, it is not surprising that bear markets were also front-loaded, with most losses incurred almost immediately (or even before the first hike).

Finally, a rise in Treasury yields is not bearish for risk assets. The Fed is only going to raise rates in response to continued nominal growth, which implies that happy days for corporate profitability will continue. Inflation cutting into profit margins drastically would mean that labour is suddenly getting a bigger slice of the income pie, which seems somewhat optimistic. Faster nominal growth swamps the effect of a higher discount rate.
For those of you who don't know him, Brian Romanchuk is one of the smartest guys in the fixed income world. We worked together twice, once at BCA Research where he was helping to publish fixed income products and later at the Caisse where he was a senior quant analyst at the Fixed Income group.

Brian has a PhD in electrical engineering but his interests have evolved over the years into monetary economics, in particular modern monetary theory. He has published a few short books on Amazon that are well worth the price and I highly recommend his blog, Bond Economics, which delves into topics that are academic and market oriented.

Brian is also a genuinely nice guy with a quirky sense of humor. I remember plenty of conversations we had on bond bears and how many hedge funds got destroyed shorting JGBs over the last 20+ years.

The problem with bonds is people get way too excited without thinking things through. Readers of my blog know I'm not in the bond bubble camp because I worry about long-term structural deflation. Here is a sample of past comments where I discussed my thoughts:
It's important to distinguish between structural (long-term) factors and cyclical (short-term) when discussing bonds.

For example, I typically focus on seven structural factors that lead me to believe we are headed for a prolonged period of debt deflation:
  1. The global jobs crisis: High structural unemployment, especially youth unemployment, and less and less good paying jobs with benefits.
  2. Demographic time bomb: A rapidly aging population means a lot more older people with little savings spending less.
  3. The global pension crisis: As more and more people retire in poverty, they will spend less to stimulate economic activity. Moreover, the shift out of defined-benefit plans to defined-contribution plans is exacerbating pension poverty and is deflationary. Read more about this in my comments on the $400 trillion pension time bomb and the pension storm cometh. Any way you slice it, the global pension crisis is deflationary and bond friendly.
  4. Excessive private and public debt: Rising government and consumer debt levels are constraining public finances and consumer spending.
  5. Rising inequality: Hedge fund gurus cannot appreciate this because they live in an alternate universe, but widespread and rising inequality is deflationary as it constrains aggregate demand. The pension crisis will exacerbate inequality and keep a lid on inflationary pressures for a very long time.
  6. Globalization: Capital is free to move around the world in search of better opportunties but labor isn't. Offshoring manufacturing and service sector jobs to countries with lower wages increases corporate profits but exacerbates inequality.
  7. Technological shifts: Think about Amazon, Uber, Priceline, AI, robotics, and other technological shifts that lower prices and destroy more jobs than they create.
These are the seven structural factors I keep referring to when I warn investors to temper their long-term growth forecasts and to prepare for lower returns ahead as we enter a long period of debt deflation.

Essentially, what this means is long bond yields around the world are capped on the upside. Can long bond yields rise in the short run? Sure they can but as I keep telling you, don't confuse cyclical swings due to factors like short inflation bursts linked to lower US dollar and rising oil prices with structural factors that cap yields on the upside.

And when US long bond yields rise, long bond prices (TLT) fall, offering opportunities for investors to reduce risk in the portfolio by loading up on long bonds as they sell off.

In fact, this is what is happening now, and a quick look at the chart tells me this recent selloff in US lond bonds (TLT) is just another buying opportunity:

Can long bond prices fall further? Absolutely but as Brian states, "any losses on long-term bonds are still paper losses. If there is a recession within the next few years, 10-year bonds purchased earlier might still outperform cash if held to maturity."

Remember, the short end of the curve (yields up to the two year bonds) is influenced by the Fed and its intention to hike rates whereas the long end (10-year+ bonds) is influenced by US inflation expectations which are at their highest since 2014:
An important market measure of inflation expectations has risen to its highest level since 2014, as investor’s show strong demand to purchase protection against the threat of rising interest rates and declining bond prices.

The 10-year break-even rate, a market measure of inflation expectations derived from Treasury Inflation Protected Securities (Tips), has risen to 2.09 per cent, it’s highest level since September 2014 when oil prices were collapsing. The impact of oil prices on break-evens is strong, with analysts attributing at least part of the recent rise in inflation expectations to rising oil prices.

At a $13bn auction of Tips on Thursday, primary dealers — responsible for bidding on a pro rata share of the auction to ensure the sale of the debt — walked away with a smaller than average share of the securities, as other investors came in aggressively to buy.

“Bottom line, protection from inflation was in high demand in today’s auction,” said Peter Boockvar, chief investment officer at Bleakley Advisory Group.

The 10-year Treasury yield has risen 20 basis points so far this year to 2.6 per cent on Thursday, closing in on its 2017 high of 2.63 per cent.

“Whether its wage fears or the rise in commodity prices, the inflation view is shifting and I repeat my belief that higher cyclical inflation in 2018 is a large under-appreciated risk,” added Mr Boockvar.
Wage inflation? A sustained rise in commodity prices? I don't see it. The simple explanation to this temporary rise in inflation expectations is the decline in the US dollar (UUP) over the last year, leading to higher oil prices and more importantly, temporary higher import prices:

I emphasize temporary because the decline in the USD cannot, I repeat, cannot continue indefinitely without global repercussions. Why? Because the USD is declining relative to the euro and yen, which effectively means these currencies are appreciating, lowering import prices in these regions, exacerbating deflationary headwinds there.

[Note: We shall see what happens with the NAFTA negotiations taking place in Montreal this week, but if they derail, and protectionism starts ruling the day, we might see a meaningful reversal in the USD. Even if they don't global PMIs weakening is bullish for the greenback. Period.]

This is why I'm not in agreement with Chen Zhao's macro thesis recommending international stocks and commodities and more in agreement with François Trahan's macro thesis recommending a return to stability.

Importantly, with global PMIs weakening, I expect we will see lower US long bond yields (higher bond prices) by yearend. You might not see this right now but I suspect by the second quarter, people aren't going to be talking about global synchronized growth any longer.

And without global growth, there's no way US long bond prices (TLT) are heading lower because they will offer the most attractive yields in the world.

Remember, and Brian alluded to this in his comment, asset allocators matching assets with liabilities are long duration, meaning they're scooping up US long bonds as yields rise (prices fall). Pension funds and other large institutions matching long-dated liabilities are using any backup in yields to de-risk their portfolio. This too places a natural ceiling on long bond yields.

So will the yield on the 10-year Treasury head to 3% this year and even 3.5% over the next two years? With global growth waning, I strongly doubt it, and if we get another crisis in the US or elsewhere, I can guarantee you long bond yields will head back down and make new secular lows.

Where I disagree with Brian is in his last paragraph where he says the rise in Treasury yields is not bearish for risk assets. That all depends on whether the Fed over-hikes and we get an inversion of the yield curve which is bearish for risk assets (see my Outlook 2018 for details).

Lastly, all this talk about technical breaks in US Treasury yields is much ado about nothing. In fact, Jeffrey Snider of Alhambra Investments wrote a comment, What About 2.62%?, poking fun at this silly notion. You can read this comment here and print it on PDF here.

I think too many investors worried about missing out on the great 2018 market melt-up are not focusing enough on downside risks.

I know it's hard to fathom but stocks don't go up forever and neither do bond yields. Always worry about downside risks especially in an environment where fear of missing out (FOMO) reigns supreme. When the music stops and the tide turns, you don't want to be caught with your pants down.

I think the biggest risk now is that stocks keep melting up in Q1 and more and more investors will start chasing them higher and higher at a time when the global economy is slowing. It won't end well for stocks but it will end well for bonds. That's my call so trade and hedge accordingly.

Below, Danielle DiMartino Booth, founder of Money Strong, LLC and advisor to Richard Fisher, talks about how rising interest rates could impact the economy.

This interview took place last week, Danielle was recovering from a cold but take the time to listen to her comments. She talks about the problem with the Fed's favorite measure of inflation (core PCE),  how Mother Nature played her part in this latest boom in US growth and saved the auto sector from marked slowdown, and why she likes Jerome Powell the new Fed Chair.

Interestingly, the "sugar high" she refers to is due to the billions in losses insurance companies sustained last year which are going back to rebuilding the US economy but in a conversation with Cornerstone Macro's François Trahan over the weekend, he said the "sugar high is from the delayed effects of lower global bond yields following the Brexit vote."

By the way, before I forget, subscribers to Cornerstone Macro's research should take the time to read the latest portfolio strategy comment, Anatomy of a Market Melt-Up, as well as last week's comment, 4 Top Risks to Our base case Outlook in 2018. Both are excellent comments worth reading.

As always, please remember to show your support for this blog via a PayPal donation or subscription on the top right-hand side under my picture. I thank all of you who take the time to support this blog.

Friday, January 19, 2018

Why the 2018 Consensus is Wrong?

Earier this week, Chen Zhao, chief global strategist at Alpine Macro, hosted a webcast to discuss their 2018 Macro Outlook and investment strategy, Coming Boom and Policy Clashes: Why the 2018 Consensus is likely Wrong.

The key questions that were addressed were the following:
  • Is the recent spurt of strong growth around the world a late cycle phenomena or mid-cycle expansion?
  • How long will the “sweet spot” last in the eurozone?
  • Why has U.S. wage growth been so tepid against the booming job market and low unemployment?
  • Is inflation in the U.S. economy a serious threat to the equity bull market?
  • With global equities in a melt-up, what is the sensible investment strategy?
  • What to do with emerging markets, international stocks, value and small cap equities?
  • How high will the 10-year Treasury yield go?
  • Is the recent rally in commodities a real breakout that will lead to a new bull market or a fake-out that will end in new lows?
Please note that a replay of this webcast is available to qualified investment professionals. For the access code, you can send an email to with your contact details including name, firm, phone number and country.

Before I begin, let me thank Chen for providing me his slides and notes for this webcast. I was hoping they would post it on YouTube so I can embed it here but I think it's best you contact them here, get a trial access to their research and watch a replay of the webcast (it was short, concise and thought-provoking).

For those of you who don't know, Alpine Macro was formed by three industry veterans, Tony Boeckh who led BCA Research from 1968 to 2001 (see company's history here), Chen Zhao who worked many years at BCA as a Managing Editor of the Emerging Markets and Global Investment Strategist publications before going to work at Brandywine Global and David Abramson who was the Managing Editor of BCA's F/X and commodities publications. You can read more about them here.

Collectively, Tony, Chen and David have many years of experience and they have seen it all, so I would definitely subscribe to their market research because as you'll see, it's not based on consensus. They have their own views on markets which you may or may not agree with but I guarantee it will make you think hard about where we're headed.

You'll recall I alluded to Alpine Macro's 2018 outlook in my comment after Christmas looking at whether it's time for the Santa rally:
It's particularly hard trading when markets enter a melt-up phase, where everything explodes up, and this in spite of the Fed raising rates.

In my experience, this is when the biggest gains are made. This is why I've been trading stocks over the last month like crazy, because I knew as long as that tax bill wasn't signed, markets will keep going higher in anticipation of  the new tax plan.

Now that we got this tax bill out of the way, it will be interesting to see if markets keep forging ahead despite the Fed rate hikes.

Personally, I'd love to see a healthy pullback on the S&P 500 (SPY) right back to its 50-week moving everage before it takes off again. It doesn't mean it's going to happen, especially in these markets where traders chase momentum.

But these markets aren't just about momentum and chasing trends. Some argue the fundamentals warrant more upside in stocks.

In fact, Chen Zhao, Chief Strategist at Alpine Macro, sent me this in an email Friday morning:

Alpine Macro’s 2018 Outlook, titled “Unanticipated Boom and Coming Clashes”, is currently being completed and will be released on January 5th . The report’s release will be followed by a live Webcast where I will answer your questions. Here is a preview of the report:

Entering 2018, the investment community has comfortably converged to the view that economic growth in the U.S. will be around 2.5%, growth in the Eurozone will decelerate to about 2% and China’s economic growth will soften to 6.3%, ergo the consensus calls for a replay of 2017 in 2018. As for markets, most investors are cautious on stocks, bearish on bonds and uncertain about commodities and emerging markets.

Maybe the consensus is right, but we disagree. We are looking for a low-inflation economic boom, driven by private capex, re-leveraging and an possible “race to the bottom” in tax cuts around the world. We are looking for much stronger growth in G7 in 2018, while China’s economy could also deliver a positive surprise.

As for financial markets, our research suggests that the bull market in U.S. stocks has not yet matured. Despite the recent price gains, the total return index for the S&P 500 has not even returned to its long-term trend (see chart above). Should a low inflation boom indeed develop, a “melt-up” in global equity prices could be the big surprise in 2018. We are not particularly bearish on US treasury bonds, but the dollar story will become complicated in the New Year.

Finally, various risks will also escalate next year, suggesting that financial market volatility will be sharply higher. Investors should think about hedging strategy, especially now with VIX index at extremely low levels.
Chen is right, don't discount the low-inflation melt-up in global equities in 2018, it might happen and take everyone by surprise.

Importantly, after years of quantitative easing (QE), there is still a tremendous amount of liquidity in the global financial system driving stocks and other risk assets higher. And all this talk of rate hikes and reducing central banks' balance sheets is much ado about nothing.

Where I disagree with Chen and the folks at Alpine Global is on their "particularly bearish" call on US Treasuries (TLT) as we head into 2018. Why do I disagree with this call? Simply put, deflation remains the biggest threat as lofty stock markets head into the new year.

This is why I'm still recommending buying the dips on US long bonds (TLT) and still believe that melt-up or meltdown, Treasurys offer the best risk-adjusted returns going forward:

I realize this is counterintuitive but think about this way, if stocks keep melting up, downside risks will soar too, and if they melt down, well, there won't be many places to hide except for US long bonds, the ultimate diversifier in these insane markets.
So far this year, US long bonds (TLT) haven't been performing well as the 10-year Treasury yield jumps to its highest level since 2014 (remember, bond prices are inversely related to yields, so if yields rise, bond prices decline).

According to J.P. Morgan Asset Management, the 10-year Treasury yield will edge higher throughout 2018 towards, but not above 3 percent, as central banks relax their stimulus.

This remains to be seen but there is no doubt that with the 10-year yield breaching the 2.63% technical level (it's at 2.64% at this writing), US long bond prices are getting hit and bond bears like Jeffrey Gundlach and Bill Gross feel vindicated (for now). More on that later.

Back to Alpine Macro's webcast. Chen kindly provided his notes and charts to this webcast (added emphasis is mine; click on each image to enlarge):
Before I start my presentation, let me share a piece of good news with our clients. Many of you might have known Yan Wang, who was BCA’s chief China strategist and managing editor of BCA China Investment Strategy from 2003 to 2017. Effective this week, Yan has joined us to head up our emerging market and china research.

I think that Yan is probably one of the best China experts around the world and he is known for thoroughness, objectivity and contrarian ideas for his research. I am really thrilled that Yan is now with us. He will launch our EMC strategy in due course. So, stay tuned.

Back to the outlook, I will spend about 20-25 minutes to lay out the key points of our macro story and investment strategy for 2018 and this will be followed by a Q & A session.

Throughout the webcast you may send in your questions via email and I will try to answer them as much as I can. In case I don’t have enough time to handle all the questions, I will email you with my answers separately.

The world economy has entered 2018 with a strong note. Everyone understands that the world economy is in a synchronous economic expansion for the first time in eight or nine years.

The consensus view suggests that the latest spurt of strong global growth is a late cycle phenomenon. This is primarily based on the fact that US economic expansion has lasted eight nearly nine years and the Fed has already begun to raise rates. In history, the combination of strong growth and tightening monetary policy almost always leads to an end of a business cycle expansion.

Maybe this consensus is right, but I would like to offer you an alternative view. That is, while everyone is trying to figure out when the next recession will hit us, the world economy has just gone through a recession in 2015/2016. If So, the latest strength in economic growth is likely to be a mid cycle expansion instead of an end of a cycle phenomenon.

Here a few points are worth sharing with you:
  • Chart 1 on page 2 shows nominal GDP growth in the US. The US economy grew 2.5% nominally in 2015/16. This is a nominal growth rate was often seen in past economic recessions.
  • Even in real terms, you could say that the U.S. is in a mild recession. Chart on page 3 is the growth rate of real GDP created per labor, or real growth in GDP relative to labor force. On per-labor basis, we had a mild recession in 2015. Actually, the depth of that recession was comparable to 2001.

  • Chart on page 4 shows China’s nominal GDP dropped to very low levels in 2015. In fact, it was the first time when nominal GDP was even lower than real GDP in China’s post reform history. It is not an exaggeration to say that the growth slump in China in 2015 was worse than 2008 when global financial crisis struck.
  • Of course, there was severe recession in many resource-heavy economies in the EM universe. Russia, Brazil, South Africa and Indonesia were all in deep recession between 2014 and 2016.
  • Only Europe and Japan were doing ok during 2015/16, but these two economies came out of extremely depressed bases so one would hardly feel that they were in recovery during these two years.

  • Chart on page 5 shows that the SPX stayed flat for nearly two years from early 2015 to late 2016, while EM equities collapsed during this period
  • Other market signals were also consistent with that of a mild recession. Chart on page 6 shows that stock bond ratio collapsed in 2015 along with profit recession in the US. Bond yields made new lows. Chart on page 7 shows that Commodity prices collapsed, while junk spread blew up.

All of these market signals are consistent with a mild recession during 2015. Therefore, it is legitimate to argue that the recent economic strength around the world is actually a mid cycle story. My judgment is that the world economy is probably still in its most dynamic phase of economic recovery.

This is a key reason why we are calling for a mini boom around the world this year.

There are several key developments supportive of our assessment: a few reasons for this call:
  • Chart on page 8 Consumer deleveraging is drawing a close. We know that the consumer deleveraging has been the key reason causing recovery to be anemic for the last several years because consumers have been preoccupied by saving more and spending less to pay down their debt. The good news is that this process is ending, as evidenced by a flattening debt-to-disposable income ratio.
  • Importantly, consumer debt creation is way below historical average and it has a lot room to accelerate. This would suggest that consumer spending can now grow at the same rate or even stronger than income growth, if they begin to take on leverage again.

  • Please go to Chart on page 9 In recent months, falling unemployment and tight labor market have fostered a sense of optimism. This is reflected by surging Consumer confidence, suggesting that a spurt of strong consumption growth will likely follow.

  • Chart on page 10…Corporate Capex has been very bad for the advanced economies throughout the post 2008 period and the U.S. is no exception. There is a net depletion in corporate capital stock in the US since investment growth has fallen short of deprecation rate for the last few years. As a result, capital-labor ratio has also fallen, perhaps to a point that is causing problem for profit maximization (left panel of chart on page 10)
  • If you look at the right-hand side of this page it shows that capex cycle is already beginning to unfold even without the enacted tax cuts. This process will be further enforced by GOP tax reform.
  • There are all kinds of estimates on the impact of Trump tax cuts and most tend to believe that the impact is modest.
  • On this issue, the best analysis is the one done by professor Robert Barro of Harvard University. He estimates, based on cross-country analysis, that the full expensing of capital expenditure, plus lower tax rate, should add about 0.4% to GDP growth in the next five years as firms front-load capex. The longer-term impact should be around 0.3% p.a.
  • Importantly, lower corporate tax rates in America, plus cheap energy and land cost, can indeed attract much FDI into the country, adding strength in growth. All of this is to say that GDP growth in the US could accelerate towards 3% this year, or better.

Turning to China, the investment community has formed a unanimous view that the Chinese economy will be softer in 2018 than 2017. Everyone thinks that the Chinese government’s deleveraging effort will shave some growth from the economy.

We take a different view. We feel that growth will not be any different from 2017 and in fact could even be a tad stronger. Three key driving forces for China’s economy:
  • First, Chart on page 11: inventory-sales-ratio the residential market has dropped precipitously in the property sector, suggesting that the inventory has been depleted quickly as a result of sustained deceleration in real estate investment.
  • This week the Chinese government has announced a major land reform package. Essentially, this package breaks the state monopoly of land supply, allowing private sector to participate in the land supply formation process. This is a big deal.
  • I think that the low inventory, strong demand and flexible land supply will lead to a significant rebound in real estate investment this year. This is something many people do not anticipate now.
  • Second, corporate profit and private investment: Private sector has run down its investment for years and much overcapacity has largely been worked off. With corporate profit rising strongly, private capex should strengthen.
  • Finally, Chinese exports are bouncing back quickly. Strong global demand is clearly helping the Chinese manufacturing businesses that are exporting their products at a double-digit rate.
  • As for Europe and Japan, these economies are still in a “sweet spot” where policy is ultra easy, inflation is low, and growth is recovering from a depressed base. This means that that growth in these areas can sustain at their current rates without provoking serious inflation threat. Policy is still focusing on protecting growth.

Inflation Scare?

  • With the world economy being strong, there is a natural concern that inflation could soon become a problem.
  • Chart on page 12 Inflation scare is possible, and we mean a few months of creeping inflation could scare off investors. Should a mini boom develop, nominal pressures will build, leading to some increase in inflation. It is not clear how central banks will react.
  • But historically, central banks are always fighting the last war. ECB is clearly fighting collapses and deflation at a time when deflation risk has subsided.
  • However, I doubt that inflation will become a major threat. It shows that total private credit creation remains weak, and usually inflation does not develop a sustain uptrend if credit creation is tame.
  • Chart on page 13 also shows that inflation rates in most parts of the world are still below central bank targets. That would also encourage central banks to err on the side of being too easy for too long.

Investment Strategy

Against this background of strong growth and low rates and modest inflation, it is reasonable to believe the financial markets will be dominated by risk-on trades.

Our main calls can be summed up as the following: Long equities versus bonds, long international stocks versus the SPX, long commodities and stay short the USD.

  • We believe that the US stock market will underperform the global counterparts. It has proven that an lukewarm economy is great for stocks, but the odd is that the US economy will be running much hotter than it is now. This means that both profit growth and interest rates will head higher, with latter probably being faster than what is discounted now. The higher rates will not kill the bull market, but will curtail the speed of price advance in SPX. As a result, an underperforming SPX is likely, but price volatility will rise sharply.
  • We are much more bullish on international stocks, EM equities in particular. We are also bullish on values versus growth, bullish small caps versus large caps in anticipation of leadership changes.
  • Chart on page 14 (EM relative performance) tells me that the relative cycles between EM and SPX go by decades. Now, the secular bearish phase for EM is over.
  • Chart on page 15 Valuation for EM is better, especially considering the possibility of a large drop in interest rates in LatAm. EM profit growth has surged, and P/E is significantly lower than SPY.
  • European stocks have a lot room to expand their multiples. Dividend yields are high, at over 3% and the spread over SPX is over 100 basis point. I think that that the rates will head higher in Europe but at equilibrium discount factor is much lower than that of the US. As a result, on valuation basis, EFEA stocks look attractive.

  • Central bank policy from US to Europe to Japan has been geared towards fighting deflation and for a long time G7 government bonds priced in high probability of widespread deflation. However, with global mini-boom developing, the risk or danger of deflation has subsided. As a result, bond yields will likely back up globally to reflect a more normal economic condition.
  • Chart on page 16 is our bond model for 10-year US Treasury bonds. It looks that bond yields will likely touch 3% before the market could settle down, so my projection is that 10-year Treasury yields will rise towards that levels soon. At that point, it would probably trigger some negative reaction from the stock market and this would create a reason for the bond market to rally.
  • German bunds are much more vulnerable. We wrote a piece titled “Sell Bunds” and it argued that the ECB would have to end QE earlier than expected. Now, it is beginning to do so. The bunds market is in max. danger. We made good money on this. More price weakness to come.

Currencies and Commodities

On the currency front, I like EM currencies, especially resource-based currencies.

I think that the US dollar topped out more than a year ago and it is already in a bear market, but conditions for a counter-trend rally are in place.
Chart on page 17 The Yen is a flat story because Abnomics aims at reflating nominal GDP so Japan cannot afford a stronger yen.

I like MXN BRL and Chilean peso. A virtuous circle is developing where a steady to strong currencies led to falling rates….pretty similar to the 2000s.

I also watch to buy EUR on major pullback. I think CAD will reach 1.10 this year so any pullback in CAD is worth buying. I am bullish on AUD too.

There are lots of dollar bulls because tax cuts and tighter money seems bullish for currency. I take a different view. Tax cuts and tighter money are known story for a long time and these are well digested by the market.

If you look at the recent history, the dollar tends to weaken at the time when the Fed lifts rates. The key point here is that growth outside the US is accelerating but rates are still suppressed by the authorities. As a result, the currency markets will have to strengthen more other they would otherwise do to compensate for excessively low interest rates that are still available outside the US.

Chart 18-19 suggest that commodity prices are in a new bull market, especially against the SPX. This asset class goes for 10-year cycle and the current position appears to be very bullish. Good global growth, a weakened dollar and much-reduced production capacity argue for a sustained bull market in CRB, crude market in particular.

Finally, a few risks for 2018:
  • Trade war: Trump will likely turn to trade after the tax cuts and regulatory reforms. I am concerned that a tit-for-tat trade war and retaliation could be quite disruptive. The biggest weapon the US has is its trade surplus with China, and the biggest weapon China has is its dollar asset holdings.
  • Beijing has hinted that it may not want to hold the treasury bonds. In case of a trade war, China may seek a RMB devaluation to fend off higher US tariffs. In the meantime, Beijing may offload its US papers, prompting a selloff in bonds. In the end, it is difficult to know what the dollar would do but bond yields could be a lot higher, thus hurting the economy
  • Panic reaction of the Fed to an inflation scare. The Fed is willing to err on the side of being too easy, but in case of a mini economic boom and core PCE inflation creeping up, the hawks at the Fed may push for quicker rate hikes. This in turn may curtail stock market performance.
I thank Chen for sharing his notes and slides with my readers. Once again, you can contact them here, get a trial access to their research and watch a replay of the webcast or just email them at

Also, please remember you cannot redistribute these charts without permission from Alpine Macro.

Needless to say, January isn't over yet and I provided you with my Outlook 2018 featuring insights from Cornerstone Macro's Francois Trahan on why we need to focus on stability, another comment earlier this week discussing the great market melt-up of 2018 featuring some insights from David Rosenberg and Martin Roberge (the latter is in line with Chen's views) and now this comment going over Chen Zhao's outlook.

After reading these three comments you might be confused but that's what makes a market. I can give you strong arguments for and against why global synchronized growth will or won't continue this year and this will turn out to be the most important question to ponder when determining your asset allocation.

The key thing to remember is if you believe global growth will continue to surprise to the upside, you should overweight cyclical sectors like energy (XLE), metals and mining (XME), financials (XLF), and industrials (XLI) and underweight less cyclical sectors like healthcare (XLV), consumer staples (XLP) and utilities (XLU). You should also overweight commodity currencies like the Canadian dollar (FXC) as well as emerging market stocks (EEM) and bonds (EMB).

If you believe things are going to cool off this year, you need to position your portfolio more defensively and even buy US long bonds (TLT) as they sell off (like now).

Hope you enjoyed this market comment and my other comments. Please share this blog with your contacts and kindly remember to support it via a donation or subscription on the top right-hand side under my picture. I thank all of you who take the time to donate to support my efforts in bringing you great insights on markets and pensions.

As far as clips, Chen Zhao, chief strategist at Alpine Macro, was on BNN Friday explaining why investors should be long international stocks and why oil could climb to US$100/bbl. I cannot embed but you can watch Part 1 this interview here and Part 2 here.

Below, the “Fast Money Halftime Report” traders discuss the volatile week for stocks with Tom Lee, Fundstrat, and Mike Wilson of Morgan Stanley who says stocks will handily beat bonds this year.

Lee also said that he and the firm's technical strategist think stocks will likely run higher for annother 11 years:
"Both [Fundstrat technical strategist Rob Sluymer and I] think it's more like 2029 is the peak of this equity market cycle and then, the S&P is 6,000 to 15,000," said Lee, head of research at Fundstrat Global Advisors, on CNBC's "Halftime Report" on Friday.

"So I think it's just important to be long-term oriented right now."
Take that Jeremy Siegel! To be fair, Lee is talking about the long run but I still think he's way too bullish.

Lastly, David Riley, head of credit strategy at BlueBay Asset Management, discusses monetary policy and the US bond market. Like I've said before, prepare for a bumpier ride ahead.

Thursday, January 18, 2018

Canada's Hyper-Leveraged Economy?

Natalie Wong of Bloomberg reports, Canada’s Debt Binge Has Macquarie Sounding Alarm on Rate Hikes:
The unprecedented rise in consumer debt means the Bank of Canada’s rate-hiking cycle is already the most severe in 20 years and further increases will have far graver consequences than conventional analysis shows, Macquarie Capital Markets Canada Ltd. said.

Assuming just one further rate rise, the impact would be 65 percent to 80 percent as severe as the 1987 to 1990 cycle, according to Macquarie, which took into account five-year bond yields, household debt and home buying. Canada’s housing market slumped in the early 1990s after that rate-hike cycle and a recession.

“The Canadian economy has experienced an unprecedented period of hyper-leveraging,” analysts including David Doyle wrote in the note released Thursday. According to Macquarie, this is underlined by the fact that:
  • About 30 percent of nominal GDP growth has come from residential investment and auto sales over the past three years. This is about 50 percent greater than what has been experienced in similar prior periods.
  • The wealth effect from rising home prices has driven nearly 40 percent of nominal growth in gross domestic product over the past three years, about two to four times the amount experienced previously when the BoC was hiking rates.
  • Even as this has occurred, fixed business investment and exports have struggled, limiting the ability for a virtuous domestic growth cycle to unfold. This again is in sharp contrast to similar periods in the past when these were accelerating.
New mortgage stress-test rules will also have a larger impact than estimated, Macquarie said. The new rules in isolation are expected to reduce buyers’ maximum purchasing power by as much as 17 percent. That jumps to about 23 percent after incorporating the rise in mortgage rates since mid-2017, according to the note.

Governor Stephen Poloz has indicated high household debt could make the slowing impact of rate hikes harsher, and that the impact of 2017’s increases will not be fully clear for 18 months, Doyle said.

“When taken together, these observations mean the Bank of Canada is proceeding with hikes despite uncertainty surrounding the severity of tightening performed so far,” Macquarie writes. “This elevates the risk of policy error.”

Macquarie expects only one more rate hike in either April or July.
On Wednesday, the Bank of Canada increased its target for the overnight rate by 25 basis points (0.25%) to 1 1/4 per cent. The Bank issued this press release (added emphasis is mine):
The Bank of Canada today increased its target for the overnight rate to 1 1/4 per cent. The Bank Rate is correspondingly 1 1/2 per cent and the deposit rate is 1 per cent. Recent data have been strong, inflation is close to target, and the economy is operating roughly at capacity. However, uncertainty surrounding the future of the North American Free Trade Agreement (NAFTA) is clouding the economic outlook.

The global economy continues to strengthen, with growth expected to average 3 1/2 per cent over the projection horizon. Growth in advanced economies is projected to be stronger than in the Bank’s October Monetary Policy Report (MPR). In particular, there are signs of increasing momentum in the US economy, which will be boosted further by recent tax changes. Global commodity prices are higher, although the benefits to Canada are being diluted by wider spreads between benchmark world and Canadian oil prices.

In Canada, real GDP growth is expected to slow to 2.2 per cent in 2018 and 1.6 per cent in 2019, following an estimated 3.0 per cent in 2017. Growth is expected to remain above potential through the first quarter of 2018 and then slow to a rate close to potential for the rest of the projection horizon.

Consumption and residential investment have been stronger than anticipated, reflecting strong employment growth. Business investment has been increasing at a solid pace, and investment intentions remain positive. Exports have been weaker than expected although, apart from cross-border shifts in automotive production, there have been positive signs in most other categories.

Looking forward, consumption and residential investment are expected to contribute less to growth, given higher interest rates and new mortgage guidelines, while business investment and exports are expected to contribute more. The Bank’s outlook takes into account a small benefit to Canada’s economy from stronger US demand arising from recent tax changes. However, as uncertainty about the future of NAFTA is weighing increasingly on the outlook, the Bank has incorporated into its projection additional negative judgement on business investment and trade.

The Bank continues to monitor the extent to which strong demand is boosting potential, creating room for more non-inflationary expansion. In this respect, capital investment, firm creation, labour force participation, and hours worked are all showing promising signs. Recent data show that labour market slack is being absorbed more quickly than anticipated. Wages have picked up but are rising by less than would be typical in the absence of labour market slack.

In this context, inflation is close to 2 per cent and core measures of inflation have edged up, consistent with diminishing slack in the economy. The Bank expects CPI inflation to fluctuate in the months ahead as various temporary factors (including gasoline and electricity prices) unwind. Looking through these temporary factors, inflation is expected to remain close to 2 per cent over the projection horizon.

While the economic outlook is expected to warrant higher interest rates over time, some continued monetary policy accommodation will likely be needed to keep the economy operating close to potential and inflation on target. Governing Council will remain cautious in considering future policy adjustments, guided by incoming data in assessing the economy’s sensitivity to interest rates, the evolution of economic capacity, and the dynamics of both wage growth and inflation.
Clearly the Bank of Canada is proceeding with caution given the ongoing NAFTA discussions. Bank of Canada Governor Stephen Poloz stated it would be wrong to assume NAFTA's death would only be a small shock to economy:
The sixth round of NAFTA negotiations between Canada, the U.S. and Mexico get underway next week in Montreal. President Donald Trump has repeatedly threatened to withdraw.

Poloz said it’s very difficult to quantify NAFTA’s impact because it varies not only by sector, but also from firm to firm. “So we’ve chosen not to get buried in all of that,” he said. The immediate impact — already being felt — is a chill on business investment in Canada, as it’s either deferred or simply made in the U.S. instead. “That’s the sort of effect that could be bigger, in a binary sense, if an announcement is made that NAFTA is no longer to be. But again, even then, it would take time.”

The U.S. could also layer on additional trade actions that would worsen the blow, he said, citing ongoing actions in the aerospace and lumber sectors. “The analyses that you’re looking at do not consider the channel that I’m trying to emphasize the most,” he said, adding the shock of a NAFTA collapse is difficult to analyze. He contrasted it to the 2014 collapse in oil prices, whose effects were easier to predict.

“You will need the benefit of time and data to understand this as it all unfolds, and so markets should not think of it as a binary event, and I’m hopeful that they’ll appreciate the conversation we just had,” Poloz said.
There is a lot at stake if NAFTA dies for all countries involved but there is a lot of scaremongering going on too.

Importantly, the death of NAFTA, if it happens, doesn't mean the death of trade between Canada, the US and Mexico. It just means new tariffs and new rules and new bilateral trade talks for Canada and Mexico (with the US).

I say this because people are running around saying the Canadian dollar will plunge 20% if NAFTA dies and I would urge all hedge funds and large institutions to load up on the loonie and Canadian stocks and bonds if such an overreaction occurs (look at the British pound now relative to where it was right after Brexit vote).

Speaking of the loonie, according to forexlive, there was some fishy business in Canadian dollar trading moments before the Bank of Canada announcement:
The Bank of Canada decision hit the newswires at exactly 10 am ET but there was a big jump in USD/CAD beforehand.

It wasn't just a liquidity issue either, there was two way trade higher for at least 20 seconds before the announcement.

Now maybe that was some kind of engineered squeeze, because even if the hike leaked, you wouldn't be pounding the 'buy' button in USD/CAD. However, given all the news in the statement, buying was definitely the right short-term trade.

The Bank of Canada and StatsCan have had issues with data security in the past. I think it's time for another investigation.

For those of you who don't know how it works, reporters covering the decision are in lockup three hours prior to the release of the statement. I'm assuming they turn in their cell phones at the door but are allowed to visit the restroom if they need to.

It wouldn't be such a stretch of the imagination to assume someone leaked the news and what really irks me is it has happened before in Canada and the US. If authorities really wanted to properly investigate this, they can easily trace where the buy USD/CAD orders came from and get to the bottom of this "unusual trading activity" moments before the announcement (what a disgrace).

But currency markets still being the Wild West of trading, don't hold your breath on any investigation taking place.

Anyway, Canada's large banks wasted no time to raise prime lending rate to 3.45% in wake of Bank of Canada hike which means the rate on variable-rate mortgages and some lines of credit is going up.

[Note: Canada's big banks will find any excuse to raise the prime lending rate. If the Bank of Canada didn't raise, they would use the recent rise in US long bond yields as an excuse to raise the prime lending rate. Heads or tails, they win!!]

The Canadian dollar sunk after the Bank of Canada rate hike and got hit more today after President Trump stoked worries on NAFTA outlook.

The important thing to remember is when the Canadian dollar gets hit, import prices go up, inflation pressures build. Conversely, when it appreciates, import prices decline, inflation pressures abate. This is especially true for a small open economy like Canada.

In financial terms, the financial conditions tighten when the Canadian dollar appreciates and loosen when it depreciates. What is important is to look at the trend over the last 18 months and take the average exchange rate over that time to see the effects on the real economy.

But it's also important to note if the Canadian dollar appreciates a lot going forward, it takes pressure off the Bank of Canada to raise rates. Still, typically currencies move ahead of a rate decision and once it is announced, they sell off if expectations were priced in for an increase.

This is why even though the Fed has signaled it's raising rates, and the market is pricing it in, the US dollar has weakened as the markets expect slower growth prospects in the US relative to the eurozone and Japan. Once their central banks start raising, the euro and yen will decline relative to the USD.

Looking at the weekly chart of the Canadian dollar ETF (FXC),  you see seasonal yearend weakness was followed by an appreciation as oil prices moved up (click on image):

The loonie is at an interesting technical level and if global growth comes in stronger than expected, oil prices continue to rise, and NAFTA talks don't fall by the wayside, we might see an important breakout in Q1 and Q2.

This remains to be seen. On Friday, I will be discussing whether a mini global economic boom is underway and it's an important comment you don't want to miss.

Anyway, back to Canada's hyper-leveraged economy. I have been short Canada for the longest time and been dead wrong. Like many others, I've been worried about Canada's real estate mania and the country's growing debt risks.

I have been scratching my head trying to understand how grossly indebted Canadians are still able to get by and wondered whether the subprime mortgage crisis was going to come back to haunt us all.

It turns out I was wrong to be so pessimistic on Canada. A recent special report by the National Bank's Economics and Strategy team, Is Canada’s household leverage too high — or on the low side?, dispels many myths surrounding Canada's true debt profile relative to other OECD countries.

You can download the report here and I guarantee you it will be an eye-opener. The National Bank's chief economist and strategist, Stéfane Marion, and senior economist, Matthieu Arseneau, put together a series of charts that explain why things aren't as bad as naysayers claim.

Below, a small sample of charts that caught my attention (click on images):

That last one really caught me off-guard. Again, take the time to download the entire special report which is available here. It's excellent and since I worked with Stéfane Marion in the past, I know he's a great economist who is careful with his analysis (there is no hyperbole here).

Still, I remain highly skeptical on Canada's debt profile and growth prospects going forward, and if we don't get more solid global growth over the coming year, it won't bode well for the Canadian economy and overindebted Canadians.

For example, one astute investor shared this with me:
Regarding the National Bank piece, you might be interested in this slide deck that was referenced by Josh Steiner of Hedgeye during a recent Macro Voices podcast interview of him. The interview was interesting (see below).

The National Bank piece begs a question: is debt to disposable income the only or most important ratio to consider in relation to the overall issue at hand?

Josh gestures at the above question when he points out in the podcast that over the last 15 years Canada has moved from being a resource economy to a FIRE economy, where real estate related activity has become a major driver of GDP.

If he is right about this, then perhaps debt to disposable income is a misleading ratio: debt increases as property prices increase and income increases due to high real estate activity, creating a virtuous cycle on the way up, and vicious one on the way down. If we are a FIRE economy, then perhaps saying everything is cool based on debt to disposable income is comparable to telling the employee with his life-savings invested in his employer’s stock that everything is cool based on the price of the stock alone.
To underscore the point that Canada has become a FIRE economy, he referred me to this Financial Post article which talks about Macquarie's research and states this:
 About 30 per cent of nominal GDP growth has come from residential investment and auto sales over the past three years. This is about 50 per cent greater than what has been experienced in similar prior periods. The wealth effect from rising home prices has driven nearly 40 per cent of nominal growth in gross domestic product over the past three years, about two to four times the amount experienced previously when the BoC was hiking rates. Even as this has occurred, fixed business investment and exports have struggled, limiting the ability for a virtuous domestic growth cycle to unfold. This again is in sharp contrast to similar periods in the past when these were accelerating.
Also, take the time to read Garth Turner's latest comment, What it means, where he states the following:
Only in Canada would a quarter-point rate increase grip the nation. It’s weird. The folks in Venezuela (inflation 2,350% this year) would laugh at us. Such first-world problems we have.

However, there’s a good reason this week’s news matters. Consider those lines of credit secured by real estate that people have binged on. We owe an historic $211 billion in HELOCS. Astonishingly (says the federal government) four in ten people are paying nothing on them. Nada. Ziltch. Another quarter pay just the interest. So, two-thirds of borrowers haven’t been reducing their debt load by a penny – even during a time when the cost of money’s been incredibly low. What a losing strategy. Everyone should have known rates would rise. Now they are.

Home equity lines float along with the prime. A quarter point increase means families will have to fund $1.6 billion more in bank charges in 2018, or try to absorb that amount of additional debt. That’s what a lousy quarter point means. When surveys show us almost half the households in Canada have less than $200 after paying the monthlies, how can this not matter?
Garth isn't making this stuff up, there are far too many Canadians who have been highly irresponsible with their home equity line of credit and if rates start rising, it will come back to haunt them.

But as I keep telling people (including Garth), stop only looking at rising rates, they are only part of the puzzle. You need to also look at employment because in a debt deflation economy, if there is a shock to the global economy and unemployment in Canada starts rising fast, it will be game over for the housing market and the economy for a very long time. At that point, record high debt levels will really hurt consumers and the economy.

I hope I'm wrong on the global economy but that is going to be a discussion for my subsequent comment on Friday. Stay tuned.

Below, take the time to listen to the press conference from Bank of Canada Governor Stephen S. Poloz and Senior Deputy Governor Carolyn A. Wilkins. I don't envy Steve and Carolyn's job, this is far from being an easy environment to conduct proper monetary policy.

Also, thake the time to listen to Erik Townsend and Josh Steiner discuss the global housing bubble on MacroVoices. Steiner thinks Canada's "Minsky Moment' has arrived and if he's right, it spells big trouble ahead for the Canadian economy an over-indebted Canadians. Steiner is even more bearish on Australia's housing market. See the accompanying slides here.

Wednesday, January 17, 2018

CPPIB Investing in UK's Housing Shortage?

IPE reports, Lendlease and CPPIB team up to invest £1.5bn in UK BTR sector:
Lendlease and Canada Pension Plan Investment Board (CPPIB) have partnered to invest an initial £1.5bn (€1.7bn) in the UK build-to-rent (BTR) sector.

The partnership will begin with an investment of £450m in the next phase of new homes at Lendlease’s £2.3bn Elephant Park development in Elephant & Castle, London.

CPPIB will invest around £350m for 80% stake and Lendlease will invest the balance.

This partnership is in addition to the £800m that Lendlease has already committed to housing and infrastructure in the development and will accelerate the delivery of private rental and affordable homes.

Construction has already commenced, and the first homes in this phase are expected to be completed in 2020.

Following this initial investment, the partnership will also pursue opportunities within Lendlease’s wider residential urban regeneration activities in London and across the UK under a 50:50 joint venture.

It aims to help address the UK’s housing shortage, over time, providing thousands of homes in London and across the UK via the development, and long-term ownership, of BTR product.

Lendlease will develop, construct and manage the BTR homes on behalf of the partnership.

Dan Labbad, the CEO of Lendlease’s international operations, said: “In recent decades, structural shifts in the housing market have meant that demand has outstripped supply in the private rented sector, leading to a shortfall of homes in London and across the UK.

“Today’s announcement is a logical next step for us as a business and delivers on our strategy to grow our urban regeneration pipeline and accelerate the delivery of much-needed homes, by working with institutional capital partners to launch this new asset class for Lendlease’s investment platform.”

Andrea Orlandi, the managing director and head of real estate investments Europe at CPPIB, said: “This investment is a great opportunity for CPPIB to further diversify our European real estate portfolio, while at the same time addressing a need in the UK.

“Through this partnership, we are able to access a sector we believe is poised for long-term growth, and we are pleased to be able to do so with Lendlease, one of our existing top global partners.”

CPPIB is already a long-term global partner of Lendlease.
You can read CPPIB's press release on this deal here. Lendlease has a good description of Elephant Park on its website:
Lendlease is working in partnership with Southwark Council to deliver a GBP£2 billion regeneration programme on 28 acres of land in the centre of Elephant & Castle. Situated in London's Zone 1, our vision is to create Central London's new green heart.

Inspired by the strength of its past, we will re-establish Elephant & Castle as the most exciting new neighbourhood in London not only through what we're building, but also how we're doing it. Our approach to urban regeneration in Elephant & Castle is already setting new standards in sustainability, that will not only will make the Elephant a great place to live, but will play a vital role in tackling issues such as air pollution and carbon emissions, creating a positive impact beyond just the Elephant.

The regeneration comprises three sites:
  • Elephant Park Masterplan Almost 2,500 new homes on the site of the former Heygate Estate. Received outline planning permission in 2013 and will be completed in phases between now and 2025. The first two phases South Gardens and West Grove are in construction. 25% affordable housing.
  • Trafalgar Place 235 new homes, including 25% affordable housing and a local café. Completed May 2015.
  • One The Elephant 284 homes in a 37 storey tower and four storey pavilion building, adjacent to the councils new Leisure Centre. Completes June 2016.
Lendlease views the Elephant & Castle regeneration as a unique opportunity to work with a local authority to create positive change. We will harness the scale of the project to tackle head-on some of the most challenging issues that affect global cities like London.

The Elephant Effect is what will happen when we apply all our imagination, empathy and dedication, and get this right. To do this, we take a long term view to consider how our project will be used to enable sustainable outcomes, such as enhancing biodiversity in parks and buildings, improving public transport and cycle networks, and maximising the resource efficiency of homes. The approach to development and construction will also contribute to sustainable results, such as: utilising cross laminated timber building frames, providing interim site uses to during the construction phase, and working with our supply chain to trial new technologies.

The Elephant & Castle regeneration is one of 18 projects from across the world chosen to be part of the Climate Positive Development Programme. We have set a roadmap that will deliver a climate positive development by 2025, and through the programme, global projects will learn from our outcomes and best practice.

Elephant & Castle is also one of ten low carbon zones identified by the Mayor of London tasked with local production of cleaner better value energy to fuel local households and businesses. As such, we are developing plans for a combined heat and energy centre to power our sites and the surrounding area.
As you can read, not only is this project going to transform this London neighborhood into one of the most exciting ones, it is also respecting climate control principles, all part of CPPIB's environmental and socially responsible investing.

This is a mammoth project and one which will deliver excellent long-term cash flows and capital appreciation to CPPIB and its partner, Landlease. This is the value in finding a solid long-term partner in real estate that adds value to major projects like this.

It also seems this deal is coming at a good time as the British pound has strengthened considerably since Brexit:

Remember, CPPIB doesn't hedge currency risk so any strength in foreign assets due to capital appreciation and gain in foreign currencies works to the Fund's advantage over the long run even if there are short-term swings in currencies which can impact gains on any given year.

And in another major real estate deal announced last week, Cortland Partners, CPPIB and GIC Form Strategic Joint Venture in U.S. Multifamily Real Estate:
Cortland Partners, Canada Pension Plan Investment Board (CPPIB) and GIC announced today that they have formed a joint venture with a targeted equity amount of US$550 million to acquire and renovate 8,000 to 10,000 Class B multifamily units in the U.S. CPPIB and GIC will each own a 45% interest in the joint venture and Cortland Partners will own the remaining 10% interest.

Class B properties are generally well-maintained older assets with opportunities for improvements to the buildings for the benefit of tenants, ongoing maintenance and long-term appreciation. The joint venture has initially acquired three value-add, Class B garden-style communities located in high-growth markets of major U.S. metropolitan areas:
  • Lakecrest at Gateway Park, a 440-unit rental complex located in Denver, Colorado;
  • Aurum Falls River, a 284-unit rental complex in Raleigh, North Carolina; and
  • Waterstone Apartments, a 308-unit rental complex in Austin, Texas.
“Partnering with these first-class organizations solidifies our business model and proves that a Class B multifamily investment strategy reflects smart money,” says Mike Altman, Chief Investment Officer, Cortland Partners. “We look forward to expanding our relationship with CPPIB and GIC through this joint venture.”

The joint venture will pursue additional opportunities to acquire multifamily properties that are candidates for value-add strategies, primarily in major markets throughout the Southern and Southeastern U.S.

“The U.S. multifamily real estate sector continues to offer compelling risk-adjusted returns for the CPP Fund, driven by favourable population growth and employment trends,” said Hilary Spann, Managing Director, Head of Americas, Real Estate Investments, CPPIB. “By focusing on Class B asset opportunities, this joint venture enables us to add diversification to our U.S. multifamily portfolio, which is concentrated in prime urban locations. We are pleased to form this new joint venture with Cortland Partners, a vertically integrated operator and one of the largest multifamily owner-operators in the U.S., and GIC, a longstanding partner we know well.”

Lee Kok Sun, Chief Investment Officer, GIC Real Estate, said “This venture will pursue a value-add strategy to capture the strong demand and resilient return profile of the U.S. multifamily sector. We look forward to growing this venture with Cortland, an experienced multifamily firm with a sizeable presence in the Sun Belt target markets, and CPPIB, a partner who shares our long-term investment philosophy.”

About Cortland Partners

Cortland Partners is a global, multifamily real estate investment firm that leverages proprietary design and build supply chains with in-house construction, property, and facilities management services to unlock value in high-growth U.S. markets. Headquartered in Atlanta, GA, Cortland owns and manages over 45,000 apartment communities across the U.S. with regional offices in Charlotte, Dallas, Denver, Houston, and Orlando. Cortland also houses a global materials sourcing office in Shanghai, China and an international development office in London, U.K. Cortland Partners is a National Multifamily Housing Council (NMHC) Top 50 Owner and Manager and is ranked among Atlanta’s “Top 25 Largest Workplaces” (2017). For more information, visit


Canada Pension Plan Investment Board (CPPIB) is a professional investment management organization that invests the funds not needed by the Canada Pension Plan (CPP) to pay current benefits on behalf of 20 million contributors and beneficiaries. In order to build a diversified portfolio of CPP assets, CPPIB invests in public equities, private equities, real estate, infrastructure and fixed income instruments. Headquartered in Toronto, with offices in Hong Kong, London, Luxembourg, Mumbai, New York City, São Paulo and Sydney, CPPIB is governed and managed independently of the Canada Pension Plan and at arm's length from governments. At September 30, 2017, the CPP Fund totalled C$328.2 billion. For more information about CPPIB, please visit or follow us on LinkedIn, Facebook or Twitter.

About GIC

GIC is a leading global investment firm with well over US$100 billion in assets under management. Established in 1981 to secure the financial future of Singapore, the firm manages Singapore’s foreign reserves. A disciplined long-term value investor, GIC is uniquely positioned for investments across a wide range of asset classes, including real estate, private equity, equities and fixed income. GIC has investments in over 40 countries and has been investing in emerging markets for more than two decades. Headquartered in Singapore, GIC employs over 1,400 people across 10 offices in key financial cities worldwide. For more information about GIC, please visit
You will recall last March I discussed why CPPIB and Singapore's GIC were betting big on US college housing, so I'm not surprised to see these two huge funds partner on this particular deal.

Lastly, in another huge deal announced this week, CPPIB and Goldman Sachs Asset Management LP led an investment round of more than $950 million for Enfoca, a Peruvian private-equity firm.

There is more detail on this deal from this press release:
Enfoca, a leading private equity fund manager based in Lima, Peru, today announced the completion of a General Partner-led secondary transaction in which a new investment fund managed by Enfoca purchased exposure to the portfolio companies of three Enfoca-managed funds by providing a liquidity option to the existing Limited Partners (LPs). The new fund also obtained commitments for new capital to develop the portfolio.

Canada Pension Plan Investment Board (CPPIB), which made a capital commitment of US$380 million, and Goldman Sachs Asset Management LP’s Vintage Funds (GSAM) led the transaction. The three largest Peruvian pension funds, Integra, Prima and Profuturo, which have invested with Enfoca since 2007, are also committing new capital to the fund after taking advantage of this opportunity to obtain partial liquidity for their existing investments with Enfoca. In aggregate, the transaction represents a total capital commitment of over US$950 million and sets a new benchmark for General Partner-led liquidity alternatives in the LatAm private equity market.

Through a competitive bidding process, the transaction provided Enfoca’s existing LPs with a liquidity option with attractive returns on their original investments. The transaction gives the new LPs the opportunity to invest in a unique high-growth portfolio of Peruvian mid-market companies and also provides Enfoca with access to capital for new investments and continued growth of the portfolio, as well as an extended duration to realize the portfolio’s potential. Enfoca will serve as the General Partner of the new fund and will manage the portfolio post-closing.

“We are pleased to deliver liquidity for our existing LPs with attractive returns in a landmark transaction for the LatAm private equity market, while introducing CPPIB, a sophisticated global institutional investor, and GSAM, a successful global private equity investor, to our fund. The significant unrealized value in the portfolio provides our new investors with unique access to sectors in the Peruvian market and the Andean region that have experienced rapid growth,” said Jesús Zamora, Co-Founder and Chief Executive Officer of Enfoca.

“This sizable transaction supported by our new investors represents an important milestone for Enfoca and provides our portfolio with greater flexibility and access to capital,” said Jorge Basadre, Co-Founder of Enfoca. “We thank those LPs who are exiting our fund for their support over the years and look forward to working closely with our new and continuing investors as we grow our businesses in the future.”

“CPPIB is delighted to partner with Enfoca and GSAM in this direct secondary transaction, which allows us to benefit from their deep market expertise and track record in Peru,” said Michael Woolhouse, Managing Director, Head of Secondaries & Co-Investments, CPPIB. “Through this transaction, CPPIB will gain further access to this growing market and increase its overall investment in Latin America, one of our strategic focus regions.”

Steve Lessar, co-head of Goldman Sachs Asset Management’s Vintage Funds, said, “We are pleased to be partnering with Enfoca and CPPIB to invest in a portfolio of market-leading, consumer-oriented companies with meaningful growth prospects driven by a strong Peruvian economy. We have been impressed with Enfoca’s investment strategy and look forward to investing additional capital to support the growth of these portfolio companies.”

Park Hill Group LLC served as financial advisor and Davis Polk & Wardwell LLP and Payet, Rey, Cauvi, Pérez Abogados served as legal advisors to Enfoca.

About Enfoca

Enfoca, founded in 2000, is a private equity fund manager based in Lima, Peru. Enfoca manages funds with more than US$1 billion in assets, investing in Peru and other Andean region markets. Enfoca targets companies that operate in sectors that Enfoca believes are positioned to benefit from growth in the economy and consumer spending, such as healthcare, media, education, housing and consumer goods. For more information about Enfoca, please visit:


Canada Pension Plan Investment Board (CPPIB) is a professional investment management organization that invests the funds not needed by the Canada Pension Plan (CPP) to pay current benefits on behalf of 20 million contributors and beneficiaries. In order to build a diversified portfolio of CPP assets, CPPIB invests in public equities, private equities, real estate, infrastructure and fixed income instruments. Headquartered in Toronto, with offices in Hong Kong, London, Luxembourg, Mumbai, New York City, São Paulo and Sydney, CPPIB is governed and managed independently of the Canada Pension Plan and at arm's length from governments. At September 30, 2017, the CPP Fund totaled C$328.2 billion. For more information about CPPIB, please visit or follow us on LinkedIn, Facebook or Twitter.

About Goldman Sachs Asset Management LP’s Vintage Funds

The Vintage Funds invest in the secondary market for private equity, providing liquidity, capital and partnering solutions to private market investors and managers globally. With over $26 billion in committed capital, the Vintage Funds have been innovators in the secondary market for over 20 years. The Vintage Funds are managed by the Alternative Investments & Manager Selection (“AIMS”) Group within Goldman Sachs Asset Management. The AIMS Group provides investors with investment and advisory solutions across hedge fund, private equity, real estate, public equity, fixed income and environmental, social, governance and impact-focused investment strategies. For more information, visit:
Below, an interview with Chris Baines (environmentalist) and Carlo Lorenzi (London Wildlife Trust) on the benefits of having inner city nature on your doorstep.

I also embedded an interview with Lendlease Project Director for Elephant & Castle Pascal Mittermiaer on their world leading plans for sustainable 'healthy homes' and green spaces at Elephant Park, utilising innovative materials such as cross-laminated timber.

Third, Sustain's Sarah Williams talks about the growing popularity of inner city grow gardens and the benefits of growing your own food, no matter where you live.

Lastly, welcome to West Grove, the next chapter of Elephant Park, Central London’s greenest new place to live. West Grove is set around two landscaped courtyards in two distinct neighbourhoods, Highwood Gardens and Orchard Gardens. West Grove is ideally located to enjoy the independent shops on Elephant Park’s new central shopping street, as well as the brand new park at the heart of the development. The estimated completion date for West Grove is Spring/Summer 2018.

It looks like paradise in London. You can watch more clips on Elephant Park here. This is another great long-term investment for CPPIB, one that will benefit all Canadians.