An Investor’s Dilemma: Being Mindful in 2015 January 5, 2015 · Mindful in 2015 January 5, 2015 “Few of us ever live in the present. We are forever anticipating what is to come

C I O P E R S P E C T I V E S

Weiss Multi-Strategy Advisers LLC. 1

An Investor’s Dilemma: Being Mindful in 2015

January 5, 2015

“Few of us ever live in the present. We are forever anticipating what is to come or remembering

what has gone.” ― Louis L'Amour

On a recent episode of 60 Minutes, there was a segment by Anderson Cooper on the power

of mindfulness and its growing popularity in a world of technological distraction. It addressed the

increasing number of scientific studies showing both the physiological and psychological benefits

of mindfulness. One of the important points made in the 60 minutes segment was the distinction

between meditation and mindfulness. Meditation helps you to be mindful. It allows you to

understand the difference between your brain and your mind. Simply put, meditation is exercising

your brain. Mindfulness, however, is awareness; simply being present and paying attention to your

senses…the here and now. Meditation and mindfulness have both been a part of my daily life for

the last four years and the benefits are clear to me. In my experience, when meditation and

mindfulness are combined, successful results are easier to achieve. Certain common phrases

athletes hear or say every day are based on the same principles of mindfulness, such as “taking it

one swing at a time”, or “only worried about the game in front of us” or “the game is slowing

down for him.” It’s awareness of the game at hand.

Distraction, however, is the bane of awareness and technology is a major cause of

distraction. Not only can technology be a cause of personal distraction, but it can also be

disruptive. In 1997, Professor Clayton Christensen wrote a great book titled The Innovator's

Dilemma. In the book he described the differences between "sustaining technologies" and

"disruptive technologies." He described sustaining technologies as innovations that help

companies make marginal improvements in their business. Disruptive technologies, on the other

hand, are unexpected breakthrough innovations that force companies to rethink their

existence. For example, ten years after Christensen’s book was published, Apple introduced the

iPhone. Although by that point Apple had already disrupted many industries with earlier

technology, the iPhone was a breakthrough innovation that accelerated the pace of

disruption. The disruption caused by the iPhone is now so widespread, and happened so fast, that

it is difficult to appreciate. Consider that the App store was created in July 2008, only six and a


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half years ago. In June of this year, Apple announced users had downloaded 75 billion apps to

date. And that was a 47% increase from the prior year. Think about how many apps you use

today and then think about how the word “app” did not exist just 7 years ago. The disruption

which started with iTunes in music and publishing spread across all industries and to all parts of

our life. Perhaps the easiest way to fully understand disruption and its importance is think about

how you feel when you misplace your smart phone, or when it runs out of juice. Then marvel at

our dependency on something that did not even exist until 2007.

In 2013, I wrote two articles titled Adapt or Die – An Investment World Driven by QE,

Tweets, Clouds, Robots, Singularity, and Luddites and Adapt or Die Part 2 – The Signal or the

Noise. The articles focused on the positive side of exponential innovation and how it related to

efficiency, productivity, rapid problem solving and transparency. There is no doubt exponential

innovation benefits us all, but at the same time we all need to remember that the benefits of

technology referenced by Clayton Christensen come with disruptive consequences for the

unprepared. The same holds true for the iPhone. It’s tremendous for real time information,

sharing things quickly and connecting us globally. But this technological innovation, and the

resulting life changing disruption, can lead to distraction. As the 60 Minutes segment set forth, in

the same way that mindfulness and being more present can help balance out the distractions

caused by technology, I think the time has come for investors to increase their awareness, or their

mindfulness, to navigate market disruptions. One of the dangers of investing is being prone to

recency bias; extrapolating recent trends into the future indefinitely. This is where mindfulness

becomes important. To get out of a slump in baseball, you need to take it one swing at a

time. The same holds true for investing. Take a deep breath as we prepare for the year ahead,

but be aware of what’s happening here and now. The benefits of low interest rates, inflation and

increasing multiples have helped the S&P 500 to its sixth positive total return year in a

row. However, as we exit 2014, I believe the signs of disruption have reached levels where the

probabilities are rising that 2015 may be a year titled the “Investor's Dilemma”.

“Economic forecasting is like driving a car blindfolded with directions from a passenger who is

looking out the back window” – Anonymous

Business cycles are very important to both running a business and investing. The problem

is that the forecasting of business cycles is backward looking. As a young derivatives trader at

Morgan Stanley, my first trading book was Mexico. I began running that book in October of

1994. Two months later, the peso broke its peg and the “tequila crisis” ensued. Over the course of

the next five years, I traded various emerging market books and tried to navigate the EM chaos as

it moved around the globe. I ultimately landed in Sao Paulo, Brazil and left following the

devaluation of the real in January 1999. That five year experience taught me two important

lessons. First, don’t listen to economists’ forecasts and second, the door of liquidity closes very

quickly in emerging markets as they head into a recession. Those lessons inspired me to go on to

create probabilistic models which would hopefully highlight risks of a recession in the future. I


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based these models on the same principles established by the founding father of leading

indicators, Geoffrey Moore. Moore’s work was based on economic indicators that he believed led

cycles. In emerging markets, cycles are shorter and sharper, which is why the door of liquidity

closes so quickly. This led to the decision to use asset prices as real time inputs for my

models. Right now, despite rosy forecasts in the U.S., based on what we can see out the back

window, my model (Exhibit 1, below) is telling me that the risk of recession has reached a point

similar to that of early 2007. Granted, like any probabilistic model, it is just a probability. But

based on where sentiment and positioning are in the markets as we leave 2014, ignoring the

probability seems like a bad risk to reward.

Exhibit 1

GDP Oscillator Risk of Recession (Proprietary)

Source: Bloomberg, Weiss Calculations

The model in Exhibit 1 is built around the rate of change rather than extrapolating the most

recent data. Constructing it in this fashion helped me not only in 2007 but also in 2009, around

the same time people began using the phrase "green shoots." A green shoot (or brown weed) is

just another way of looking at the second derivative. For this model I use stock prices,

commodity prices, jobless claims, household net worth and corporate profits. Although the model

has been indicating all year that growth is weakening, it’s the actual market signs themselves

confirming the model’s message that makes it more compelling. Small cap stocks have

underperformed large cap stocks. Utilities, Health Care and Consumer Staples have been three of

the top four sectors this year. From a factor basis, we saw a sharp fall in secular growth and

momentum in March and April. Global bond yields have fallen sharply. Market inflation


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expectations seen through TIPS have fallen as well. Commodities have been weak all year. The

MSCI World ex US Equity Index is down for the year and, starting in June, we began to see the

high yield market spreads bottom out and begin a march higher all the way into

December. Recently, EM sovereign debt has seen pressure as well.

“China is in the midst of a digital revolution.” – McKinsey’ & Company’s China’s Digital

Transformation: The Internet’s Impact on Productivity and Growth

Back in 2007, when the model was also flashing warnings signs, the market signals that

suggested the weakness to come were being driven by the US housing market. This year, the

underlying weakness was driven by emerging market growth and commodities. There are many

reasons for the weakness in these two areas but I believe one of the reasons is disruption from

technology. As Professor Christensen said, disruptive technologies are unexpected breakthrough

innovations. In 2007, the year the iPhone debuted, two market beliefs were driving much of the

cap ex around the world. The first was centered around Chinese infrastructure growth and the

second around peak oil. The thought at the time was that these were secular trends that would

drive investments for the foreseeable future. Long term decisions were made by both companies

and countries to benefit from these two trends. Since that time, there has been a dramatic,

abrupt shift leaving many overinvested for long term trends that changed quickly.

Exhibit 2, below, shows what’s happened to China's real estate fixed asset investment

growth rate since the peak in 2010. There are many reasons for this downshift but one of the

major reasons is the digitization of China which I highlighted in Adapt or Die Part 2 – The Signal or

the Noise – China. In their first five year plan announcement, China’s new government said the

focus was on innovation, consumption, healthcare, education, the environment and energy. This

was a change that was not expected to take place so quickly, which is why it’s had such a

disruptive impact. China’s move away from industrialization towards digitization has hurt the

growth rate for commodity demand. Exhibit 3, below, shows the same China FAI Real Estate

growth rate overlaid with iron ore and Brent crude prices. Oil prices were slow to respond but

eventually did catch up.


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Exhibit 2

China YoY Fixed Asset Investment Real Estate

Source: Bloomberg

Exhibit 3

China Real Estate Growth, Brent Crude & Iron Ore

Source: Bloomberg

"Horizontal Drilling is the real marvel of engineering and scientific innovation" - David Blackmon,

Forbes Magazine

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Nov-04 Nov-06 Nov-08 Nov-10 Nov-12 Nov-14

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Mar-09 Sep-09 Mar-10 Sep-10 Mar-11 Sep-11 Mar-12 Sep-12 Mar-13 Sep-13 Mar-14 Sep-14

OREXI12M Index (Left Axis)

Brent Crude (Left Axis)

CNFAESTY Index (Righ Axis)


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At the same time, global commodity demand was also hit by innovations in energy

efficiency in smart homes, hybrid and electric cars and other fuel efficient forms of transportation.

Technology has also impacted the supply side. Hydraulic fracturing and horizontal drilling

have set off a shale revolution in the US which can be seen in US oil production (Exhibit 4,

below). It is highly likely in the coming years this advancement in technology will lead to similar

benefits in other countries. Most people want to believe this is a transitory fall in oil prices, but as I

have written before, I believe exponential innovation will continue to help keep companies’ input

cost side of the equation, including commodities, wages and interest rate expense, at lower levels

due to the advancements in data analytics and robotics. In the long run, I believe it keeps profit

margins high for those that benefit. For those who don't, they will suffer from the innovator's

dilemma of disruptive technologies.

Exhibit 4

EIA US Oil Production

Source: Bloomberg

The unexpected sharp fall in oil has caused widespread disruption in the second half of the

year as suffered by Russia, the Middle East, Africa, high yield debt, emerging sovereign debt,

Petrobras, MLPs and energy trusts. This is on top of the damage that was already done to coal

and iron ore related companies and countries. Sure, there are benefits to lower oil prices in the

long run. But whatever benefits come with lower gas at the pump, or oil input costs to companies,

they will be spread out over the future. The market related losses due to assets drops, however,

are real time. These are the losses that can lead to the contagion within other asset classes with

less direct association with commodities. Investor memories tend to be short, but we should all

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Sep-01 Mar-03 Sep-04 Mar-06 Sep-07 Mar-09 Sep-10 Mar-12 Sep-13


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recall this excerpt from a 2007 New York Times article written by Ben Stein of Ferris Bueller fame

(“Anyone…? Anyone…?”):

"The total mortgage market in the United States is roughly $10.4 trillion. Of that, a little over 13

percent, or about $1.35 trillion, is subprime — certainly a large sum. Of this, nearly 14 percent is

delinquent, meaning late in payment or in foreclosure. Of this amount, about 5 percent is actually

in foreclosure, or about $67 billion. Of this amount, according to my friends in real estate, at least

about half will be recovered in foreclosure. So now we are down to losses of about $33 billion to

$34 billion." - Ben Stein, The New York Times, August 2007

We all now know that the losses ended up in the trillions and, more importantly, affected

more than just the housing industry in the end. But Ben Stein is an economist. Trying to simplify

economic forecasting into numbers is not possible. It’s trying to forecast how people will react to

something and we all know that is very difficult. This is one reason why the study of behavioral

economics continues to gain in popularity. If the contagion continues, and it moves rates higher

for companies, we will see investor confidence start to fall just as the Fed ends QE and begins to

start a rate tightening cycle. Again, we are in the business of probabilities and I am concerned

that a similar complacency to that of Ben Stein’s in 2007 exists out there when thinking about the

disruptive move of oil.

"THE STALL-SPEED SYNDROME" - Stephen Roach, former chairman of Morgan Stanley Asia and

Chief Economist

My model is flashing warnings signs; the market has been showing signs all year of slowing

growth. And now the fall in oil prices is showing signs of contagion. One would think that these

together would be sufficient cause to worry. But I am surprised at investor sentiment that the

economy is healthy and strong. All year, global growth has been downgraded by the IMF, World

Bank and OECD. Indeed, the U.S. had two good quarterly reports recently, but even with those,

the latest YoY GDP number is 2.7%. And it’s true we have been, and are still, creating jobs but it is

not translating into consumption. Exhibit 5, below, shows YoY nonfarm payroll growth rate

overlaid with nominal YoY consumption going back 30 years. People may be getting hired but

they are not spending like they used to and whether it’s because of increased savings due to debt

and demographics, or the millennials who are used to getting things for free and thus are a

different breed of consumer, or because of a lack of wage growth, the fact is that consumption is

the driver of this economy. Nominal consumption remains at levels which have historically

suggested vulnerability to a recession. This is a point which former chairman of Morgan Stanley

Asia and Chief Economist Stephen Roach made in a recent article titled The Stall-Speed

Syndrome.

"such sluggish performance is the economic equivalent of ‘stall speed’ - the heightened

vulnerability that aircrafts can encounter at low velocity"


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Exhibit 6, below, shows the historical federal funds rate with the recession model. There

are two points that stand out. First, the model has been leading the Fed. Second, and more

importantly, the model is currently increasing a probability of a recession at the same time we are

beginning a tightening cycle from the zero bound. If in fact we are economically at ‘stall speed’,

the fall could be more volatile than in the past.

Exhibit 5

Nonfarm Payrolls & Consumption

Source: Bloomberg

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Jun-84 Dec-86 Jun-89 Dec-91 Jun-94 Dec-96 Jun-99 Dec-01 Jun-04 Dec-06 Jun-09 Dec-11 Jun-14

PCE YOY$ Index

NFP NYOY Index


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Exhibit 6



“Be Fearful When Others Are Greedy and Greedy When Others Are Fearful” - Warren Buffet

All of this could make 2015 an interesting investment year. Regardless of whether a

recession looms or not, we exit 2014 with increased volatility. In my last article, I referenced the

likelihood of increased volatility on the back of the end of QE, unsynchronized monetary policy

around the world and the possible strength of the dollar. I expect this to continue into next year,

which will likely bring an end to low return dispersion. Exhibit 7, below, shows the recession

model with equity market dispersion. If history is illustrative, an increase in dispersion has the

potential to make for a good relative year for active managers, which typically outperform passive

managers when dispersion increases. And they should theoretically continue to do well in a risk

adjusted manner as valuations normalize. Given the constant barrage of news about the move to

passive from active investing and CALPERS’ decision to terminate its hedge fund portfolio, maybe

these are signs of capitulation and greed setting in, where risk adjusted returns are no longer

deemed useful.

Another place where investors could be surprised is with their asset allocation. There have

been many surprising asset moves since the crisis in 2008 but not many would have predicted the

rate move given how equities have performed. On March 6, 2009 the SPX bottomed at 666 and

began its current rally to all-time highs. During that same time period we have created eight

million jobs. Who would have guessed that given these two facts, US 10 year yields would fall 60


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bps during that time? You would have done well regardless of whether you had money in bonds

or in stocks. One of the strategies that gained in popularity because of this is risk parity. Risk

parity strategies saw massive inflows during that time. By risk weighting assets, and seeing both

bonds and equities perform well from March 2009 to April 2013, the strategy has not penalized

investors for being fixed income heavy. However, with rates at low levels, we have seen the

strategy show signs of difficulty. Exhibit 8, below, shows an aggregate index chart of various risk

parity mutual funds available to investors. Today, when many investors talk about risk parity, they

express concern over the potential of a sharp move higher in nominal rates. In a world of

exponential innovation, I believe the greater risk is what we’ve seen since the ‘taper tantrum’; a

world where nominal yields stay low due to lower growth and inflation but with increased volatility

around this level (Exhibit 9, below) and higher real yields. In that case, the overall return would be

low, with sharp monthly spikes in volatility hurting Sharpe ratios. That’s reflected in the aggregate

balanced risk charts and statistics since May 2013.

Exhibit 7




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Exhibit 8

Risk Parity Performance


Exhibit 9

USG 10 Year Yield Sigma Events


One more thing investors should be thinking about in 2015 is how low rates have forced

people out on the risk curve and the possible implications. A recent report by Bank of America

highlighted the fact that about 45% of all government global debt is now yielding less than 1%. QE

has forced investors out on the risk curve as they try to find bond like returns in a world of low

interest rates. Many decisions have been made by investors in this low rate world based solely on


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income or yield, regardless of underlying risk of asset. With the recent moves in MLPs, high yield

and emerging market sovereign debt, there is growing recognition that finding bond like, risk

adjusted returns is no easy task. In addition, many of these products have seen a drop in

secondary market liquidity due to increased regulatory scrutiny. Given the lack of yield available

in the world today, if there is a recession next year, I believe that a low correlation, diversified

market neutral multi strategy component would be an attractive addition to a balanced risk

portfolio in a zero bound rate world. We’re actively exploring this very concept and I expect we’ll

be publishing additional papers on this topic shortly.

Seldom do you read outlooks mentioning the possibility of a recession. That’s because they

don’t often occur. If you look at Exhibit 1 again, you see there were only three in the last 30

years. Given these odds, I recognize a recession is not a high probability outcome for

2015. However, our job is to look at risk to reward, not just reward. Going into this year, in my

opinion, the risk side of the equation is much higher than investors think.

If there is a recession next year, one negative outcome which may surprise investors is oil

continuing to fall until the price gets close a 10:1 ratio to natural gas, a ratio last seen in June

2007. Such a fall in oil would likely continue to put pressure on the same areas that showed

weakness in the second half of last year. When crude breaks 50 dollars, thoughts of a fed

tightening may reverse and the dollar will likely begin to weaken. US 10 year yields would then

likely follow the path of bunds and break the 2012 lows. The big regional winner would likely be

Asia, with China and Japan both potentially benefitting from monetary easing and oil prices

falling. At the same time, the US would likely deal with the lagging effects of an oil fallout, rising

real rates and stronger dollar. Gold would likely rally as the ECB, BOJ, PBOC and FED might all be

forced to ease at the same time. In my experience, to get to a recession, there is usually a market

event which acts as an accelerant. And the accelerant may be Russia. We have, for the most part,

watched but largely ignored Russia this year. A continued fall in oil may just lead to a dramatic

decision by Russia and that could be just that accelerant.


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Regardless of whether or not you agree with this outlook for 2015, I think we can all agree

it’s a possibility. After six years of rapid innovation breakthroughs, market multiple expansion and

equity gains, if 2015 does prove to be an investor's dilemma, it may be a good time for investors to

begin their own practice of mindfulness. Be aware, be present and be wary of recency bias. I will

leave you with a quote from a book I have read and recommended over the years, and which I

have frequently reread. For those who have not read it yet, I will recommend it again.

“The secret is that everything is always on the line. The more present we are at practice, the more

present we will be in competition, in the boardroom, at the exam, the operating table, the big

stage. If we have any hope of attaining excellence, let alone of showing what we’ve got under

pressure, we have to be prepared by a lifestyle of reinforcement. Presence must be like

breathing.” ― Josh Waitzkin, The Art of Learning: A Journey in the Pursuit of Excellence

All the best in 2015!

AUTHOR Jordi Visser

[email protected]

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New York, NY 10022

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INQUIRIES Gillian Tullman

Director of Investor Relations [email protected]

+1 212 390-3451

WEBSITE http://gweiss.com


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The forgoing information is confidential and contains forward-looking statements, which present the Chief Investment Officer’s expectations and beliefs regarding future financial performance, and assumptions or judgments concerning such performance. Any such statements involve estimates, assumptions, judgments and uncertainties, and you should not rely on such statements to reach conclusions or make any investment decisions. You will not necessarily be informed if the Chief Investment Officer’s expectations or beliefs change after the date hereof. Weiss Multi-Strategy Advisers LLC (“Weiss”) has no control over information at any site hyperlinked to in this communication. Weiss makes no representation concerning and is not responsible for the quality, content, nature, or reliability of any hyperlinked site and is providing this hyperlink to you only as a convenience. The inclusion of any hyperlink does not imply any endorsement, investigation, verification or monitoring by Weiss of any information in any hyperlinked site. In no event shall Weiss be responsible for your use of a hyperlinked site. This is not intended to be an offer or solicitation of any security. Any such offer or solicitation may only be made by means of a confidential private offering memorandum. USE OF CONVENTIONAL RISK PARITY COMPOSITE PERFORMANCE (PROPRIETARY): The composite performance presented were derived using equally-weighted notional positions in the following publicly traded risk parity mutual funds: AQR Risk Parity Fund-I (AQRIX), Columbia Adaptive Risk Allocation-A (CRAAX), INV Balanced Risk Allocation-B (ABRBX), AMG FQ Global Risk Balance-I (MMAFX), Putnam Dymanic Risk Allocation-B (PDRBX), Salient Risk Parity Fund-A (SRPAX) and AQR Risk Parity II HV-I (QRHIX). The foregoing risk parity mutual funds do not reflect the same fees or expenses than those of other risk parity proxies or those of any Weiss funds, and other proxies and the Weiss funds may and will invest in different securities than those reflected in the above mutual funds. Sector, industry, security and country exposures, volatility and risk characteristics will also differ. Proxy data is provided for reference purposes only, and is not meant to imply that the Weiss portfolio will achieve performance similar to or better than that of the proxies.

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An Investor’s Dilemma: Being Mindful in 2015 January 5, 2015 · Mindful in 2015 January 5, 2015 “Few of us ever live in the present. We are forever anticipating what is to come